As interest rates continue their steady, if sometimes uneven, rise, so do the rates paid to guaranteed investment certificates (GICs.) That makes it time to consider the ladder.
The ladder is a relatively simple investment strategy, used most commonly in the bond market. An investor with, say, $50,000, will purchase five different bonds worth $10,000 each, with their maturity dates staggered, or laddered, over different years, rather than a single bond locked into one particular interest rate.
It’s a way to avoid being stuck with a rate that may pay less when the investment matures, if interest rates have risen. Laddering can work for GICs as well as bonds, though when interest rates drop and remain low, as they did after the 2008 recession, the strategy is less desirable.
“GIC ladders fell out of favour after the Bank of Canada cut rates. The bank cut its key lending rate from 4.75 per cent in November 2007 to 0.5 per cent in April 2009,” says Paul Shelestowsky, senior wealth advisor at Meridian Credit Union in Niagara-on-the-Lake, Ont.
In that falling-rate environment, “there was very little incentive to purchase GICs, whether laddered or individual,” because they paid out relatively little compared with other investments, such as equities or bonds, he says.
The interest rate situation now is quite different. The big question for investors is: How certain is it that rates will keep going up?
On June 27, Bank of Canada Governor Stephen Poloz suggested strongly that the bank will raise rates at its next scheduled opportunity, July 11.
“We’ve said clearly that, given where the economy is, we’re in a situation where the economy will warrant higher interest rates,” he said, following a speech in Victoria.
“We’ll ensure that that is a gradual process because there are certain issues that we must monitor along the way, and we’ve laid those out.”
The Bank of Canada has already raised rates three times since last July. Its benchmark rate now stands at 1.25 per cent.
Mr. Poloz said that in considering a gradual hike in rates, the bank is looking at objective economic data rather than day-to-day headlines, which can be alarming as the Trump administration attacks Canada and other allies over trade.
At the same time, uncertainty over Canada’s political and trade relationships, particularly with the United States, clouds the picture, making it more difficult to plot a methodical GIC laddering strategy.
It’s prudent to take any moves — for a rate hike or no rate hike — with a grain of salt, says Robert Mark, investment strategist with Raymond James Ltd. in Toronto.
“We’re getting mixed messages from the Bank of Canada. I agree — I like the fact that the bank is taking a cautious stance,” he says.
“With all this short-term craziness, on NAFTA, tariffs, trade, we’re advising clients to put their short-term money into 90-day certificates.” The interest rates on these are low — 1.65 per cent — “but we’ll re-evaluate when we see what rates are three months from now,” he explains.
Anyone intent on building a ladder in the current economic environment should choose GICs over corporate bonds, and should look toward building a ladder that extends five years or less, not longer, Mr. Mark adds. GICs are preferable because they pay better than corporate bonds right now, he says.
The downside to laddering in any interest rate environment is decreased liquidity, says Neville Joanes, chief investment officer at WealthBar, a British Columbia-based roboadvisor.
“If you are invested in a GIC, you are subject to its terms, which may prevent access to the initial capital until maturity,” Mr. Joanes says.
“Although GIC ladders are good for a niche group of investors, our strategy is to focus on short-duration, high- yielding, low-risk investment. To achieve this, we use a combination of high-interest savings accounts, mortgages, corporate bonds and government bonds. This preserves their capital and helps with cash flow,” he says.
Markus Muhs, investment advisor and portfolio manager with Genuity Canaccord in Edmonton, says that laddering strategies are more worthwhile when it’s clear that interest rates are rising steadily.
Since it’s hard to tell if this is the case, he advises using a GIC (or bond) laddering strategy for only part of a portfolio, where the investor might need the cash in the future.
“When you’re within a few years of retirement, for example, and you want to ensure that – rain or shine — the cash will be there for your first few years. Such a strategy works well when only applied to a portion of the portfolio; that portion you intend to withdraw over five or so years,” Mr. Muhs says.
“When five or so years of cash flow are more or less guaranteed, it gives the investor greater comfort in properly investing the remainder of the portfolio for the long term.”