Your portfolio’s life raft got torpedoed this year.
Bonds are supposed to float your boat when financial markets get ugly. But while stocks fell in the first eight months of 2022, bonds plunged. The benchmark FTSE Canada Universe Bond Index was down 12 per cent for the year through Sept. 8, a shocking result.
Portfolios should be divided into two principal parts, stocks and fixed income. Consider the events of 2022 as an argument for considering guaranteed investment certificates to augment or substitute for bonds as fixed income.
GICs are in high demand right now by conservative investors and savers looking for a worry-free place to put their money. Traditional investors, meaning those who hold mainly stocks, tend to dismiss GICs because they have in recent years offered safety at a cost of terrible returns. Today, you can get safety and GIC rates of 4 to 5 per cent.
Most digital brokers offer online GIC investing. Find the “trading” tab in your app or broker website and then look for GICs under fixed income. Expect to find a half dozen or more offerings for all terms from a wide variety of issuers that includes big banks, alternative banks and credit unions. You can choose from GICs that pay interest monthly or annually, or that let interest compound. The minimum investment is generally $5,000.
The highest-yielding GICs available from one of the big online brokers this week were as follows (all issuers are members of Canada Deposit Insurance Corp.):
- One year: 4.26 per cent from Fairstone Bank of Canada
- Two year: 4.45 per cent from PC Bank.
- Three year: 4.54 per cent from HomeEquity Bank
- Four year: 4.55 per cent from HomeEquity Bank
- Five year: 4.61 per cent from Canadian Tire Bank
A smart way to invest in individual bonds or GICs is to use a ladder, which means equal investments in terms of one through five years and the reinvestment of maturing GICs in a new five-year term. With the GICs listed just above, you’d get an average yield of 4.48 per cent in the first year. If you were to put money in an exchange-traded fund tracking the FTSE Canada Universe Bond Index today, you could expect an after-fee yield of 3.93 per cent.
Bond ETFs and mutual funds are the easiest way to invest directly in a diversified group of bonds issued by governments and/or corporations. But the past year has highlighted the down side of these products. When interest rates rise, the price of bonds and the funds that hold them falls.
Long-term investors need not worry. When interest rates fall, as they most certainly will when inflation is tamed, the price of bonds and bond funds will rise. Falling rates will give you a nice total return from bond funds based on price gains plus interest.
There’s no open market to trade GICs like there is for stocks and bonds, so a GIC in your investment account is basically inert for the period you own it. There’s no price volatility to distract and disturb you, but there’s also a negative side in that you can’t trade GICs in your investment account prior to maturity. Some GIC issuers allow you to redeem early with a significant penalty, but don’t count on that.
All in, though, GICs are the essence of fixed income. Your investment holds its value, and you know exactly how much interest income you’ll receive.
Thanks to deposit insurance, GICs score very well on safety. If an issuer isn’t a member of CDIC, expect it to be a credit union that participates in a provincial deposit insurance plan. In some provinces, credit unions offer much higher levels of protection than the $100,000 in combined principal and interest that CDIC covers on eligible accounts.
The highest GIC yields are found either by dealing with alternative banks directly or using a deposit broker, which is an investment firm that specializes in managing GIC accounts for clients. A quick survey of digital brokers late this week found that 4.61 per cent was the best rate on offer for five years. Six financial companies that deal directly with clients offered 5 per cent for five years, and one offered 5.1 per cent.
Is it worth giving up some yield as a DIY investor for the convenience and efficiency of holding your GICs in the same account as your stocks and bonds? Many would agree the answer is yes.
GICs can work as a bond replacement for investors with set-it-and-forget-it portfolios, but a mix of GICs and bonds is more broadly appealing. Holding bonds or bond funds gives you the opportunity to benefit from price gains when interest rates fall.
Also, bond funds allow you to easily rebalance a portfolio by buying or selling part of your holdings. With individual bonds, you can make a decision to accept more default risk to get higher yields.
Tax-wise, GICs are like bonds in that the interest they pay is taxed as regular income in a non-registered account. Think about holding both in your tax-free savings account or registered retirement savings plan. A wrinkle with GICs is that you must annually report interest income in your tax return, even if you have a compounding GIC that doesn’t pay out until maturity. Your broker should send you a T5 slip with information about this accrued interest.
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