Q. My wife and I are retired, in our late 60s. With interest rates expected to continue rising for the next year or two, and bond funds making almost no gains or even losing value in recent years, I have been considering converting the fixed income portion of our portfolio to GICs. Would this be a good strategy? — Frank
A. GICs get little respect, and that’s a shame because these humble investments can play a useful role in a balanced portfolio. Frank, your strategy for substituting GICs for bond funds is an excellent one, albeit with a few caveats.
First, we’ll consider the benefits. GICs offer significantly higher yields than government bonds of the same maturity. At the time of writing, five-year Government of Canada bonds were yielding about 1.9%, while you didn’t have to look far to find five-year GICs paying as much as 3.6%.
Normally more yield means more risk, but because most GICs are backed for up to $100,000 by the Canadian Deposit Insurance Corporation (CDIC), a Crown corporation, they don’t carry any more risk than a federal bond. (See the CDIC website for complete information on the limits of coverage.) Other GICs are backed by provincial insurance programs, which makes them at least as safe as bonds issued by those provinces. Corporate bonds may promise high yields but they have no such protection: if the issuer defaults, you can suffer significant losses.
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A second benefit makes GICs more attractive if you expect interest rates to rise. Bonds lose value when yields go up, making it possible to suffer losses in a bond fund, even over periods of a year or two. That won’t happen with a GIC: their face value remains unchanged whether interest rates rise or fall, and many investors find that stability comforting. We all understand that stocks can plummet in value, but no one likes to see even modestly negative returns in fixed income.
But before you switch all of your bond funds to GICs, Frank, you should be aware of their limitations. The most important is illiquidity: you cannot sell a GIC before it matures. (Cashable GICs are available from some issuers, but they always pay lower yields.) So if you need to sell some of your fixed income for an unexpected expense, or if you want to rebalance your portfolio after a downturn in stocks, you won’t be able to do that if you hold only GICs.
The second knock against GICs is just the flipside of one of their advantages: while they don’t lose value when rates rise, neither do they get a boost when yields fall. That means during a bear market for stocks—which often leads to falling interest rates—your GICs won’t offer the diversification you should expect from bonds.
So, Frank, you might consider a balanced approach and using both in your portfolio. For example, you could build a five-year GIC ladder with about half to two-thirds of your fixed income allocation and use a low-cost bond ETF for the rest. That should help you achieve higher yields and added stability while also giving you some liquidity and an extra layer of diversification.
Dan Bortolotti, CFP, CIM, is an associate portfolio manager and financial planner with PWL Capital in Toronto.
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