Retired Money
By Jonathan Chevreau on January 24, 2024
Estimated reading time: 8 minutes
By Jonathan Chevreau on January 24, 2024
Estimated reading time: 8 minutes
GICs were embraced by many Canadian investors last year, whether conservative or not. With rates expected to fall again in 2024, how should retirees and near-retirees incorporate them?
For years, the humble GIC—guaranteed investment certificate—was disparaged by the fixed-Income cognoscenti and more often than not financial advisors. But, things started to change when interest rates started rising a few years ago in Canada and the U.S. As of January, DIY investors in Canada should be able to find 1-year GICs paying about 5%, falling to a tad over 4%, if you go out four or five years.
While fixed-income investors were brutalized in 2022 with unexpected losses even in supposedly safe bond funds, Canadian investors who put some of their fixed-income into GICs were likely spared the carnage.
That includes my family, who for the last few years had parked some cash into laddered 2-year GICs. Today, we are gradually laddering into 5-year GICs while crossing our fingers that our modest bond exchange traded fund (ETF) positions return at least to a break-even level.
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To be sure, some financial advisors are still skeptical about GICs—even now with rates at near-generational highs. It’s true that GICs can be a bit illiquid if you lock up your funds for 5 years, although you can get around that by laddering and having some mature two or three times a year. Another option is cashable GICs, which pay a bit less in return for the added flexibility.
A recent MoneySense survey on “Bad Money advice” touched in part on GICs. Almost 900 readers were polled about what financial trends they had “bought into” at some point. The list included AI (artificial intelligence), crypto, meme stocks, side hustles, tech and Magnificent 7 stocks and GICs. Perhaps it speaks well of MoneySense readers that the single most-cited response was the 49% who said “none of the above.” The next most cited was the 16% who cited a “heavier allocation to GICs.”
I did find a couple of other findings to be worthy of note for retirees and would-be retirees who read my Retired Money column. Not surprisingly, tech stocks (FANG, MAMAA. etc. were the runner-up to GICs, receiving 13.24% of the responses. Not far behind were the 10.55% who plumped for crypto and NFTs (non-fungible tokens). AI was cited by 3.7%—less than I might have predicted—and meme stocks were only 2.8%.
As I said in executive editor Lisa Hannam’s insightful article which highlighted 50 of the worst pieces of financial advice, GICs are at the opposite end of the spectrum from such dubious investments as meme stocks and crypto. I’d put tech stocks and AI in the middle.
Certainly, when I scan our family’s investment portfolios, laddered GICs are our single most-owned asset class, although individual stocks and dividend stocks and ETFs are close.
Now that investors have to worry about the reignited Middle East powder keg in addition to the Ukraine war and China’s Taiwan sabre-rattling, I don’t think retirees need to apologize for sheltering between 40% and 60% of their portfolios in safe guaranteed vehicles.
Retirees don’t need to take more risk than is necessary, so our January 2024 tax-free savings account (TFSA) contributions were entirely in 5-year GICs. Of course, we already have plenty of equity exposure in taxable portfolios.
On the other hand, younger Canadian investors need more growth in order to fight off inflation. That’s why Allan Small, a Toronto-based advisor who occasionally writes MoneySense’s popular weekly “Making sense of the markets” column, is among GIC skeptics. His problem is GICs “don’t grow wealth. They can act as a parking lot for money for some people but over time there have been very few years in which people have made money with GICs, factoring in inflation and taxation.”
Citing lack of liquidity for GICs, Small prefers the “flexibility of a fully liquid money market or high-interest savings account.” Alternatively, he suggests short-term bonds, where Canadian investors can make about 5% without having to tie up money for a year or more. GICs may pay a slightly higher rate but you “cannot sell when you want. Flexibility and liquidity is more important to me,” he says.
What about bond ETFs? “I would rather own bonds themselves individually, if yields are the same or better, as bond ETFs are obviously more affected by interest rate movements,” Small says. With owning a bond, “you know that at maturity you get your money back. For the low-risk part of a diverse portfolio, this is a better option.”
Small agrees inflation has been full of surprises throughout its three-year climb in the U.S. However, “one thing that apparently hasn’t changed is its overall path when compared with what it did between 1966 and 1982.”
My own advisor wrote a bulletin for clients based on a question from a reader wondering about buying bond ETFs. He cautioned against it, citing a recent Marketwatch story on inflation. It warned current inflationary trends are eerily similar to the path taken between 1966 and 1982.
And investment coach Aman Raina of Sage Investors says that for the first time in about 15 years, near-retirees can generate meaningful yield and near-equity long-term returns at a lower risk profile while also protecting their purchasing power from inflation.
“We’ve been living a forced TINA lifestyle for yield but now we’re going back to long-term behaviors. This is a good thing,” says Raina. “It’s a golden time for savers.”
In other words, during the near-zero interest rates that prevailed until recently, investors wanting real inflation-adjusted returns had almost no choice but to embrace stocks. (Read more about TINA and other investing acronyms).
GICs have a place in locking in some real-returns, especially if inflation tracks down further. But Raina says investing in bonds offer opportunities to lock in healthy coupon returns, with the prospect of higher capital appreciation opportunities if interest rates fall further, since bonds currently trade at a discount. The risk is the unknown: when interest rates will start falling. Based on what the Bank of Canada (BoC) announced in the fall, Raina feels that could be some time in 2024. (On Dec. 6, the BoC announced it was holding its target for the overnight rate at 5%, with the bank rate at 5.25% and deposit rate at 5%.)
CFA Anita Bruinsma, of Clarity Personal Finance, is more enthusiastic about GICs for retirees in Canada. “I love GICs right now,” she says. “It’s a great time to use GICs.” For clients who need a portion of their money within the next three years, she says, “GICs are the best place for that money as long as they know they won’t need the money before maturity.”
Other advisors may argue bond funds could have good returns in the coming years, if rates decline. However, “I would never make a bet either way,” Bruinsma says, “I think retirees looking for a balanced portfolio should still use bond ETFs and not entirely replace the bond component with GICs. However, I do think that allocating a portion of the bond slice to GICs would be a good idea, especially for more nervous/conservative people.” For Bruinsma’s clients with a medium-term time horizon, she recommends laddering GICs so they can be reinvested every year at whatever rates then prevail.
An alternative is the HISA ETFs. (HISA is the high-interest savings accounts Small referred to above). HISA ETFs are paying a slightly lower yield than GICs and also do not guarantee the yield. “I also like this product but GICs win for the ability to lock in the rate,” says Bruinsma.
Another consideration is that GICs are relatively illiquid if you lock in your money for three, four or five years or any other term. “If you are uncertain if you will need those funds in the near future, you can look at a high interest savings account ETF like Horizon’s CASH,” says Matthew Ardrey, wealth advisor with Toronto-based TriDelta Financial. “This ETF is currently yielding 5.40% gross—less a 0.11% MER.”
Apart from inflation, taxation is another reason for not being too overweight in GICs, especially in taxable portfolios. Even though GIC yields are now roughly similar to “bond-equivalent” dividend stocks (typically found in Canadian bank stocks, utilities and telcos), the latter are taxed less than interest income in non-registered accounts because of the dividend tax credit. In Ontario, dividend income is taxed at 39.34% versus 53.53% for interest income at the top rate in Ontario, according to Ardrey. This is why, personally, I still prefer locating GICs in TFSAs and registered retirement plans (RRSPs).
Ardrey says GICs can be a valuable diversifier when it’s difficult to find strong returns in both the stock and bond markets. “This is especially true for income investors who would often have more of a focus on dividend stocks.” Using iShares ETFs as market proxies, Ardrey cites the return of XDV as -0.54% YTD and XBB is 1.52% year to date (YTD). “Beside those numbers a 5%-plus return looks very attractive.”
Indeed, as of early January, ratehub.ca shows one-year GICs in Canada paying as much as 5.40% but less as you go out to 5-years: typically 4.25%. (Ratehub and MoneySense are both owned by Ratehub Inc.)
“Why a lower rate if you must be illiquid for longer?” Ardrey asks, then answers with this: “This is because most analysts feel that rates will have the potential to decline in the second half of 2024 if the economy slows substantially.”
However, Ardrey cautions those who are just now fleeing equity markets for GICs. If you have lost money in stocks and sell those stocks to move to GICs you are creating a permanent loss, as the GIC does not have the potential for recovery like a stock does.
“This becomes more noticeable when we take a single stock like BCE, which is -15.04%. I think most investors would agree that BCE will recover if given time.” Many dividend stocks have been beaten down, thereby boosting yields.” BCE is currently yielding 7.11%.
Unless you’re a retiree with a generous employer-sponsored Defined Benefit pension plan (increasingly rare these days), I believe GICs should make up a good chunk of one’s fixed-income assets. So if your asset allocation is roughly 50/50 stocks to fixed income, I’d be comfortable putting at least half of the fixed-income portion in GICs.
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