My latest MoneySense Retired Money column looks at the vexing problem retirees and near-retirees face when their GICs have matured in recent months. Click on the highlighted text for the full column: Recovering from GIC sticker shock.
If before you were getting 2 to 3% on 2, 3, 4 or 5-year GICs, you may be shocked to discover you’ll be lucky to get 1% and only then by declining to take the first suggested GIC your brokerage has on offer. Going out 5 years may only gain you 0.5% or so, depending on provider.
Nor will matters improve any time soon. The Federal Reserve, Bank of Canada and other central banks have suggested interest rates will stay “lower for longer.” The Fed in particular has indicated rates are unlikely to rise for at least three years.
The piece passes on the views of financial advisors Adrian Mastracci and Matthew Ardrey on what to do about it. It amounts to grinning and bearing it and settling for lower guaranteed returns, or biting the bullet and taking a bit more risk with equities or alternative investments.
But what if you insist on what our family has done historically: leaving half your fixed-income allocation in GICs? Personally, I aim for roughly a 50/50 asset allocation and for the fixed-income portion historically have split it between laddered GICs and bond ETFs, or asset allocation ETFs with a healthy dose of bonds.
Odds are if you use the major discount brokerages of the big banks, you may need to leave them to find more generous GICs available from independent places like Oaken Financial, which has a 1-year registered GIC paying 1.4% and a 5-year GIC currently paying 2% through Home Trust and Home Equity Bank.
Personally, I have reinvested some GIC cash in 2- or 3-year maturities, on the hope rates start to rise three years from now. While 1% or so is pathetic at least it’s a positive number (ignoring inflation): with so many mentions of negative interest rates in Europe and sometimes floated by central bankers in North America, any positive return at is not to be sneezed at.
Conservative Asset Allocation ETFs are one possible alternative
Among the gambits I’ve tried is to raise risk slightly by moving some of this cash to ETFs like Vanguard’s Conservative Income ETF Portfolio [VCIP/TSX], which is 80% fixed income but provides a modest 20% equity kicker. Those who don’t wish to mess with their pre-existing asset allocation might consider the Vanguard Global Bond ETF [VGAB], roughly split between US and global bonds, all hedged back into the Canadian dollar. Continue Reading…
When I started in the business in September of 1993, it was a great time for new client acquisition. The reason is simple: there were so many new clients to be had – in the form of first-time investors. As interest rates plummeted from their all-time highs in the early 1980s, the fulcrum began to shift. Specifically, as the risk-free rate (anything that could be attained on a guaranteed basis) dropped, people became increasingly willing to absorb risk.
Starting around 1982, the long-term macro trend that continues to this day began. That year marked the cyclical high in long-term interest rates (in the mid to high teens!) along with a multi-generation low in price/earnings ratios (well into the single digit range!). For nearly 40 years, interest rates have been seeing a secular decline, while market valuations the world over have been creeping up. The correlation is predictable. As rates drop, people are prepared to take on increasingly large amounts of risk in their quest for financial reward. Totally understandable.
Rates are essentially at Zero
Now that rates are essentially at zero throughout the developed world, the trend has become acute. The question that people might now be asking themselves is: will people stay out of traditional income investments for the foreseeable future? Continue Reading…
Earlier this year, the Hub ran a blog by Franklin Templeton Canada entitled A cure for the headaches of Fixed Income investing, written by Ahmed Farooq, Vice President of ETF Business Development for the company. Franklin Templeton is a sponsor of the Hub. Today’s blog is a question-and-answer session between Ahmed’s colleague, Jon Durst, Vice President, ETF Business Development, that picks up where we left off.
Jon Chevreau, Q1: Do you believe active management makes more sense in the fixed-income space versus the equity space? Perhaps it makes sense in both?
Jon Durst, Franklin Templeton’s Vice President, ETF Business Development
Jon Durst: There are merits to active management in both equities and fixed income; however, I feel recently, it has been a heavy skew towards active fixed income in this current market environment, and for many reasons. Early in March 2020, we saw a 50bps cut in interest rates by the Fed in the US: it was the first unscheduled rate cut since 2008 and the biggest cut since the financial crisis. There also appears to be a strong consensus on the street that rates will be “low for longer” going forward. If you own a passive fixed income strategy, the goal is to minimize tracking error to the index and what it cannot do is to adjust or try to anticipate any type of market events, like interest rate changes or changing company fundamentals.
This can certainly be a worrisome event for most advisors if they buy their own bonds directly or passive fixed income products covering different sectors/regions, as they have to scramble and figure out if they should continue with the same fixed income allocations in their portfolio, as the onus of making any changes to their portfolio will be on them.
Active managers with years of experience can focus solely on their investment mandates and can adjust to different types of market events, such as shape of the pandemic recovery or the consequences of the Democrats winning the 2020 US elections.
Outsourcing in this market environment and buying active fixed income exposures that align with your client’s outcomes will hopefully provide a calming effect that is certainly needed. Not to mention, active fixed income ETFs in particular are now often priced very similarly to passive indexed products, which is even more important in this low rate environment to help maximize clients cash flow.
Jon Chevreau, Q2: For income-oriented retirees, do you generally see more opportunity in corporate or government bonds?
Jon Durst: I do see more opportunity in corporates debt, as the yields are higher, they also tend to be less sensitive to interest rate movement, but the risk level and volatility do tend to slightly go up.
A passive aggregate bond strategy that encompasses both corporate and government debt in Canada yields around 2.55%, a pure passive Canadian government bond strategy at 2.11%, and a passive Canadian corporate strategy around 2.77%. On the other hand, for example, an active Canadian corporate strategy FLCI – Franklin Liberty Canadian Investment Grade Corporate ETF, yields 3.12%. An active manager can select certain bonds over others, perhaps looking for higher coupons and/or YTMs, or overweighting certain sectors that will benefit from the pandemic trade or the Biden Presidency.
Jon Chevreau, CFO of Financial Independence Hub
Jon Chevreau, Q3: How much exposure should Canadian investors have in US and international bonds and through what vehicle? On that note, what is your stance on currency hedging?
Jon Durst: We do need to think outside of Canada; even from a fixed income perspective, Canada’s total debt in comparison to the world is about 3-4%. Also, there is no tax incentive to buying solely Canadian debt, unlike the Canadian Dividend Tax credit provided on distributions from Canadian equities. There are many fixed income opportunities to take a look at – a solution based option via a Canadian Core Plus strategy is one – where you would still keep 70-75% in Canadian bonds and have an active manager select the 25-30% in the US and/or globally. You could also consider a more broad-based global aggregate option, having the portfolio manager look for opportunities from a global stand-point, which offers the PM a lot of flexibility to diversify geographically and from a currency perspective. Yields in different countries can vary significantly which can create a lot of opportunity for higher yields and capital appreciation, not to mention diversification benefits.
In terms of buying a pure-based exposure – in other words, buying direct US, EAFE or EM debt, either by purchasing individual bonds or a managed product — I find most advisors are still tippy toeing into pure US, EAFE or EM debt spaces: most still maintain a home country bias and the complexity of selection, weighting, and trading these exposures is difficult, to say the least. Those that see the value in investing outside of Canadian debt usually outsource this complexity by using active fixed income strategies that provide access to the US/Global exposure, in addition to Canadian bonds.
I am for 90-100% in currency hedging fixed income exposures. With interest rates and yields being at historical lows, another level of worry should not be placed on how the global currencies are going to perform relative to the CAD$, especially in fixed income, which is supposedly the conservative component of a client’s portfolio. In my opinion, currencies should be hedged out as much as possible in fixed income.
Jon Chevreau, Q4: Your blog back in February compared bond funds to GICs. Do you see a role for both and in what proportion?
Jon Durst: In this environment, it can get even trickier: do you really want to lock into GICs for a certain period of time at a certain rate? Or want to be nimble and have liquidity? It’s a question on how to balance stable income that is locked in (currently at historically low rates) and/or including a short term bond strategy that can yield a little more in this environment and provide liquidity in the event of a requirement. I am beginning to see a fair number of advisors who have started to allocate to short term bonds funds as client GICs mature. Usually cash, GICs and short-term bond funds make up about 5-10% of a clients portfolio, but GIC investors are being compensated very little, so short term bond funds are being used for those with a higher need for income, and cash now being used for those with a 100% capital preservation requirement (not taking inflation into the equation). GICs appear to be losing some steam.
Cash is king during times of economic trouble. Working families need emergency savings to pay the bills in case of job loss or a reduction in wages. Retirees or near retirees need a cash cushion to avoid selling stocks at a loss. But should you park your cash in a high interest savings account or a GIC?
For a short time, not too long ago, we lived in the golden age of high interest savings. The competition was lively, as online banks and credit unions pushed interest rates well above 2 per cent (LBC Digital briefly paid 3.3 per cent).
Rising interest rates on savings deposits made GICs look less attractive. GICs paid the same rates or lower, yet savers had to lock-in their deposits for 1-5 years. Where did the liquidity premium go?
High Interest Savings Account rates
The situation quickly changed when the coronavirus pandemic forced central banks to take emergency action and cut interest rates. The Bank of Canada lowered its key interest rates by 50 basis points on two occasions. The ripple effect caused high interest savings account rates to plummet.
LBC Digital had already lowered its rate to 2.8 per cent – now it sits at a still respectable 2.25 per cent. Wealthsimple Cash had arguably the worst-timed launch when it came out with a 2.4 per cent interest rate for its chequing/savings account hybrid. That rate was quickly dropped to 1.9 per cent, and then lowered again to 1.4 per cent.
EQ Bank lowered the interest rate on its Savings Plus account to 2 per cent, while motusbank dropped its rate to 1.75 per cent. What a difference a month makes!
Here are the top high interest savings account rates today (March 25, 2020):
Bank
Interest rate
LBC Digital
2.25%
Motive Financial
2.20%
Implicity Financial
2.10%
Outlook Financial
2.10%
EQ Bank
2.00%
Oaken Financial
2.00%
As always, savers need to look beyond the big banks to maximize the interest earned on their deposits. If inflation averages 2 per cent, then you need to earn at least 2 per cent on your savings to maintain purchasing power. Even still, at best you’re treading water.
Despite the recent drop in rates, a high interest savings account is still the best place to park your emergency savings. You never know when you’ll need to access cash for an unexpected bill, or to pay for your living expenses during a period of unemployment.
A high interest savings account is also a must-have for retirees and near-retirees to stash one year’s worth of spending – the first bucket in the three-bucket approach to retirement income planning.
What this current rate crisis has highlighted is the fact that high interest savings account rates are not guaranteed. Those who eschewed GICs to chase higher yielding savings accounts now find their savings account paying 0.50 – 1.00 per cent less than it was a month ago. Not ideal.
GIC rates
One of my clients recently alerted me to an email sent by Oaken Financial advertising an increase in GIC rates. Its one-year GIC now pays 2.5 per cent, which is a full 25 basis points more than the top-paying high interest savings account. Oaken’s five-year GIC now pays 2.95 per cent interest. It looks like the liquidity premium is back.
You’ll easily find one-year GIC rates paying at or above the best high interest savings account rate.
Bank
Interest rate
Oaken Financial
2.50%
Canadian Tire Bank
2.50%
EQ Bank
2.40%
Wealth One Bank of Canada
2.40%
Peoples Trust
2.30%
Longer-term rates vary widely so be sure to shop around for promotions. Here are the top five-year GIC rates as of this writing:
Bank
Interest rate
Oaken Financial
2.95%
Wealth One Bank of Canada
2.60%
Canadian Tire Bank
2.55%
EQ Bank
2.55%
Peoples Trust
2.55%
Readers should know that GICs are typically non-redeemable, so you should be absolutely certain that you won’t need the money when you lock it in for 1-5 years.
That means GICs are ill-suited for an emergency fund, but ideal for a goal with a specific time period.
Using High Interest Savings Accounts and GICs for Retirement Income
For retirees and near-retirees, GICs are best-suited for “bucket two” in your three-bucket approach to retirement income. Bucket two is where you build a GIC ladder with three to five years of annual retirement spending. Continue Reading…
My latest MoneySense Retired Money column has just been published. It looks at the reversal the past year in interest rates, which impacts seniors who had started to look forward to at least half-decent GIC rates near 3%. You can find the full piece by clicking on the highlighted headline: Are GICs right for retirees looking for Fixed Income?
Short of embracing high-yielding dividend paying stocks, the more palatable alternative for conservative retirees might be fixed-income ETFs. The article focuses on a recent video by CFA Charterholder Benjamin Felix, an Ottawa-based portfolio manager for PWL Capital. Felix argues that at a minimum such investors should have a mix of both fixed-income ETFs and GIC ladders.
The latter let you sleep at night because they are invariably “in the green” in investment accounts. But while in the short term fixed-income ETFs can be in the red — just like equity ETFs — Felix makes a compelling argument for the higher potential returns of bond ETFs.
Felix believes that what really matters for investors is total return: “Holding a lower-rate GIC after a rate increase still results in an economic loss.” Bond returns consist of principal, interest payments and reinvested interest, so focusing only on return of principal misses the point. Individual bonds are not ideal for individual investors, as they require extensive research, are relatively expensive and tricky to trade.
Short-term GICs miss out on the term premium
But short-term GICs miss out on the term premium, which is substantial over time. Going back to 1985, Felix says short-term bonds returned 6.51% annualized versus 7.97% for the aggregate bond universe (which includes some short-term bonds). This shows how much mid- and long-term bonds bring up the overall return. To be clear, this period captures one of the greatest bond markets in history but Felix says it is still reasonable to expect a relationship between riskier longer-term bonds and higher expected bond returns. Risk and return should be related.
GICs are also illiquid, so even if an investor chooses to include GICs in a portfolio, they will generally also include bond ETFs, which – like stock ETFs – can be sold any trading day. Nor do GICs provide exposure to global bonds.
Of course, a nice alternative are those asset allocation ETFs we have often discussed on this site. See for example this excellent overview by CutthecrapInvesting’s Dale Roberts: Which All-in-One, One-Ticket Portfolio is right for you?
The Felix video can be found at his Common Sense Investing YouTube series here.
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