Introduction to GICs and Interest Rates
Fixed-income savers have something to celebrate, as yields on one-year guaranteed investment certificates (GICs) have remained in the 3.5 per cent range despite a steady drop in the Bank of Canada benchmark rate over the past year and a half. The Bank of Canada has held its official rate at 2.75 per cent, the same level it’s been since March, as inflation remains close to its two per cent target rate. This is a significant development, especially considering that the Bank of Canada has lowered its rate from five per cent since April 2024.
Why GICs Are Not Matching the Bank Rate
GIC rates have also drifted lower over that period, but rate tracker Robert Mclister from Mortgage Logic says the 30-year correlation between one-year GICs and the Bank of Canada overnight target rate is loosening to benefit savers. He notes that the average one-year GIC yield is currently trading at about 65 basis points over the Bank rate, compared to an even trade one year ago and a 10-basis point spread two years ago. This shift is important, as it means that GIC investors are getting a better deal than they would have in the past.
How Long Can GICs Out-Yield the Bank Rate?
According to consensus, the Bank of Canada will cut its rate before the end of the year. If that happens, Mclister says GIC yields "may drop a little". However, if the BoC does nothing over the next few years or comes under the consensus 25 basis point (one-quarter percent) cut, he says "GIC rates shouldn’t stray too far from where they are today". On the other hand, if the BoC surprises everyone and hikes its rate to combat runaway inflation, "GIC rates are almost certainly headed higher across the board", he says. This uncertainty highlights the importance of staying informed about interest rates and their impact on GICs.
The Importance of GICs in a Retirement Portfolio
A set portion of GICs, and other fixed income products like investment-grade government and corporate bonds, acts as a stabilizer to the more volatile equity portion of a portfolio. This is crucial, as it provides a sense of security and predictability in retirement. Equity returns are historically higher, but fixed income generates reliable returns that compound over time and provide a steady stream of cash in retirement. Retirement investors will generally hold fixed income to maturity, unlike professional bond traders or bond funds, which seek gains by trading existing debt to take advantage of short-term fluctuations in interest rates.
Strategies for Maximizing Fixed Income Returns
There are strategies for retirement investors to maximize fixed income returns by staggering maturities to take advantage of the best going yields as often as possible. The most common strategy, known as laddering, involves maturing investments over a fixed period. This approach can help investors make the most of their fixed income investments and ensure a steady stream of income in retirement.
Tax Perks from Fixed Income
In addition to hedging risk, fixed income investments can also generate tax savings in registered accounts such as a registered retirement savings plan (RRSP) and tax-free savings account (TFSA). This is a significant advantage, as it allows investors to keep more of their earnings. In comparison, fixed income investment yields are fully taxed outside a registered account, making it important to consider the tax implications of fixed income investments.
Striking the Right Mix
There is no single set of rules when it comes to managing a fixed income portfolio for individuals. The portion of fixed income in the overall portfolio, the total duration of a ladder, and the types of fixed income investments depend on when and how the investor wants to retire. The right mix between fixed income and equities also depends on the individual investor, but a qualified advisor can help formulate strategies to maximize fixed income returns. A general rule is to allocate a percentage of your portfolio to fixed income equal to your age. In other words, if you are 60 years old, 60 per cent of your portfolio should be invested in fixed income.
Conclusion
In conclusion, GICs and other fixed income investments play a crucial role in a retirement portfolio, providing a sense of security and predictability. While interest rates may fluctuate, it’s essential to stay informed and adapt to changes in the market. By understanding the importance of GICs and using strategies such as laddering, investors can maximize their fixed income returns and ensure a comfortable retirement. With the right mix of fixed income and equities, investors can strike a balance between risk and reward, ultimately achieving their long-term financial goals.
