We had not seen yields on guaranteed investment certificates (GICs) top five per cent for thirty years and it could be another thirty years before we see them again.
This year will go down as the year retirement investors could earn a decent return without having to venture into the troubled waters of equity markets.
GIC returns are still decent but the reward for savers is fading. This week’s jumbo rate cut of 50 basis points by the Bank of Canada, and the promise of further cuts in the new year, means GIC yields will continue to fall in tandem.
According to online yield-tracker Ratehub, some Canadian borrowers are still offering four per cent yields as far out as five years. That means investors can lock in four per cent returns in the fixed income portions of their portfolios up to five years into the future.
In dollars, $100,000 invested at an annual rate of four per cent compounding over five years would generate a return of $122,000.
Fixed income investing
Regardless of yield, investing a portion of a retirement portfolio in fixed income such as GICs and investment grade bonds is a great way to temper the volatility of equities. Any rate of return is welcome if stock markets tank when retirees need a reliable cash supply for living expenses.
In addition to hedging risk, fixed income investments can also generate tax savings in registered accounts such as a registered retirement savings plan (RRSP), tax free savings account (TFSA), registered education savings plan (RESP) and first home savings accounts (FHSA).
In comparison, fixed income investments are fully taxed outside a registered account.
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.
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, ladders maturities over a fixed period of time.
Striking the right balance
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 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 50 years old, half of your portfolio should be in fixed income. It’s a way to automatically reduce equity risk as you age.
Balancing risk
While the return on GICs is guaranteed, there is always a risk part of it will be eaten by inflation, which is why the Bank of Canada decided to start raising its benchmark interest rate in the first place.
The only alternative for income-hungry investors are dividend stocks trading in the often-volatile waters of the equity market.
Right now, some of the old Canadian dividend stalwarts such as the big banks are offering yields above four per cent, but dividend payouts and their amounts are always at the discretion of the company and far from guaranteed.
In addition, the value of the underlying dividend stock is at the discretion of the broader market and is a poor substitute for the safety of fixed income.