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In our new high-interest rate investing environment, fixed-income products have become more valuable than ever. Not only have they benefited from these rates, but they provide a safer haven for investors to diversify in a more volatile equity environment.
As the hunt to find lower-risk investments continues, two primary contenders stand at the top: Guaranteed Investment Certificates (GICs) and bonds. In this blog post, we'll explore the benefits and considerations of each, helping you make an informed decision in today's unpredictable economic landscape.
A GIC or a Guaranteed Investment Certificate is an investment product that works like a special kind of deposit where you are guaranteed to get the amount you deposited back at the end of the term.
It's similar to a high-yield savings account, where generally the longer the term, the higher the interest you will earn. However, with a high-interest savings account you may only be offered a basic rate of 1.5%, while a GIC may offer 5% or more.
Most GICs pay a fixed rate of interest for a set term, which can range from 30 days or up to 10 years, and the minimum amount you can typically invest is $500. Some GICs will offer variable interest rates, but regardless at the end of your term, you are paid back your full principal in addition to any interest still owning.
GICs are also protected with deposit insurance, which means that if the financial institution fails, your initial investment and accumulated interest are still guaranteed by the government through the Canada Deposit Insurance Corporation (CDIC) for banks and your provincial government for credit unions.
Bonds serve as loans for governments or corporations, allowing them to raise capital. When you buy a bond, you're lending money to the issuer, and in exchange, they pay you interest for a specified period. Upon maturity, you get back your initial investment.
There are various bond types, such as government, corporate, and municipal bonds, each named based on their maturity period. These range from Treasury bills (T-bills) for terms under 1 year to bonds for over 10 years, with the 5-year Government of Canada bond being widely referenced.
Credit rating agencies grade bonds to assess the issuer's default risk. Higher credit ratings indicate lower default risk, ensuring timely and full interest payments. Conversely, lower-rated bonds offer higher interest rates, attracting investors seeking greater returns but accepting higher risk. Ratings range from AAA (highest) to C or D (default), with bonds below BBB- considered speculative or high-yield bonds, also known as junk bonds.
In recent years, GICs have evolved from being an overlooked investment option to a compelling choice, especially with our current interest rates and high turbulence in stock markets. GIC rates have surged to over 4% per year (or more!), providing a stable alternative for risk-averse investors. The key benefit of GICs lies in their guaranteed returns, offering a fixed interest rate over a predetermined period (typically one to five years). GICs can also be integrated into registered plans like TFSA or RRSP, which makes them useful for risk-adverse investors looking to leverage their tax-free investments.
Lastly, because GICs are typically covered up to $100,000 dollars by the CDIC, it makes them a serious consideration for organizations and institutions who cannot afford to lose any of their cash but want to secure against the inflation risk of just holding it in the bank.
There’s a misconception that GICs are completely inflexible products that lock your money in once invested. We’ve debunked this in our Ultimate GIC Guide, where we talked about the different redeemable and non-redeemable types of GICs.
If you’re looking for more flexibility, you can employ a strategy known as 'laddering' where you seek to diversify investments across different terms and re-evaluate and reinvest at the end of each term. By mixing different term lengths and redemption criteria across your investments, you can create a robust plan on how much of your investment you’re willing to keep locked-in to maximize returns, versus how much cash you want to be available for potential expenses.
Bonds present an alternative low-risk investment compared to equities, involving lending money to the government with a guaranteed repayment at maturity. The bond yield, encompassing interest coupons and potential face value fluctuations, represents the overall return. Bond yields are directly correlated with mortgage rates, with average yields of a 10-year bond at 3.11% as of Dec 21st, according to the Bank of Canada.
Bonds are not entirely risk-free, as their prices are affected by interest rate changes. As interest rates go up, the price of existing bonds tends to decrease, as new bonds are reissued at higher coupon values. This means higher average yields for new investors, but a decrease in value for existing bondholders. 2021 and 2022 were difficult years for bond investors, with 2022 seeing a –12.91% yearly return according to the FTSE Canada Universe Bond Index. However, as interest rates appear to hit their peak, some investors believe current low prices present an opportunity in 2023.
Bonds offer more liquidity than GICs, as investors are allowed to buy and sell at any point. This flexibility, coupled with the potential for bonds prices to increase, makes bonds an attractive option for well-diversified portfolios. Financial advice often recommends investors to allocate a percentage of their portfolio to bonds to mitigate risk based on market conditions. Because of their liquidity, investors can make follow-up decisions once market conditions change, should they decide to reinvest their capital into other investments.
Based purely on current rates, GICs currently hold the edge, however the decision between GICs and bonds is nuanced as bondholders have the opportunity for higher yields over time, based on changes of the bond’s price. If you’re willing to withstand greater uncertainty, over extended time horizons bonds can provide the potential for higher returns, but in the short-term the thing that can be guaranteed is the coupon rate at purchase.
When deciding between GICs and Bonds, you should make your choice based on your individual risk tolerance, time horizon, the interest rate environment, and the need for liquidity.
When choosing between GICs and bonds, it's crucial to assess your risk tolerance and investment objectives. Are you seeking a secure, low-risk investment with guaranteed returns? Alternatively, are you open to assuming more risk in pursuit of potentially higher returns?
Opt for GICs if your aim is capital preservation and a stable income. On the other hand, if you desire greater returns and are comfortable with increased risk, bonds might be the more suitable choice.
Based purely on current rates of 1 year and 5 year returns, GICs currently hold the edge, however the decision between GICs and bonds is nuanced as bondholders have the opportunity for higher yields over time, based on changes of the bond’s price.
If you’re willing to withstand greater uncertainty, over extended time horizons bonds can provide the potential for higher returns, but in the short-term the thing that can be guaranteed is the coupon rate at purchase.
When interest rates decline, the value of bonds increases, making long-term bonds appealing due to attractive returns. Conversely, in a rising interest rate scenario, bond values decrease, making them less favorable for investment. Hence, when deciding between GICs and bonds, it's crucial to consider both present and anticipated future interest rates.
Bonds are generally traded on financial markets, providing a higher level of liquidity as they can be bought or sold at prevailing market prices. GICs, on the other hand, are time deposits who's returns are determined by a predetermined maturity date. Investors who need to be able to withdraw their funds easily should ensure that they are comparing bonds to more flexible GIC options such as redeemable or cashable GICs.
Both GICs and bonds serve as effective tools to mitigate overall portfolio risk while providing steady returns. As you weigh the options, consider your risk tolerance and investment preferences. Whether you lean towards the stability of GICs or the flexibility of bonds, finding the right balance is key to navigating today's dynamic financial landscape.
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