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A trusty alternative for stressed-out bond investors
Thursday, February 08, 2018
There will be blood if you hold bonds or bond funds through a cycle of rising interest rates.
Frankly, so what? Long-term investors will make out fine with bonds if they hold through the rising rates that hurt bonds and the falling rates that help. All the while, bonds will pay a reliable flow of interest and act as a cushion if stocks should tank.
But it's becoming clear there's a class of investor who has no interest in participating in a down period for bonds. The worst mistake these people can make is substituting stocks for bonds. A much better solution is to use a ladder of guaranteed investment certificates instead of bonds.
GICs may not be cashable before maturity unless you pay a significant penalty, so don't use them if you need the liquidity you get with bonds and bond funds. But if you're willing to lock in money, a GIC ladder can produce comparable or better returns than bonds and bond funds, with far less drama.
Because GICs aren't listed for trading, unlike bonds and stocks, they don't fluctuate in price on your quarterly or monthly investment statements. Emotionally, this is a major plus for investors who dread seeing losses on the fixed-income side of their portfolio.
Many online brokerage firms offer a wide selection of third-party GICs and many advisers do as well. Here's a five-year GIC ladder I built from the online inventory at one particular broker, which include: One-year: Bank of Nova Scotia at 2.05 per cent; Two-year: B2B Bank at 2.35 per cent; Three-year: Home Trust at 2.63 per cent; Four-year: VersaBank at 2.67 per cent; Five-year: Manulife Trust at 2.8 per cent.
The average yield for this ladder is 2.5 per cent, which compares with an after-fee weighted average yield to maturity of 1.85 per cent for a popular bond ETF that replicates a five-year ladder of government bonds.
Some advisers suggest using a three-year ladder instead of a five-year version because the reward in extra yield from locking in money for four- and five-year terms is modest. If you build a ladder using just the one- through three-year GICs listed above, your average yield would be 2.35 per cent.
Maintaining a GIC ladder is supereasy - just replace all maturing deposits with a new one at a five-year term (or with a three-year term in the case of the three-year ladder). Each renewal allows you to capitalize on higher rates, while also limiting the amount you must renew if rates fall. Bonds and bond ETFs still have a role in portfolios, but the GIC ladder is a no-drama alternative.
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