Fixed-income investments and low interest rates: do you have alternatives?
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“A diversified portfolio has a mix of equities, fixed-income investments, and cash”. “Never put all your eggs in one basket.”
For years, investment experts have preached the importance of diversification within a portfolio, and fixed-income investments such as Guaranteed Investment Certificates (GICs) have always been an important part of the equation.
What are fixed-income investments?
Issued by a government, corporation, or other entity, they generally refer to types of investments that pay a steady stream of income and return of principal upon maturity. Examples include bonds, treasury bills, GICs, and mortgages.
Bill Rakovitis, Educators Senior Financial Advisor says, “Because of their stability and security, fixed-income investments provide balance for your equities, which by their nature are more volatile. Many Educators’ investors, particularly retirees, like fixed-income investments because they’re a secure, low-risk way to generate steady income. As long as they are held to maturity, they also provide a guaranteed return on your investment, with payments known in advance.”
However, with today’s interest rates at a historic low, investors holding fixed-income investments are naturally asking, “Is it possible to find an investment that combines the safety of a GIC with a higher rate of return?” Here’s what these investors should know:
To begin with, interest rates will likely be low for a while.
Low interest rates have been in place in Canada for some time – the Bank of Canada’s (BoC) overnight interest rate plummeted from 4.25% in 2008 to 0.25% in 2009. Skip forward to the current pandemic and, in an effort to stimulate the economy, the overnight rate has returned to 0.25%. The BoC has indicated that rates will likely remain low for at least the next two years.
And the return on GICs? At the time of writing, the return on a one-year GIC ranges from about 0.75% to 1.5%.
How do low interest rates affect investors?
Low interest rate environments typically have little effect on long-term investors who generally have a higher allocation of stocks. But they can be disadvantageous to those with a higher dependence on investment income or those with a very low-risk tolerance (like GIC investors).
There are strategies to maximize your GIC returns.
“Before scrapping your GICs, consider ways to squeeze more returns from them,” says Bill. “One tried and true method is to ‘ladder’ your GICs by maturity dates.
To build a five-year ladder, start by investing roughly equal amounts in five individual GIC terms: one-, two-, three-, four- and five-year. Every year, one of your GICs will mature, at which time you’ll have the option to reinvest those funds in a new five-year term or withdraw those funds if you need it. By laddering, you receive the benefit of maximizing your interest payments (since longer-term GIC’s usually carry a higher interest rate) while balancing out fluctuations in interest rates.
Another strategy is to look beyond the big banks for GICs. Online research and calling around will often result in finding higher returns at smaller institutions, however, investors should be mindful of what protection is available for their money. Insurance is automatically provided by the Canada Deposit Insurance Corporation (CDIC) on eligible deposits held in CDIC member institutions. To find out which financial institutions are covered, view CDIC’s complete list of members.
Does the perfect alternative to GICs exist?
The reality is that investments that offer higher potential returns than GICs will also have a higher degree of risk. Investors must take a good look at the degree of risk they are willing to accept.
Educators Monitored Portfolios™ Conservative Portfolio may be the answer.
“Our Educators Monitored Conservative Portfolio may be a consideration for those who have a medium-term time horizon and like the low-risk nature of a GIC,” says Bill. “It’s a mix of 5% cash, 67% fixed income, and 28% in equities. Its principal is not guaranteed like a CDIC insured GIC, but it offers the potential for greater returns for those willing to move up a little higher on the risk curve. Its average annual return over the last 3 years was 3.76% as of February 2021.”
Please read the prospectus before investing. Mutual funds are not guaranteed, their value changes frequently and past performance contained in this article are not a reliable indicator of future performance.
Learn more about hands-free investing with Educators Monitored Portfolios.
Other alternatives some investors may consider:
High-interest rate savings accounts (HISA): HISAs are similar to GICs in that your principal is guaranteed (assuming it is covered by the CDIC), however unlike GICs, they are not locked in for a specific term and in exchange, their interest rates are lower.
Bonds: Bonds can be issued by governments (federal and provincial), municipalities, or corporations. Like GICs they offer a fixed stream of income and can be held to maturity (upon which principal is returned). However, their values can show fluctuations in response to interest rate movements. You could suffer losses if interest rates spike and you need to sell your bonds prior to maturity.
Mutual Funds and ETF’s: You can access a variety of bonds and other forms of fixed-income investments through a mutual fund or ETF. There are various types with various risk levels.
Remember, it’s not an all-or-nothing proposition. You can still hold GICs for the stability they provide while diversifying with other investments to enhance your return/income potential.
Still have questions about the impact of low interest rates?
If you are concerned about low interest rates preventing you from meeting your investment goals or income objectives, it’s important to know your options, as well as the risks and rewards before making changes to your portfolio. Meet with your financial advisor at Educators to discuss your objectives and possible alternatives.