Fixed-income savers who remember the years of near-zero interest rates still have something to celebrate.
Yields on one-year guaranteed investment certificates (GICs) have managed to remain 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.
This week, Canada’s central bank 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.
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 says the average one-year GIC yield is currently trading at about 65 basis point over the Bank rate compared with an even trade one year ago, and a 10-basis point spread two years ago.
Three years ago, GIC investors were getting a yield of 1.75 per cent over the bank rate.
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 the GIC yields; “may drop a little”.
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”.
If the BoC surprises everyone and hikes its rate to combat runaway inflation, or whatever; “GIC rates are almost certainly headed higher across the board,” he says.
Some longer-term GICs are yielding slightly more but Mclister says the reward is not worth being locked in for over a year.
Why are GICs important for 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. You can count on more buoyancy when markets tank.
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.
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, maturate over a fixed period.
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).
In comparison, fixed income investment yields are fully taxed outside a registered account.
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. As you age, your nest-egg becomes more secure.
