Interest rate cuts from central banks in Canada and the United States this week, and a vow for more to come, means a dwindling safe-haven for long-term retirement investors.
While borrowers celebrate a general trend toward lower yields, the reward for savers who want their cash to grow is diminishing.
The Bank of Canada has lowered its benchmark rate by 0.25 per cent to 2.5 per cent; down from five per cent since April 2024.
GIC yields holding ground - for now
Yields on guaranteed investment certificates (GICs) have been surprisingly resilient in the face of the rate tightening cycle.
As of Friday, one-year GICs tracked by ratehub.ca were paying out up to 3.5 per cent annually. It’s a far cry from the five per cent plus yields two years ago but investors wanting to lock part of their portfolios in the safety of GICs can still grow their investments.
They can also lock in slightly higher rates on longer maturities. According to ratehub, Mcan Wealth is paying out 3.95 per cent annually on 5-year GICs, while Oaken Financial pays out 3.8 per cent over the same period.
Income alternatives up the risk ladder
Income investors have been here before in the years during and before the 2020 pandemic when central bank rates were near zero and fixed income, like bonds and GICs, were yielding less that one per cent.
To keep the income stream flowing, retirement investors were forced into riskier dividend-paying stocks, real estate investment trusts (REITs) and other income generating investments.
There’s a big difference. While the principal and interest on GICs is “guaranteed”, dividend equity investments trade on the broad equity markets and their day-to-day value is subject to its whims. Dividends are cold comfort for retirees who can’t afford to wait out a market downturn and need to sell beaten-down stocks to pay their bills.
It’s also important to know dividend payouts are at the discretion of the companies that issue the shares, which makes them far from fixed.
The extra risk might be worth it for investors who need to boost returns to meet retirement goals. Big Canadian banks stocks currently pay annual dividends between three per cent and five per cent and have a long history of never cutting their dividends.
Big Canadian telecom, and some resource companies, pay similar dividend yields.
Why fixed income is 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. With fixed income 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, ladders maturities over a fixed period of time.
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.
A qualified advisor can be a big help but make sure investment fees aren’t eating too much into returns.
