Fixed-Income Investing: Bonds or GICs Revisited – And What About Cash?
On July 4, 2022, I posted my 154th blog, on the topic of bonds and GICs. Coming off a long-term situation when the returns from these fixed-income products left many investors with little interest in buying something other than equities (individual stocks, equity mutual funds or ETFs), a year ago, the returns on fixed income were beginning to look remarkably good. The only caveat was that inflation was still running higher than the interest rates available from these products.
Fast forward one year and inflation has begun to drop while rates available from bond funds and GICs have increased, although they are leveling off recently. If you were reluctant to invest in these types of products before, now may be your opportunity.
I will not revisit the entirety of last year’s blog post, but you may be interested in comparing some of the rates that are available now. As I write this, the latest rates are as of Friday, August 11, 2023.
Yields
Guaranteed Investment Certificates
GICs are bought at par and redeemed at par at the end of their term. In this case, par means the value of the principal. If you buy a GIC for $1,000, you will get $1,000 back at maturity plus any interest that was part of the contract. Therefore, the GIC buyer will get exactly the interest that was promised, without any concern for losses or gains on the principal.
People often go to their local bank branches to buy GICs, but even if you prefer not to take any risk, one way to get access to a wider range of options is through a broker that offers GICs. Certain businesses specialize in this market, while many of the discount or online brokers that are usually associated with stock investing also offer this option. The benefit of using a broker is that you can buy from a wider variety of issuers, which gives you both the opportunity for better rates and the ability, if you plan on spending more than $100,000 on GICs, to expand your coverage under the terms of the Canada Deposit Insurance Corporation (CDIC), since each issuer is insured separately.
Here is a list of brokered GIC rates offering through TD Direct Investing. I’ve provided both monthly and annual pay rates. Note that for the 4-year and 5-year options, one Bank is superior for the monthly pay while another is superior for the annual pay option. The inferior rate is greyed out. Be aware, as well, that investors can allow the annual pay versions to compound until the term is done, allowing interest to be earned on the interest.
While brokered GICs have their advantages, especially if they are part of a larger diversified investment portfolio, you can go to other sources for your GICs. Online banks are always an option. Two that I always look at are EQ Bank, a division of Equitable Bank, and Oaken Financial, a division of Home Trust. Until recently, Oaken seemed to be winning the rate game, but recently EQ Bank has done better. EQ Bank offers only annual pay or compounding GICs, whereas Oaken will also allow monthly (and semi-annual) as well as annual pay or compounding GICs. Again, note that the rates are different if you choose more frequent pay periods.
Reviewing the options presented, EQ Bank is consistently tied with or superior to the others. That may change at anytime, however, so if you are interested in the best rate, regardless of issuer, flexibility to move your money around may be the most important quality you can possess.
In comparing these GICs to the short-term bond ETFs below, you may want to consider the averages. If you were to buy a five-year “ladder” of these GICs, assuming you put the same amount of money into each term, your weighted average term would be 3 years (the average of 1-, 2-, 3-, 4-, and 5-year terms). Across the different sources: brokers, EQ Bank, and Oaken Financial, the average yield to maturity is 5.27%. However, if you focus on EQ Bank’s GICs alone, the average yield to maturity increases slightly to 5.30%.
Bond Funds
While the return from GICs is found strictly in the interest rate that they offer, the return from bonds consists of both the interest rate at which the bond was offered and the discount or premium from par at which the investor purchases them. When bonds are sold at a premium, it means that the interest rate a particular bond provides is deemed higher than what a similar bond would provide if it were issued today. To compensate the seller of the bond appropriately, the bond commands a premium above “par” (par or face value refers to the stated value at the time the bond was first issued). For example, let’s consider a bond that was issued at par, or 100% of its original issue price, and with an annual “coupon” or interest rate of 6%. If substantially identical bonds are issued today at a rate of 5% interest, then the seller of the bond that provides for 6% can command a premium, i.e., a price greater than par. The effect is that part of your bond’s yield consists of the interest payments and the capital loss from buying the underlying bonds at a premium (above 100%) and selling them at par (100%) when they mature.
On the other end, if bonds that were issued a few years ago provide fairly low interest rates compared to the prevailing interest rate for today, then to compensate and provide for an equivalent yield or overall return, they need to be traded at a discount to par (less than 100% of the face value). This latter situation is largely the case today. For the last many years, bonds have been issued at low interest rates. Now that inflation has gone up, and the Bank of Canada has raised overnight interest rates, bonds that are being issued today are being offered at higher interest rates. That means that bonds issued a few years ago need to discount their prices to compete in the bond market. The table of short-term fixed-income ETFs, below, illustrates this situation.
Index-based ETFs and mutual funds that contain hundreds of bonds show their terms, coupons, and yields in weighted terms based on the “weight” or proportionate influence that a given bond has in the overall portfolio that is represented by the fund. You can see how the coupon or interest rate is low compared to the yield to maturity. Using the average figures, the weighted average coupon is only 2.29% but the weighted average yield to maturity is 4.97%. To make up that difference between the interest that is being paid and the market rates prevailing today, the price of the underlying bonds is being discounted to create an effective yield that is competitive with bonds available today.
Note the last of the four ETFs, ZSDB, the BMO Short-term Discount Bond ETF. While the other three ETFs are discounted because of the market rates, this fund focuses on discount bonds in particular, making it particularly suitable for non-registered accounts since more of the payment is delivered in the form of capital gains versus interest. Capital gains are taxed at only half the rate of interest (the 50% inclusion rate).
Cash
With the increase in interest rates, a convenient and flexible option is the High-Interest Savings Account, often abbreviated as HISA. If held in a brokerage account, it may also be known as an Investment Savings Account or ISA. Just a couple of years ago, the term “high interest” was mocked as the rates were often below 1%. These days, however, you can get rates well into the 4% range.
While you can get fairly good savings account rates at online sources like EQ Bank or Oaken, one of the best sources is a discount broker that gives you access to the F-Series HISAs (or ISAs) that are bought and sold like mutual funds with a one-day settlement. That means, you enter an order to buy or sell on one business day and the transaction is completed on the next business day. These HISAs retain CDIC coverage as well for those who are concerned about the security of their cash in the event of the insolvency of the issuing bank.
If you are considering a discount brokerage for your investing and want to keep your cash in a HISA, one of the better options is Qtrade. It generally scores high among online brokers and allows access to HISAs from a wide range of issuers. Below is a list of rates as of August 11, 2013.
Several ETFs serve as equivalents to these products but pay rates greater than 5%. However, the brokers tied to the big banks typically do not offer these ETFs for sale, favouring their own products, and if there are commission charges involved in either buying or selling, those “frictional” costs can eat into your yields. In addition, they do not provide CDIC coverage. This is not to say that you should not use them; only that their superior rates may come with some disadvantages.
Timeframe
Although some issuers sell GICs with longer maturities, most of those available are between 1 and 5 years. Similarly, short-term mutual funds and ETFs usually limit their maturities to five years. High-Interest Savings Accounts can be redeemed within 24 business hours, so their maturity is virtually immediate. If liquidity is a concern, then the HISA is your choice. Just be aware that although the rates can be adjusted upward quickly, they can also drop quickly.
With GICs, it is usually the case that the longer the term, the higher the rate. These days, however, the reverse is true, with one- and two-year rates higher than four- and five-year rates. This suggests that the markets are projecting a reduction in rates in the future. What can you do? If your temptation is to load up on one and two-year GICs, be aware that the rates available in 2024 and 2025 may be meaningfully lower than they are now. For that reason, when it comes to GICs, I usually encourage a ladder of GICs that mature at yearly intervals, allowing you to spread your risk over time. This recommendation does not apply, however, if you have a specific date in mind when you need the money.
For bond funds, whether ETFs or mutual funds, there are no maturities as such. The underlying bonds at the short end are continuously maturing and being replaced by new bonds at the long end. If prevailing rates decline, the already-issued bonds will increase in value, reaching premium status again. If your time horizon is longer, you may even wish to avoid short-term bond funds in favour of broader “universe” or “aggregate” bond funds so that your average term is longer.
As for cash, while the rates are good now, recognize that cash is for short-term needs and rates are of secondary concern to ready access or liquidity. Cash deposits in high-interest savings are great for emergency funds, but investing is a long-term project and cash should, therefore, be allocated accordingly.
This is the 210th blog post for Russ Writes, first published on 2023-08-14
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.
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