In the wake of the central bank’s fourth consecutive outsized hike to fight inflation, yields on fixed income vehicles continue to rise.
Subscribe to BNN Bloomberg’s personal finance newsletter, Home Economics
Hours after Wednesday’s announcement, two-year Canadian government bond yields rose slightly to 3.62 percent and yields on some one-year guaranteed investment certificates (GICs) reached 4.5 percent. Earlier this year, investors were lucky to get one percent in a GIC — but times are changing. Wednesday’s increase of 75 basis points (which is a different way of saying three-quarters of a percentage point) brings the Bank of Canada’s key lending rate to 3.25 per cent after a surprise full-point increase in July and by half a percentage point increase in April and June. Before then, it was at a pandemic emergency low of 0.25%. And the central bank isn’t done. has clearly signaled that more hikes are coming. Markets are pricing in a solid chance of another half-percentage-point hike in October, which is expected to be further reflected in fixed income rates. Some income-hungry investors have already jumped on the GIC bandwagon. The latest data from the Investment Funds Institute of Canada (IFIC) showed investors pulled $4.5 billion net from mutual funds in July after net buying of $10.4 billion in June. In a conference call with analysts last month, Royal Bank of Canada Chief Financial Officer Nadine Ahn said much of the money drawn from RBC mutual funds in the third quarter of its fiscal year went into GIC products. Don’t jump to the highest performance just yet Yields on long-term fixed-income vehicles are typically higher than short-term maturities, but experts caution savers against jumping on the bandwagon in a rapidly rising interest rate environment. The official rate of inflation has eased since the interest rate hikes began, but is still well above 7%. That means even a GIC paying 4.5 percent is well below the cost of living. Currently, most fixed income managers recommend scaling fixed income in short-term increments so that they mature often enough to take advantage of returns as they rise. After all, 4.5 percent might look like chicken feed a year from now. Not all incomes are fixed As the name suggests, payments from GICs are guaranteed and essentially backed by the government. So are government bond payments. If they go bankrupt, we’re all in big trouble. Fixed income is reliable income that we can rely on when we need it. Dividends from stocks and real estate investment trusts are considered income, but not fixed, because payments are at the discretion of the company or trust and the value of the underlying investment can rise and fall with the vagaries of the market. Many investment advisors who are only qualified to sell mutual funds (and are compensated only by selling mutual funds) try to replace the fixed income portion of a portfolio with bonds. Bond funds are not fixed income because their holdings often trade in the broader bond market and are not held to maturity. Many bond funds posted losses as interest rates fell. Fixed income as part of a portfolio It’s important to have a fixed income component in any retirement portfolio, regardless of where the returns lie. Having a significant portion of your savings in fixed income acts as a cushion against volatility on the equity side of a portfolio. Any positive performance is better than losses in equity markets so far this year, for example. Three decades ago, before interest rates bottomed out, the rule of thumb for investing called for a fixed income portfolio that sat around the age of the investor. That means a 50-year-old will have half of his portfolio in fixed income. If your retirement goal required an annual real return of six percent, a five percent return in the fixed income portion of your portfolio made that much more achievable. GICs will pay more in the future, but they have always been a stimulant to help investors sleep at night. Payback Time is a weekly column by personal finance columnist Dale Jackson on how to prepare your finances for retirement. Have a question you want answered? Email [email protected]
