Bonds vs. GICs: Where should you invest your fixed-income dollars?

Meanwhile, “HISA rates are starting to come down,” says Travis Koivula, an investment advisor with Aviso Wealth in Victoria. (HISA stands for high-interest savings account.) His clients are increasingly asking whether they should shift some of their savings into traditional fixed income.

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This comes after a long stretch of miserable performance for the fixed-income asset class. The historically low interest rates of the 2010s left bonds and guaranteed investment certificates (GICs) paying barely-there levels of interest. (At one point in 2019, a quarter of the global bond market sported negative yields!) Bonds then got crushed when inflation and interest rates took off in 2022.

Today, bond and GIC yields are respectable, and the prospect of further interest rate declines makes the outlook relatively rosy for bonds on a risk-adjusted basis. Meanwhile, GIC investors are scrambling to lock in long-term rates before they fall. Judging by fund flows, investors are ready to rotate back into the asset class.

How interest rates affect bonds and GICs

When interest rates rise, prices for existing bonds fall because comparable new bond issues pay higher yields. The price drop makes them competitive with these new issues in terms of total yield to maturity. Likewise, legacy GICs paying lower rates of interest look less attractive; however, GICs can’t be traded so their value stays fixed.

What is meant by fixed income and how to invest in it

How should you invest your cash? Should you buy individual bonds, bond funds or GICs? Let’s look at the characteristics of each investment vehicle.

Individual bonds

This was likely the way your grandparents invested: by buying low-risk government bonds. If you have a brokerage account, you can still do it. It’s sort of like owning a cashable GIC; you have the choice of holding it to maturity or selling it at its market price when you need the money for something else. And, even if interest rates fall, the interest it pays is locked in. Its price fluctuates up and down with interest rates, especially if it has a long term to maturity, but it will mature at its face value.

Bond funds

Most Canadian investors these days own bonds indirectly by buying bond mutual funds or bond exchange-traded funds (ETFs), which can also be bought through an online brokerage. This way you rely on portfolio managers (or an index) to pick the underlying bonds. You get wider exposure to the bond market, too. The downside is you are exposed to market volatility. If interest rates rise, the value of your holdings could fall. Also, you’ll have to pay management fees (deducted from your returns), though in the case of ETFs, these are very small—even as low as 0.1% or less.

GICs

GICs are the safest kind of debt investment available to Canadians, but they come at the price of being illiquid. As their name suggests, GICs are guaranteed by deposit insurance, generally up to $100,000 invested with a bank. Insurance limits can be multiplied by holding GICs in different types of accounts or holding them jointly, and some provincial credit unions have unlimited guarantees. But you have to leave it locked up for the investment’s entire term, anywhere from 120 days to five years. They can’t be traded like bonds, although there are cashable GICs that pay lower rates of interest.

The deciding factors around bonds vs. GICs

When deciding which to choose, Koivula says that the two most common considerations are liquidity and simplicity. 

“When you buy a five-year GIC, your money’s locked away a long time, and a lot can change in five years,” he says. So, if you need access to that money, even just to rebalance your portfolio to take advantage of a stock-market slump, bonds (or bond funds) are the better choice.

Buying individual bonds, though, can be bewildering compared to investing in stocks. For example, “if you buy the common shares of Royal Bank or Fortis, they’re basically all the same,” Koivula says. “In the bond market, a single issuer might have hundreds of bonds with different terms in circulation. It can get quite complex.”

For that reason, when most investors seek exposure to bonds, they invest in bond funds.

There are exceptions, though. Some Canadian investors don’t like the volatility of bond funds—albeit small compared to those of stocks. When interest rates go up, your bond funds can drop in value to less than you paid for them. If you hold a single bond to maturity, by contrast, you can expect to get paid all your capital back with interest. Another solution to the volatility problem is target-maturity bond funds, which hold a basket of bonds that all mature around the same time.

Should you buy bonds or GICs? 

There are a few other factors that might tip the decision in favour of one investment over another.

Diversification benefits

GICs are uncorrelated to equities, but bonds have historically been negatively correlated with equities. That means they tend to go up in value when stock markets crash. Also, GICs are only available in Canada, but you can buy bond funds that hold bonds denominated in U.S. dollars or other currencies. “In Canada, when stock markets go down, typically the U.S. dollar goes up,” Koivula notes. So, if smoothing out your portfolio’s ups and downs is a priority, bond funds may be the best choice, he suggests.

Tax efficiency

The interest paid by most fixed income investments (other than preferred shares) is 100% taxable outside registered accounts. But it is possible to lower your tax bill by buying discount bonds or bond funds that pay low yields and offer more return to maturity in the form of tax-efficient capital gains that may be only half taxable. 

Your risk tolerance

If you put the highest priority on preserving capital, GICs win out. They are guaranteed and you’ll never lose money due to market movements.

What should fixed-income investors in Canada choose: GICs or bonds?

Of course, deciding to invest in fixed income is a personal decision that plays into diversifying your investments, taking advantage of market conditions, what you’re familiar and comfortable with and more. So, really, it’s up to you. 

Read more about investing:

• Making sense of the markets this week
• Best online brokers in Canada
• The best GIC rates in Canada
• Top 100 dividend stocks in Canada

About Michael McCullough

Michael is a financial writer and editor in Duncan, B.C. He’s a former managing editor of Canadian Business and editorial director of Canada Wide Media. He also writes for The Globe and Mail and BCBusiness.

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