GIC vs. aggregate bond ETF: Which is best for a retiree?

– Dali

A: The Bank of Canada has now raised its key interest rate (called the target for the overnight rate) four times since July 2017, taking it from 0.5% to 1.5%. Many forecasters expect another hike in October. As you can attest, Dali, these rate hikes have hurt fixed-income investors, since bond prices and interest rates move like a seesaw: when one goes up, the other goes down.

READ: How rising interest rates actually affect you

But the Bank of Canada’s target is not the only interest rate that affects the fixed income market. The central bank’s rate directly affects lines of credit and, to a lesser extent, bonds with short maturities—like the ones that make up 40% of your portfolio, Dali. But in the 12 months that followed the first central bank rate increase in July 2017, the yield on 10-year Government of Canada bonds ticked up only slightly, and the yield on long-term bonds (the Bank of Canada’s benchmark has a 30-year term) actually declined. So if you held an “aggregate” bond ETF—one that holds a mix of short, intermediate and long-term bonds—you escaped most of the damage.

Problem is, we can’t predict how interest rates will move in the future. Recently short-term yields have risen the fastest, but that may not continue. The yields on five-, 10- and 20-year bonds might soon catch up—or they might not. Trying to reposition your portfolio to profit from these moves is futile, and often counterproductive.

Dali, if you are looking for a little more stability in your income-oriented portfolio you might instead consider holding less in short-term bonds and more in GICs*. The latter offer several advantages:

• Unlike bond ETFs, which move up or down with every change in interest rates, GICs don’t fluctuate in price, and many investors find this comforting.
• GICs offer significantly higher yields than government bonds of the same maturity: for example, a five-year Government of Canada bond yields about 2.2% today, compared with as much as 3.5% for a five-year GIC if you shop around.
• GICs are insured against default by the Canada Deposit Insurance Corporation (CDIC) for up to $100,000 per issuer.
• Building a GIC ladder (keeping equal amounts in GICs with terms of one, two, three, four and five years) allows you to spread out your risk so you won’t be strongly affected by modest moves in interest rates, either up or down.

The biggest downside of GICs is that you cannot sell them before maturity. But, Dali, as long as you make sure you have enough liquidity elsewhere in your portfolio, you can likely hold more in GICs than you are now. That should help ease your concerns about the possibility of rising interest rates.

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