Personal Finance

Low-risk fixed income is boring, predictable -- and an essential part of the investment mix.
By Gail Bebee | 02/07/10

The incredible volatility that stock markets around the world have experienced over the past few years has reinforced the importance of holding some low-risk assets with predictable returns in your portfolio. Traditionally, fixed-income investments have filled this bill, and I think they still do.

About the Author
Gail Bebee is an independent personal finance speaker, teacher and the author of No Hype--The Straight Goods on Investing Your Money. She can be reached at gbebee@gailbebee.com; her website is www.gailbebee.com.

However, in today's world of financially engineered fixed-income products that many investors don't understand (asset-backed commercial paper anyone?), it's essential to choose carefully. What, then, are the best choices for this boring but essential asset class?

The venerable five-year laddered strategy, based on five guaranteed investment certificates (GICs) with five different maturities, is one simple solution.

Here's how it works: Divide your fixed-income allocation into five parts. Invest one-fifth in each of one, two, three, four and five-year GICs. When the oldest GIC matures, reinvest the money in a new five-year GIC. Repeat. Boring!

GIC ladders are often given short shrift by financial advisors and investors alike. Even so, they may be the best choice for conservative investors. Here's why:

  • Minimal research time is required. You can go to www.fiscalagents.com to find out which financial institution has the best current rates.


  • GICs are easy to purchase at your local bank, credit union, deposit broker or through other financial-services businesses, and you can do so online or by telephone if you like.


  • You don't need a brokerage account.


  • Your investment is insured against the failure of the GIC issuer as long as the issuer is a member of the Canada Deposit Insurance Corp. (CDIC), a federal Crown corporation. The original GIC maturity date must be five years or less and the maximum coverage is $100,000 of eligible deposits per person per institution. You can go to the CDIC Web site check out the fine print, and see which financial institutions are members.


  • When a GIC comes due, you are reinvesting only part of your fixed- income allocation, reducing the risk of having to reinvest at a low interest rate.

Clearly, the safety and risk-management aspects of GIC ladders are indisputable. But what about returns? A five-year GIC ladder invested at the best rates currently offered by my discount broker (as of mid-June) with each maturing GIC reinvested at the five-year rate (3.7%) would deliver a 3.41% compound interest rate over the five years.

In a rising interest-rate environment such as the one we are now entering, a GIC ladder offers the opportunity for better longer-term compound returns. These are illustrated in the hypothetical scenario below, which assumes rising rates:

Scenario5-year return
No ladder
3.70%
5-year ladder
No rate increase
(maturing GICS reinvested at 3.7%)
3.41%
5-year ladder
1% rate increase in year 2 to 4.7%
3.81%
5-year ladder
1% rate increase in year 3 to 4.7%
3.65%
5-year ladder
0.5% increase in year 2
Another 0.5% increase in year 3
3.73%

Investing directly in bonds is another fixed-income option, albeit one with more risk than GICs. If you go this route, focus on high-quality bonds like Government of Canada issues. Bonds issued by the provinces, Crown corporations and blue-chip corporations are also reasonable choices and have slightly higher interest rates. As with GICs, you'll want to ladder the maturity dates of your bond holdings.

Unlike stocks, bonds do not trade on an exchange, and the sales commission is bundled into the bond's price. So it's difficult for a retail investor to know if the commission is reasonable.

You can get an idea of current wholesale bond prices at www.canadianfixedincome.ca or www.canadianbondindices.com. Your broker might tell you the commission rate if you ask. It makes sense to hold bonds to maturity to keep these hidden transaction costs low.

Retail investors may never get their hands on the best bonds, which are scooped up quickly by institutional investors. This, along with the fact that the commissions are not easily determined, suggests that the bond-investing decks are stacked against the retail investor.

The best alternative may be to let a mutual fund or exchange-traded fund (ETF) manager do the job for you. Look for a fund with:

  • Above-average long-term rates of return within its peer group;


  • A mandate to buy bonds with high-quality credit ratings;


  • An experienced fund manager with a successful track record in managing fixed-income mandates;


  • Low management-expense ratio and low trading fees. These are especially important when interest rates are low, as they are now.

For bond ETFs, in particular, look for one whose market benchmark is a well recognized index of high-quality government and corporate bonds. (Currently, the only fixed-income ETF in Canada which has at least a five-year track record is   iShares DEX Universe Bond Index.

Opting for a mutual fund or ETF rather than holding bonds or GICs directly can make quite a difference in your returns, for better or worse. Here's a snapshot of historical returns for the five years ended May 31:

Benchmark5-yr return
Average 5-year GIC2.7
Average Canadian Fixed Income mutual fund3.7
Median Canadian Fixed Income mutual fund3.7
 iShares DEX Universe Bond Index4.5

While the returns for the mutual funds and ETF were higher than those of five-year GICs, investors need to remember that when interest rates increase, bond prices fall. In our current rising-rate environment, declining net asset values of bond funds and ETFs are likely to erode returns.

Meanwhile, returns available on newly purchased bonds and newly issued five-year GICs should be higher, reflecting rising interest rates.

One final point to factor into your fixed-income planning is protection against inflation. The solution: invest a portion of your fixed-income holding in real-return bonds, either directly or through an inflation-protected bond fund or ETF.

The Great Recession of 2008 reacquainted investors with the concept of investing risk. It served as a reminder that low-risk fixed income -- whether in the form of GICs, bonds, bond mutual funds or bond ETFs -- deserves a permanent place in the portfolio of virtually all investors.

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