Dale Jackson

Personal Finance Columnist, Payback Time

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Another interest rate hike, another crushing blow for borrowers, and another reward for savers. 

In the battle to quell inflation, the Bank of Canada increased its benchmark rate this week for the 10th time since March 2022 to an even five per cent. 

And it doesn’t appear to be over. Swaps – insurance against interest rate fluctuations traded on the options market – imply there is a better than 75 per cent chance of another increase at the central bank’s next meeting in September.     

As it stands, borrowing rates and yields on fixed income have skyrocketed by about 4.75 per cent in less than two years. Prime lending rates at the big Canadian banks are now at 7.2 per cent, and payouts on one-year guaranteed investment certificates (GICs) are now as high as 5.5 per cent.

THE WORLD IS A SAFER PLACE

The good news for savers and borrowers is; it’s working. The concerted effort by the world’s central banks, including the Bank of Canada, has tamped down stubbornly high inflation closer to their two per cent target. This week’s tamer-than-expected June CPI data from the United States is the latest sign that global inflation is under control.

The best news - aside from the obvious benefit for savers - is a safer world for everyone. Although rates have not been this high since 2001, they are more in line with historic averages. That denies speculators the cheap cash that can destabilize markets, and gives central banks more ammunition to react to the next financial shock (usually caused by speculators destabilizing markets).

It was the ability to maintain or lower rates that kept capital markets flowing after the technology crash of 2000, the global financial meltdown of 2008 and the pandemic of 2020. Risk is just part of the job for investment banks but the greatest toll from widespread financial catastrophes mostly falls on average households and long-term retail investors.

PORTFOLIO GROWTH AND SECURITY

The benefit of higher interest rates is much more direct for retirement investors who now have safer options to compound their savings.

Yields on fixed income like GICs, government bonds and even investment grade corporate bonds are reaching 20-year highs. The biggest opportunities are in shorter maturities for now because the risk of further interest rate increases are keeping investors from locking in for long periods of time.

Fixed income can now add to overall portfolio growth instead of acting as a fruitless hedge against volatile equities. It can also add to the steady flow of income required to live in retirement and replace riskier income alternatives such as stock dividends and real estate investment trusts (REITs).

A qualified advisor can help formulate strategies to maximize fixed income returns by staggering maturities within a portfolio to take advantage of the best going yields as often as possible. The most common strategy, known as laddering, ladders maturities over a fixed period of time.

An advisor can also help determine how much of your portfolio should be directed toward fixed income based on your growth goals, tolerance for risk and when you will need that cash. 

The last time interest rates and yields were this high the general rule was to allocate a percentage of your portfolio to fixed income equal to your age. In other words; if you were 50 years old, half of your portfolio should be in fixed income. It was a way to automatically reduce equity risk as you age.

That rule might seem odd now, but that’s how people rolled in the late 20th century.