Dale Jackson

Personal Finance Columnist, Payback Time

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As borrowers bemoan yet another massive interest-rate hike by the Bank of Canada, savers are getting a long overdue reward.

In the wake of the fourth consecutive outsized increase by the central bank to combat inflation, yields on fixed income vehicles continue to rise.

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Just hours after Wednesday’s announcement, payouts on Canadian government two-year bonds ticked up slightly to 3.62 per cent and some one-year guaranteed investment certificate (GIC) yields have reached 4.5 per cent.

Earlier this year, investors were lucky to get one per cent on a GIC — but the times, they are changing. 

Wednesday’s 75-basis-point (which is a different way of saying three-quarters of a percentage point) increase brings the Bank of Canada’s benchmark lending rate to 3.25 per cent following a surprise full-point hike in July and half-percentage-point increase in April and June. Before then, it sat at an emergency pandemic low of 0.25 per cent.

And the central bank isn’t done; it has clearly signalled more hikes are coming. Markets are pricing in a solid chance of another half-percentage-point increase 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 following a net redemption of $10.4 billion in June.

On a conference call with analysts last month, Royal Bank of Canada Chief Financial Officer Nadine Ahn said much of the money pulled from RBC mutual funds in its fiscal third quarter went into GIC products.

Don’t jump on the highest yield just yet

Yields on longer-term fixed-income vehicles are normally higher than shorter-term maturities but experts caution savers not to jump at the highest rate in a rapidly rising interest rate environment.

The official inflation rate has come down since the rate hikes started but is still well above seven per cent. That means even a GIC that pays 4.5 per cent is way below the cost of living. 

For now, most fixed-income managers recommend laddering fixed income in short-term increments so they mature frequently enough to take advantage of yields as they rise. 

After all, 4.5 per cent might look like chicken feed a year from now.

Not all income is fixed

Like the name implies, payouts from GICs are guaranteed and essentially backed by the government. So are payouts from government bonds. If they default, we’re all in big trouble.

Fixed income is reliable income that we can count on when we need it.

Dividends from stocks and real estate investment trusts are considered income, but not fixed, because the payouts are at the discretion of the company or trust, and the value of the underlying investment can rise and fall with the whims of the market. 

Many investment advisors who are only qualified to sell mutual funds (and are only compensated by selling mutual funds) attempt to substitute the fixed income portion of a portfolio with bond funds. Bond funds are not fixed income because their holdings are often traded on the broader bond market and not held to maturity.

Many bond funds have posted losses as interest rates declined.

Fixed income as part of a portfolio

It’s important to have a fixed income component in any retirement portfolio no matter where yields are. 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 return is better than the losses on equity markets so far this year, as an example. 

Three decades ago, before interest rates hit rock-bottom, the general rule of investing called for a fixed-income portfolio weighting roughly equal to the age of the investor. That means a 50-year-old would have half of their portfolio in fixed income. If your retirement goal called for an annual real return of six per cent, a five per cent return on the fixed-income portion of your portfolio made it much more attainable.

GICs will pay more going forward, but they have always been a tonic to help investors sleep at night.

Payback Time is a weekly column by personal finance columnist Dale Jackson about how to prepare your finances for retirement. Have a question you want answered? Email dalejackson.paybacktime@gmail.com.