Dale Jackson

Personal Finance Columnist, Payback Time

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The Bank of Canada’s surprise full-point interest rate hike on Wednesday was a sledgehammer blow to Canadian households mired in debt, and a rare opportunity for investors to generate safe income and hedge against inflation.

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The boost to the benchmark rate followed two consecutive half-percentage-point increases in the spring, and overnight swaps trading on the options market are pricing in a further 1.25-percentage-point increase by the end of this year.

In total, that would raise borrowing costs by 3.25 percentage points in 2022 alone. The central bank has vowed to keep raising rates until inflation is tamed, which it warned could take until the end of 2024.

For retirement investors looking for a safe haven from volatile equity markets in fixed income, it’s an abrupt, and welcome, turnaround.

Yields on short-term guaranteed investment certificates (GICs) that were below one per cent a year ago are now paying out well over four per cent and are expected to climb as broader interest rates rise. Returns on longer-term government bonds and investment-grade corporate bonds are also heading higher.

It’s been a hard road for retirement investors who followed the advice of most retirement experts by keeping a portion of their portfolios in fixed income regardless of yields. Even at one per cent, however, fixed income works as a safe counterbalance to equities. So far this year, as an example, tiny fixed-income gains have handily outperformed stock market losses.

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.

Once yields tanked, the average retirement investor could not reach their retirement goals unless they took on a larger equity weighting or abandoned the safety of fixed income for riskier income-generating investments like dividend stocks and real estate investment trusts (REITs).

Many investors might not realize how risky saving for retirement has become.

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 returns are reliable income that we can count on when we need it.

Dividends from stocks and REITs are not considered fixed income 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 the same as 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.

THE BEST FIXED-INCOME STRATEGY 

Most bond traders and investment advisors recommend retirement investors generally keep doing what they’ve been doing when yields were at rock bottom -- ladder maturities.

Laddering means timing GICs or bonds to mature as often as possible so they present more opportunities to reinvest as yields rise.

As an example, split your initial investment over one, two, three, four and five-year terms and reinvest the money to fill in time gaps as they mature.

Maintaining a laddering strategy can be tricky. A qualified investment advisor can help determine how far out on the maturity time ladder to go, and how much of a weighting fixed income should have in your portfolio. 

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.