December 1996

Better GIC Alternatives

© Talbot Stevens

Canadians, who have a reputation for preferring conservative, guaranteed investments, currently face one of the most difficult decisions of their lives.

Interest rates are at 40-year lows and have dropped over the last few years from well over 10% to around 3%. This means that income from fixed income investments has decreased by 70%.

Many Canadians are desperately seeking better GIC alternatives, especially seniors who depend on interest income.

Using a 1-year GIC as our base line reference, the following investments provide income without any risk of losing your principal. All quoted rates are as of November 19, 1996.

Longer term GICs generally pay more. Five-year GICs are at about 5%, versus about 3% for 1-year GICs. While this is a 2% absolute improvement, it is a 67% improvement relative to the 3% reference.

Cashable GICs offer liquidity and allow you to change your mind if something better comes up. Also consider "escalator GICs" where rates rise over time, and offer limited liquidity usually once a year. Be careful to compare "apples to apples" for the lower first year rate, and not the higher rates at the end of the term.

For short-term investments, treasury bills or T-Bills are backed by the federal government. One-year T-Bills currently yield 3.35%.

Money Market Funds are a type of mutual fund that generally invest in T-Bills, and distribute interest monthly. They are very liquid and some even offer limited chequing privileges.

For periods of more than 1 year, federal bonds pay interest semi-annually, are backed by the government, and offer slightly higher yields. Five year Canada bonds currently yield 5.25% versus 5% for a 5 year GIC. Thirty year Canada bonds yield 6.77%. By holding bonds to maturity, you are guaranteed to receive your full principal and the quoted yield. Selling before maturity can result in a capital gain or loss, depending on where rates have moved.

Mortgage Backed Securities are another federally guaranteed alternative that pay monthly interest. Current yields for 5-year terms are about 4.8%.

Seniors should also consider annuities for a small portion of their funds, perhaps coupled with a life insurance policy if passing on your principal to beneficiaries is a priority. Be sure to see a trusted advisor on this because annuity options and the fine print can be complicated.

The final and maybe most important suggestion for dealing with low rates is to accept the fact that guaranteed returns are not adequate, and invest a portion in mutual funds, which are not guaranteed. Perhaps the more conservative and stable balanced mutual funds are a comfortable way to start.

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