The article “When should I add more GICs or bonds to my portfolio mix?” was originally published in Financial Post on December 2, 2022. PHOTO BY MICHAEL M. SANTIAGO/GETTY IMAGES FILES.
Some key investment tips on how to preserve capital while maintaining some fixed-income investments in your portfolio mix
Q: “Do you have any tips to preserve capital? And when is it advisable to add more guaranteed investment certificates (GICs) or bonds to a portfolio mix?” Joan
FP Answers: Investing in mutual funds, exchange-traded funds (ETFs), stocks and bonds traditionally involves developing an investor profile. Investment advisers do this at the onset of a relationship and on an ongoing basis. A DIY investor may not consider the appropriateness of every investment for their portfolio in such a formal way, but investing commonly involves three major considerations: investment objectives, risk tolerance and time horizon.
Capital preservation may be one of an investor’s investment objectives, but it can be assessed in different ways, and can be interpreted on an absolute or a relative basis.
On an absolute basis, preservation of capital as a goal would be defined as not losing a single invested dollar. If the goal is to preserve capital on an absolute basis, this should be relatively easy considering Canada has a stable banking system where you can deposit funds to Canadian Depository Insurance Corp.-insured bank accounts, term deposits and GICs. Keeping money in a safe or wallet would have a similar effect.
The challenge occurs when trying to preserve capital on any sort of relative basis to the change in the cost of goods and services. That is, on an inflation-adjusted basis. If your goal was to preserve $100,000 of savings on a “real” basis, and inflation was seven per cent over the past year, as it has been, you would need $107,000 after one year to keep up with inflation.
Unfortunately, it is difficult to find investment products that guarantee a return on capital that have both no risk to that capital and keep up with inflation. For that reason, the example above may not be so easy to accomplish in a real-life scenario, not to mention if taxes are also considered.
GICs are one product investors can use if capital preservation is a primary goal. The less liquidity required for this investment, the more likely investors may be able to meet their goal on a relative basis. Why? GICs are issued for different terms such as six months, one year, three years, etc. Usually, the longer the term to maturity, the better rate a GIC investor can receive.
But the better rate means the investor is unable to liquidate or withdraw from the GIC during its term. There is no risk to capital on an absolute basis, but there are pitfalls in guaranteed products when reviewing this strategy relative to inflation.
In reviewing capital preservation, two major factors — taxes and inflation — may cause an investor to more closely consider how they invest their money to achieve this goal. High, persistent and sticky inflation can erode an investor’s capital, so an investor may need to be comfortable taking some risks in order to maintain wealth on a relative basis.
For instance, inflation recently hit a 40-year high in Canada, so interest rates have risen in an attempt to curb inflation by reducing borrowing. In addition to increases in borrowing rates, we’ve also experienced an improvement in the interest rates paid for investment products.
This year, GIC rates on certain terms have hit five per cent for the first time in more than 15 years. Similarly, the yield on several United States Treasury bonds has hit four per cent, which is a multi-year high.
Still, investors who want to make an incremental move into investments such as bonds need to be aware of the risks. Even a high-quality, government-issued, short-term bond could experience a double-digit percentage loss over a short period of time.
Both the stock and bond markets in North America this year have had similar negative returns even though they traditionally have an inverse relationship. The FTSE Canada Universe Bond Index is down about 15 per cent this year, which is a surprise to people who thought they couldn’t lose their capital by investing in bonds. Bonds go down when interest rates go up, and they go down a lot when interest rates go up a lot.
The third component of risk profiling is time horizon, a prime consideration for capital preservation. A shorter-term goal should indicate an ability to take on less risk than a longer-term one, because the longer the time horizon, the more likely an investor can risk short-term paper losses, and the longer they have to try to beat inflation and preserve their capital on a relative basis.
When should you add more GICs or bonds to a portfolio mix, Joan? If you need the money in the short term, GICs or short-term bonds can work well.
If you are trying to maintain a target asset allocation of 50 per cent in stocks and 50 per cent in GICs and bonds, you should be adding to your GIC and bond allocations when stocks go up and throw off your asset mix.
This should have been the case for investors in 2021, when North American stocks returned more than 25 per cent. If you’re a conservative investor and don’t like volatility, this is a great time to buy five-per-cent GICs and earn a decent interest rate.
Just remember that over the long run, GICs may not help you keep pace with inflation and you’re trading off higher long-term returns for short-run peace of mind.
Andrew Dobson is a fee-only, advice-only certified financial planner (CFP) and chartered investment manager (CIM) at Objective Financial Partners Inc. in London, Ont. He does not sell any financial products whatsoever. He can be reached at adobson@objectivecfp.com.
