There is no doubt that 2022 was one of the most volatile and distressing periods for fixed income investors. Inflation soared to levels we haven’t seen in a generation, which forced the Bank of Canada to raise interest rates. Inflation fears and the pain of losing money has caused many investors to flee for the safe and predictable returns of Guaranteed Income Certificates.
Jonathan Grant is an Associate Portfolio Manager and Senior Investment Advisor with the Grant Wealth Management Group at TD Wealth Private Investment Advice in Orillia. Jonathan says, “It may be true that GIC yields are attractive but there are other options to consider, and a better choice may be bonds.”
Why bonds?
Certainty: Purchasing a bond equates to lending money to the government. The issuer then guarantees the “face value” will be repaid at the date of the maturity, along with interest.
Jonathan says, “bonds offer safety in a rising-yield environment because they can be held until maturity at par. Unless the underlying issuer declares bankruptcy, which is highly unlikely, the bond will mature at par.”
Returns: Bonds are offering attractive yields and are trading at prices not seen since 2010. Historical data suggest that higher yield levels today will very likely translate into higher total returns in the future.
Government and investment-grade bonds will likely provide better returns and preserve capital over the long term.
Tax Advantages: Returns for GICs are taxed at the full marginal rate. Total returns for bonds, however, include interest payments plus bond price appreciation. The bond price appreciation is categorized as a capital gain or loss. Capital gains tax is only 50% of the individual marginal tax rate.
Jonathan reminds investors, “an added bonus is capital losses can be used to offset gains. When bonds trade at a discount, part of their return is taxed as a capital gain, putting more money in the investor’s pocket.” Bonds may offer a tax efficient capital gain in a falling yield environment and are currently primarily priced at discount.
Liquidity: Unlike Guaranteed Investment Certificates, bonds offer ample liquidity. Once your initial GIC is locked in, you cannot withdraw funds in a pinch. GICs must be held to maturity unless you can convince the financial institution that you’re suffering significant financial hardship, and even then there’s no guarantee that you’ll get the money. Bonds can be exited quickly, which is something you might want to do when the bond price appreciates.
GIC vs BOND: Which is the better option?
While current rates might appear to favour GICs as the preferred investment option, that may not be the case. Unlike GICs, bondholders can enjoy higher yields over time, depending on market factors. When interest rates decline, a bond outperforms, because a share of its return is a capital gain. When interest rates stay the same, a bond outperforms after taxes again, because of the capital gain component.
Jonathan points out, “even when interest rates rise, the bond offers a better rate of return because of its liquidity and more favourable rates of taxation. Whether interest rates go up or down, if you hold a bond to maturity, absent issuer bankruptcy, it will mature at par.”
Laddering over a longer term also benefits the investor. Jonathan says, “This is what active fixed income management is all about. Bond ladders can help create predictable income streams, diversify exposure across bond sectors, and manage some potential risks from changing interest rates.”
Over the next 12 to 18 months TD Wealth’s Asset Allocation Committee thinks interest rates will likely come down. Credit card debt is rising, house prices are falling, and consumer demand is slowing. Leading indicators are pointing to higher unemployment and a slower economy. Only the timing is unclear. Jonathan says, “we are confident that we have seen the bulk of the rate hikes which will likely remain stable throughout 2023. We may even see rate cuts if the economic slowdown intensifies.”
Bonds tend to perform well during recessionary periods. If inflation is lowered, it could create an even stronger backdrop for fixed income investment. One of the rules of investing in bonds is that when interest rates go down, the value of bonds goes up.
Jonathan Grant would be happy to offer his professional advice on what might be the best fixed income investment for you. Contact Jonathan at (705) 330-0067 or Email: [email protected]
Article excerpted from Bonds vs GICs, TD Wealth Investment Office, February 23, 2023
The information contained herein has been provided by TD Wealth and is for information purposes only. The information has been drawn from sources believed to be reliable. The information does not provide financial, legal, tax, or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance.
The views expressed are those of Jonathan Grant, Associate Portfolio Manager and Senior Investment Advisor with Grant Wealth Management Group as of April 14, 2023, and are subject to change based on market and other conditions. Grant Wealth Management Group is part of TD Wealth Private Investment Advice, a division of TD Waterhouse Canada Inc. which is a subsidiary of the Toronto-Dominion Bank.