Whether we like it or not, economic recessions, financial crises and fluctuations in markets are a fact of life.
In 2011, the Arab spring, European sovereign debt crisis and sluggish recovery of the U.S. economy all combined to create a volatile market environment.
Over the last 40 years, the S&P TSX composite index has had many peak-to-trough corrections of more than 20 per cent. Yet, including the recent declines, the S&P TSX index has earned a compound annual rate of return of nine per cent over 25 years.
In times of financial turmoil, investors seek a safe haven for their investments, so it’s not surprising that options like guaranteed investment certificates (GICs) and bonds have become particularly attractive components of portfolios.
Some recent BMO surveys found that 36 per cent of Canadians now are more open to including principal protected investments in their portfolios than they were in 2008 at the start of the recession, and on average 32 per cent are actually holding GICs in their portfolios.
GICs are a great investment option in times of market turbulence because the investor’s capital is guaranteed.
“This characteristic makes a GIC a perfect complement to any well-diversified portfolio by helping to balance risk,” said Dominic Gallippi, head of term investment products at BMO.
“These investors who held diversified portfolios that included GICs were less likely to pull out of the equity markets at an inopportune time and weathered the storm — they stayed invested and were in a better position to benefit from the subsequent market recovery that happened.”
There are a number of things to think about to ensure that the GIC portion of your portfolio is working for you. One of the first is whether to invest in short- or long-term GICs.
Typically, long-term GICs offer higher interest rates. However, the rate of return shouldn’t be the only consideration because investing only in the longer term GICs could limit your gains in the future if rates rise.
“Some GICs offer both: they have short-terms options along with interest rates that are guaranteed to increase over time, so the longer you invest the better,” Gallippi explained.
Creating a GIC ladder is another strategy investors often are advised to implement. Basically, this means you divide your investment into equal parts with staggered maturity dates, usually of one to five years.
“This strategy hedges the investor against interest rate fluctuations, meaning it protects you if rates go down and allows you to gain when rates go up,” Gallippi said.
Another thing to consider is flexibility.
A cashable GIC gives you the option of accessing your money before the GIC’s maturity date. You either can take the money or reinvest it if another opportunity arises.
Typically, when you redeem a cashable GIC your principal continues to be protected. On the other hand, non-cashable GICs must be held to maturity but they generally reward investors with a higher interest rate.
“So think about how much of your GIC portfolio you actually need to have cashable and have the rest in non-cashable investments to earn a better return, Gallippi said.
The last major consideration is the type of return you get from GICs.
Most GICs typically offer guaranteed fixed rates of returns, but some do offer variable interest rates. However, given that interest rates are expected to stay low for the foreseeable future, it may be best to limit exposure to that kind of product for now.
Some newer types of GICs are linked to the returns of the market. Market-linked GICs give investors the opportunity to participate in stock market performance, which traditionally has been higher than GICs and other fixed income investments, yet they continue to guarantee the safety of the principal.
“With interest rates being so low and volatility in the marketplace persisting, these are becoming very popular,” Gallippi said. “They offer an opportunity to earn more, even for customers with very low risk tolerances who otherwise would normally not have the opportunity to get exposure to the markets.”
Gallippi believes investors should hold GICs in their RRSPs, if they can, because it’s an ideal way to achieve tax-sheltered growth.
“In a nutshell, diversify your overall portfolio by including GICs, and diversify the maturity dates and types of GICs to better manage interest rate risk and improve the return potential,” Gallippi advises. “And if possible, hold your GICs inside your RSP.”
Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors.