We'll see a hike, pause, hike pattern if the BOC is concerned about overtightening: Strategist
The first benefit is obvious. After a 15-month period that took the benchmark rate from near zero to 4.75 per cent, yields on fixed income have skyrocketed. A basic one-year guaranteed investment certificate (GIC) - the most secure short-term savings vehicle available to the average investor - has topped five per cent. Savers were lucky to get one per cent before the rate hikes began.
The yield on the benchmark Government of Canada five-year bond is currently 3.75 per cent (from under 0.5 per cent), but is expected to rise further along with investment grade corporate bonds.
MACKLEM ON A MISSION
The second blessing is the Bank of Canada’s aggressive and unwavering commitment to prevent their savings from being gobbled up by inflation. This week’s interest rate increase came with the stipulation that it will raise rates further in the coming months if cost of living increases don’t fall closer to its two per cent target rate.
Despite being late to react, policymakers led by Governor Tiff Macklem have taken a global leadership role in doing whatever it takes to ensure all Canadians don’t get crushed by runaway inflation; even if it requires some bloodletting.
We’re not out of the woods yet but the latest reading puts inflation at 4.3 per cent compared with last year when it topped eight per cent.
STRANGE NEW WORLD OF INVESTING
The Bank of Canada rate has not been this high since 2001. It’s a strange new world for a generation of investors who have never had the advantage of significant risk-free returns.
Strategically, having a significant portion of retirement savings in fixed income is essential to balance overall portfolio risk against the volatility of equities. Any rate of return is welcome if stock markets tank when retirees need a reliable cash supply for living expenses.
In addition to hedging risk, fixed-income investments can also generate tax savings in registered accounts such as a registered retirement savings plan (RRSP), tax-free savings account (TFSA), registered education savings plan (RESP) and the just-introduced first home savings account (FHSA). In comparison, fixed-income investments are fully taxed outside a registered account.
There are strategies for retirement investors to maximize fixed income returns by staggering maturities within a portfolio to take advantage of the best going yields as often as possible. The most common strategy, known as laddering, ladders maturities over a fixed period of time.
Most fixed income experts are currently recommending short durations on expectations persistent inflation will force rates even higher.
Prices on bonds fluctuate before maturity based on future interest rate speculation but that’s a problem only bond traders have. Retirement investors will generally hold fixed income to maturity, so they know exactly what to expect when that day comes.
There is no single set of rules when it comes to managing a fixed income portfolio for individuals. The portion of fixed income in the overall portfolio, the total duration of a ladder, and the types of fixed-income investments depend on when and how the investor wants to retire.
A qualified advisor should be able to help.