2023-03-15
Ask the Money Lady: Investing in bonds
Dear Money Lady, I really can't handle the stock market so I wondered if you could write about investing in bonds? Thanks, Melanie
Dear Melanie, great question – there are a lot of people who feel the same way. Trading in bonds seems to be less enticing to the average investor and it surprises me how this market is often overlooked, so thank you for asking about it. Bonds seem to get a lot of bad press, and they lack the media sensation of stock spikes in the market. Let's start with the basics and then some tips on what to look for.
Fixed income securities represent the debt offered by an issuing entity, for example a bank or corporation. Governments, corporations and lending institutions finance their expansions by issuing fixed income products.
Investors can purchase these products, which allows them to essentially lend to the issuers, making you the "creditor" of the transaction, not part owner as you would be when you purchase stock in a company. Fixed income products are certainly not as glamourous as trading in the stock market, but don't underestimate this market.
The Canadian bond market has always been much larger than the equity market with $83.6 billion borrowed in the form of debt securities from Canadian governments and corporations in the last quarter of 2022 (Stats Canada, Feb. 6, 2023). This market is said to be at least 10 to 12 times the size of the equity markets with a Canadian value of more than $5 trillion in 2022.
There are many fixed income products to choose from with varying degrees of risk and rates of returns. Here's what you can consider other than a GIC (Guaranteed Investment Certificate).
- Canadian or U.S. treasury bills/notes, commercial papers (CPPP), term deposits
- Marketable bonds (non-callable federal government bonds)
- Real return bonds (Government of Canada bonds-inflation adjusted)
- Corporate bonds and corporate notes (choose AAA or AA ratings for long-term bonds)
- Provincial and municipal government bonds (only available for residents of province)
- Mortgage bonds and collateral trust bonds (choose senior securities to lower risk, first charge)
- Strip bonds (zero-coupon bonds – purchased at a discount and mature at par)
- Foreign and Euro-bonds (watch for currency exchange and fees)
- Preferred securities/debentures, (long-term 25-99 years, traded in the market)
*Tax efficient alternative to regular bonds due to dividend credit.
The most popular and mainstay fixed income product is still the GIC, available at every financial institution. It is by far one of the safest investments available.
Basically, you are lending money when you invest and the bank that issues the GIC is now legally obligated to repay the principal plus interest to the investor with up to $100,000 guaranteed coverage by CDIC (Canada Deposit Insurance Corporation).
Because of the secure nature, GICs can be used as collateral for other personal loans and can even be sold privately or through intermediaries. The term of a GIC can range from 30 days to 10 years. Here are the different offerings across Canada.
- Guaranteed return/fixed rate GICs: non-redeemable, one-year cashable, redeemable, rate advantage, Canadian or U.S. dollar.
- Instalment GICs (contributions made weekly, biweekly or monthly).
- Income Builder GIC (escalating rate GICs): interest rate increases over the term.
- Index/Market-linked GICs (exposure to the stock market): Canadian or U.S. markets, ESG-socially responsible.
- Interest rate linked GICs (linked to the Canadian prime rate-variable)
Regardless of what fixed income product you choose, why not try a laddered portfolio plan to provide more liquidity, diversification and a reduction in interest rate risks. Laddered investment strategies are not new and are often used with GICs and strip bonds.
With this type of strategy, you would divide your investment into one-, three-, five-, and seven-year terms. As each portion matures, it can be reinvested or redeemed as needed. To ensure you always have access to the investment and have more control over the locked-in rates, you may want to opt for an annual maturation.
Christine Ibbotson is a national radio host, YouTuber and author of three finance books plus the Canadian best-selling book How to Retire Debt Free & Wealthy. Send in your money questions to www.askthemoneylady.ca.
