Many fixed income investors do themselves a disservice by holding GIC Ladders. In this essay I attempt to highlight the weaknesses in the strategy and show how these weaknesses may be addressed by the addition of Preferred Shares or other longer-dated fixed income instruments.
Look for the research link!
Update, 2009-8-29 This essay was picked up in a Globe & Mail Round-up:
The 411 on GICs
The manual for conservative investing starts with the concept of the bond or GIC ladder, where you divide your money evenly into terms of one through five years. It’s a strategy that gives you new money to invest every year at potentially higher rates, while limiting the damage if rates fall. Now, read about the down side of laddering GICs from James Hymas, one of Canada’s foremost experts in preferred shares.
Mr. Hymas’ comments have been posted on the website of an independent education website called Independent Investor, which itself has some comments on GICs (called certificates of deposit here) and preferred shares.
The linked website provides its own perspective on the question, but I take issue with one aspect of the commentary:
He recently published a text (or a PDF version doc.1399) which criticizes the technique of building a ladder of fixed income investments using certificates of deposit, and proposes instead investing in preferred shares a significant portion (but less than 50%) of the fixed income portion of the securities portfolio of most (but not for all since , for example, he excludes 70 + years of age investors) investors.
I didn’t exclude investors of 70+ years of age, but I did state:
The ‘one size fits all’ nature of the fixed income strategy allows advisors to brush aside considerations such as:
- • the purpose of the portfolio
- • the likelihood of the portfolio achieving that purpose
- • the ability of the client to question the skill of his advisor
These elements should not be ignored when constructing a fixed income portfolio. The fixed income portfolio of a high-net-worth seventy-year-old retiree should be very different from that of a forty-year-old with a family and mortgage to support; but to the best of my knowledge these questions have not been addressed by any of the proponents of the strategy.
… which is not the same thing as a flat exclusion – in fact, when I chose those two examples, I was thinking that the forty-year-old should be less exposed to preferreds than the seventy-year-old, since the former must address the possibility of job-loss, medical problems and university tuition (each of which could require some degree of portfolio liquidation) while the investment objective of the latter would have a greater weighting towards a desire for preservation of income over a thirty-year period.
Update, 2010-1-15: In the Ignorance Is Bliss department, Rob Carrick weighs in with In praise of a much maligned investment:
There’s some compensation for the lack of liquidity in a GIC. If there’s no market for selling them before maturity, then there’s no need to track daily prices as they rise and fall in response to interest rate changes. Net result: the value of a GIC in your account will remain steady as rates rise or grow in value to reflect the interest payments you’re accruing. If rates rise, bonds and bond funds fall in price.
I’ve said it before, I’ll say it again: just because the daily change in value is not reported doesn’t mean it doesn’t exist.