Graph of the Bank of Canada rate over the past 10 years ending with March 2009.Graph showing how the yield curve has become steeper in March 2009, since short-term GIC rates have falled more than 5-year rates since the summer of 2008.Diagram showing how a 5-year GIC ladder can provide regular income, while still allowing access to 20% of the capital each year for unforseen expenses or changing needs.

WEALTH Matters — SPRING 2009

Interest rates and fixed-income investments

Page and Associates ltd:

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Interest rates and fixed-income investments

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recession recovery

But won’t you be better off taking short terms until the economy stabilizes and interest rates go back up?

Timing the market usually generates lower overall returns than sticking with a longer-term strategy. This is as true with GIC terms as it is with equities, because it is so difficult to predict when rates will go up or down and by how much. Since the yield curve almost always slopes upward for longer terms, the average of 5-years rates is consistently higher than 1-year rates. And when rates are low, the curve is usually steeper, so you give up so much interest by taking a 1-year term, that you would have to reinvest for the next 4 years at a much higher rate than the current 4-year rate just to equal what a 5-year term would pay right now.

Many of our clients eliminate the guesswork and enjoy a much higher and more stable overall interest rate by holding a portfolio of 5 year GICs with their maturity dates staggered across time.

This way not all your money comes due at once, so you earn the average of the 5-year rates, much higher than the average of the 1-year rates.

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Interest Rates are at Historic Lows.

On March 3rd, the Bank of Canada announced that it had cut its ‘overnight rate’ to 0.5% – the lowest level in history.

The more often-quoted ‘Bank of Canada Rate’ is a quarter-point higher at 0.75%.

In a slowing economy, central banks often reduce interest rates to stimulate growth. Back in 2004, interest rates were already at 40-year lows mainly because inflation was at much lower levels than at any time since the late 1960s. Interest rates back in 2004 were actually very close to the long term average back in the 1950s to the mid 1960s.

Interest rates paid on GICs are significantly higher than the Bank Rate. Of course GIC rates have come down in the past 6 months, but not anywhere near as much as the Bank Rate.

The chart at left shows that the rate drop is larger for shorter terms, which is typical of what happens when the Bank Rate declines.

1-year GICs are paying 1.5% less interest than 6 months ago, while the 5 year GIC rate has barely dropped only 0.8%. Six months ago a 5-year GIC paid about 0.6% more than a 1-year GIC, but now it pays 1.3% more – about 50% more interest. This ‘steeper yield curve’ creates a much larger reward for investors who choose longer terms.

Also, you can access 20% of your capital each year because one-fifth of the portfolio matures each year. If you have specific cash needs, we can program for those. And in case you die, the GIC issuer will cash out your GIC when your Estate Trustee directs them to, even if there are still several years left to the normal maturity date.

Ask us how a 5-year GIC ladder might work for you. 

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