You hold bonds in a portfolio to hedge against stock market risk, but what happens when stocks and bonds both fall?
That’s one of the investing stories of 2022 so far – the S&P/TSX Composite Index was down about 3 per cent for the year through late January, and the FTSE Canada Universe Bond Index was down pretty much the same. Both declines are on a total return basis, including dividends and bond interest.
Rising inflation and the expectation of a cycle of rising interest rates are weighing on both stocks and bonds. If stocks crash, bonds will hold up better. But as we navigate through the unusual economic landscape of early 2022, it’s clear that a conventional mix of stocks and bonds isn’t thriving.
Here’s a thought for investors who want something understandable and accessible in their portfolio to offset stock market risk, but not bonds that look set for a long period of price declines while rates rise. Consider the humble guaranteed investment certificate, with yields as high as 1 to 2 per cent for a one-year term and 2.25 to 3 per cent for five years. A five-year Government of Canada bond yielded about 1.7 per cent in late January.
The FTSE Canada Universe Bond Index had a yield of about 2.4 per cent. But it contains a large helping of bonds that mature in five years or more, and about 70 per cent of the portfolio is in government bonds. These two factors add to its vulnerability to price declines as rates move higher. GICs are illiquid, which is bad if you might need to sell before maturity. But they also don’t fluctuate in price in your portfolio, dragging down overall returns.
A ladder of GICs provides interest income and stability. A ladder, by the way, is equal investments in GICs or bonds maturing in one through five years. When a GIC matures, the proceeds are reinvested in a new five-year term. Some investors might prefer using GIC maturing in no more than three years, given that some GIC issuers don’t offer much of a premium for locking in for five years.
Online brokers typically offer access to GICs from multiple issuers, but those with the very best rates are generally not included in the mix. For access to those GICs, you need to deal directly with the issuer. One of the bigger online brokerages recently had five-year GICs with yields as high as 2.65 per cent, three-year GICs as high as 2.22 per cent and one-year GICs as high as 1.55 per cent.
Even the highest GIC yields currently available offer far from stellar returns when inflation is close to 5 per cent, but there’s no risk of losing money if you stay within deposit insurance limits. Consider this tradeoff if you want a stock market hedge that isn’t losing value right now.
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