Radar Screen:- Fixed Term Investments
Source: Manulife Financial,
Feburary 8 ,2001
Title: GICs vs Bond Funds - another perspective
Most advisors agree that a properly diversified portfolio includes a component in fixed-income investments. These fixed-income investments typically include bonds, bond funds and, what is becoming more common, GICs. The actual percentage of the portfolio that is in fixed-income investments usually depends on the clients risk tolerance, investment horizon, and required return. Some use the guideline that the fixed-income component should be equal the investor's age. Many feel this is too conservative and simplistic and prefer to place more faith in asset allocation tools, such as Invest Right to come up with percentages. But let's face it, when returns and markets are soaring, it's easy to forget about the "boring" fixed-income side of the house. The year 2000 was a good example of why portfolio diversification is so important.
Although each fixed-income product is a bit different, their main investment objectives are usually to: * add a degree of portfolio stability by limiting, or reducing overall volatility,
* ensure part of the portfolio is growing no matter how stock and bond markets perform,
* earn a predictable return based on current interest rates, which generally provides a positive gross return above inflation, and
* provide a stable, more secure stream of income.
SOME OF THE RISKS IN USING BOND FUNDS
Historically, bond funds seem to have been the investment of choice when selecting the fixed-income portion of the portfolio. However, it's important to understand some of the risks in using this strategy and to explore alternatives or complementary investments.
* In an interest rate environment like today, where rates are fluctuating and trending one way or the other, bond funds may not reduce overall portfolio volatility.
* There is no guarantee a bond fund will increase in value over a specific period; 1998 and 1999 offer a good example of this.
* Bond fund returns are significantly impacted by fund Management Expense Ratios (MERs) ranging from 1% to 2%. In a low interest rate environment, this is more significant and MERs can easily account for over 30% of the bond yields produced. A key consideration is that the actual bond fund return will fluctuate with interest rate movements and the ability of fund managers to predict this movement. Especially in the short term, this can be detrimental or beneficial to the investor, depending on the direction of movement and the fund managers forecast. In either case, bond fund returns can't be guaranteed.
* Bond funds can't guarantee a fixed-income amount without potentially sacrificing capital in the future.
ADVANTAGES OF USING GICs IN A DIVERSIFIED PORTFOLIO
GICs are certainly not as sexy as bond funds, but they still account for a large percentage of the fixed-income product sales in Canada and over $300 billion in assets. This is likely due to some of the advantages that many feel GICs offer over bond funds or as a complement.
* GICs are one of the most secure and predictable investments available. Unlike bond funds, GICs include CDIC or CompCorp insurance, which protect investments up to specific deposit levels. In addition, GICs offered by life insurance companies offer potential creditor protection and certain estate planning advantages which allow investors to put more money into the hands of their beneficiaries, sooner. * GIC investors will never see their investment decline in value over a period of time (as long as withdrawals do not exceed interest earned). This is especially important when you want to ensure that at least portion of the portfolio is constantly growing.
* GIC growth is guaranteed through the locked-in, guaranteed interest rate. GIC rates are typically very comparable to returns available on Government of Canada bonds. In addition, investors can stagger the maturity dates of several GICs to create a three- or five-year "laddered" GIC portfolio, averaging the interest rate earned over a number of years. This further reduces reinvestment risk while increasing portfolio liquidity.
* GICs can ensure capital is not eroded if interest-only payments are selected. This feature allows investors to receive a stream of income without any risk of reducing the capital invested.
SO WHAT SHOULD YOU DO?
We aren't suggesting that investing in bond funds can't be profitable for you, nor are we suggesting that you abandon these investments. What we are suggesting is that when selecting fixed-income investments for your [Portfolio], make sure the product matches your client's investment objective. Consider GICs for all or part of the fixed-term investment component of the client's asset mix. When reviewing the fixed-income portion of a portfolio, consider the benefits of a secure, dependable, predicable return where capital never decreases in value. GICs can still be one of the best investment choices to give your peace of mind through these very volatile stock and bond market trends. Our suggestion, consider using GICs to add some certainty to your clients portfolio.
TAKE ADVANTAGE TODAY!
For more information on Manulife Financial GICs including Term Account and Lifestyle RRIF, refer to the Manulife Financial GIC home page on Repsource: https://hermes.manulife.com/Canada/epe.nsf/Public/fixedsplash
To discuss these and other ideas further, please contact Fiscal Agents