The Money Management Newsletter: GICs and Fixed Income
GIC Laddering offers investors flexibility, liquidity

By David Newman
Money Management Newsletter

Investors looking for safe havens often turn to Guaranteed Investment Certificates (GICs), but in many cases they do so without realizing that these investment products can inject flexibility and liquidity as well as security into their portfolio.

Beyond offering a guarantee of principal and a fixed rate of return, frequently ignored benefits of wisely managed GICs can include penalty-free access to a source of income just when it's needed, and the elimination of guesswork in relation to fluctuating interest rates.

These advantages and more can be secured through a portfolio-management technique know as laddering, or staggered investing. It's a relatively simple concept... basically, the investor purposefully purchases GICs with differing dates of maturity and thus rates of return... and it can be extremely useful in meeting various portfolio needs.

Consider income taxes. Many investors faced with quarterly income-tax payments struggle to come up with cash at the right time to fulfill their obligations to the tax man. But if they know the size of their payments each quarter, then they can buy a GIC that pays interest quarterly, thus ensuring that they have sufficient income to meet their needs. And it's the same with any other periodic obligations such as property taxes.

If you are considering implementing laddering for your fixed term GIC portfolio.Here's how to start. Using a calendar, document your periodic expenses. At the same time, review the streams of cash you can take advantage of. There may be regular pension payments, cheques from government sources and income from investments including GICs. Carefully assess the maturity dates of your GIC investments and the corresponding reinvestment dates.

Many investors need their GIC income to help meet their regular expenses. If you find that your investments income doesn't mesh with your cashflow needs, then you are a candidate for restructuring of the GIC component of your portfolio. Take a look at the reinvestment dates of the GICs you own. If the timing is off, you may wish to temporarily park the funds in a short-term note or investment savings account, waiting to then reinvest so the interest payment arrives prior to the when you have to pay the obligation.

If you look around, or have your financial advisor do so, you'll be surprised at the variety of terms being offered to help investors meet specific needs. Some institutions now offer GICs with such terms as 18, 19 or 20 months these can be incorporated into a laddered GIC portfolio as an alternative or complement to shorter terms. The bulk of the interest earned on say a 19 month-GICs would be on the 12th month anniversary date. It goes without saying that, since longer terms are associated with higher rates of return, you will want to purchase as many of the longer-term GICs with targeted maturity dates as fit into your schedule of needs.
Over time, as you adjust the terms of your GIC holdings to meet your liquidity needs, there will be other benefits that come your way, such as balancing the annual cash flow, reinvestment and deployment of some portions of the portfolio into other type of investment vehicles.

Another consideration for investors who hold several GICs that all renew at the same time, or one large GIC, is the loss of flexibility since they are limited to accepting whatever rate is offered when their investments mature. There is nothing like that sinking feeling some investors have when most of the conservative component of their portfolio is due for renewal and they realize they are faced with low returns for the foreseeable future. At this time, they may begin actively seeking alternative investment solutions, another source of stress.
But if you have embarked on a program of laddering, you can avoid being faced with this mass renewal during a period of lower GIC returns.

As the charts below illustrate, assume that certain sums (say $20,000) are invested to mature at different times. Because a portion is engineered to mature at yearly intervals, you have access to that capital without disturbing the full amount. Also if rates are on the incline, you can reinvest the maturing capital at the new higher rate. On the other hand, if rates have softened, you have assured that not all of your capital will have to be renewed in a low rate environment.

Developing a laddered GIC portfolio plan is an easy way to help you maximize GIC return

Some strategic benefits are: -

• Reduces risk - with diversified maturities reduces the impact of interest rate fluxuation
• Flexibility - still able to take advantage of attractive long term interest rate.
• Disciplined - structured approach eliminates "chasing interest rates' or 'waiting out low rates'
• Liquidity - with part maturing each year, you can access your money without penalty.

The first example is one where the investment once in-place will reinvest in 5 year GICs. It provides access to 1/5 of the initial sum each year.

The easy way is to divide the investment into 5 equal amounts, invest the first in a 5 year GIC the second for one year and them at maturity re-invest for 5 years, the third portion for 2 years and at its maturity re-invest for 5 years. Following on with the same type of staggering, invest the balance in the same manner.

Now let's look at some of the characteristics and advantages of different types of specialty GICs you may wish to consider in this context.

Rasteriser or Escalator-type GICs offer hassle-free long-term investments, but for a true comparison to regular GICs you need to remember to look at the average rate of return over the term. This type of investment will only accumulate the interest and pay it out at maturity - much the same way normal compounding certificates operate. With any compounding interest-bearing investment, the interest earned annually has to be included in any tax filings as interest income.

Step over investment matures all the investments to a 5 year horizon.

The caveat here is that you are paying taxes on interest income each year well before it's in your hands, possibly causing a cash-flow problem. However, some Rateriser or Escalator-type GICs can be converted into a regular GIC on the second, third or fourth anniversary date (note, it has to be with that same institution and no shorter in term than the original GIC commitment). If rates rise, this flexibility can be rewarding.
GICs with a link into potential higher returns, such as Market Linked or Index Linked GICs, have become a favourite with investors who are looking to take advantage in the growth potential of the stock market while minimizing the downside risk. Certainly, stock markets are down considerably from the highs they one reached, but their long-term potential for growth, as evidenced by historical analysis, remains high.

Interested in stock market growth and a guarantee of principle - stock-linked GICs may provide the answer.

Market Linked GICs reflect the performance of a basket of public companies or a particular market index such as the S&P 500 or other grouping of companies traded on Canadian or international exchanges. Look for links to indexes with a good track record. Here again your not alone, your financial advisor/Deposit Broker is in the know!
The risk, aside from the volatility of the market is very low. GICs are guaranteed by the issuer and insured for up to $100,000 by the Canada Deposit Insurance Corporation. The return is considered to be interest and reported as such on the tax return. Some institutions guarantee a minimum rate of return while other don't. Some limit the potential growth?, protecting themselves if the market really takes off?, and some don't.
All in all, Market Linked GICs give you an option of the best of both worlds without full exposure to the markets or foreign currency fluctuations. However, a Market Linked GIC will take more work and understanding of both interest rate and market risks on your part than with regular GICs.

One more thing you should know about the term "GIC" is that an investment issued by an insurance company that's being marketed and called a GIC is actually a Guaranteed Interest Contract. For the most part certificates and contracts have the same basic characteristics when building advantages into a laddered portfolio. Guaranteed Interest Contracts issued by a life insurance companies have estate benefits (beneficiary designation) plus potential creditor protection built-in.

To find out if your GICs need revamping call your Fiscal Agents advisor or 905-844-7700.

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