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The Money Management Newsletter: Savings
GIC savers in a dilemma

"The current low interest rate environment has left many GIC savers in a dilemma."

If you have GICs maturing now should you park the money in a savings account and wait for rates to rise or should you invest now because rates could still go lower?

You may be comforted to know that there is no right answer because nobody can accurately predict interest rate movements. Generally the direction of rates is influenced by bond investors and central bank perceptions of future inflation and employment levels based on a vast array of economic indicators that are sometimes contradictory. At various times external forces (direction of U.S. rates) and other internal forces (threat of Quebec separation) can affect rates as well. You will never know for certain where rates will be a year or two down the road.

At the present time Canada has low inflation, low growth and high unemployment all of which would suggest stable or lower interest rates. In addition, our governments are trying to lower both their deficits and overall debt so that external forces such as the direction of US rates will be minimized in the future thus permitting Canada to determine its own interest rate levels (we are not there yet).

How can this knowledge affect your strategy? Well a study done for the Bank of Montreal in September of this year by Mary McDonough Research Associates looked at a hypothetical GIC investor who had a choice of two investment options. For each month over the 30 year period from 1965 to 1995 the choice was either a one year term GIC to be compounded and renewed each year for the following 5 years or a 5 year term compound interest GIC. Over the full 30 year period the 5 year term strategy was better 71% of the time.

Does this mean you should lock all your GIC investments into a 5 year term? Not necessarily. It means you should take comfort in knowing that you can invest some of your money for 5 years and have a greater success ratio than consistently buying one year term GICs. In fact according to the same study the 5 year term strategy was better 85% of the time in the 1980's and has also been the better strategy to date in the 1990's.

Due to the sheer magnitude of GIC investment possibilities the study did not consider any terms other than the continuous one or five year term option.

That doesn't mean that you shouldn't. One of the most important things to remember for any investment portfolio is balance. Ideally the balance will come from a variety of investment types, however there are still many people who are only comfortable will GICs.

For the GIC only investor the balance should come from having an equal portion of their money coming due each year over a 5 year or longer cycle. Once you have funds invested to mature each year of the cycle simply roll over maturing GICs each year for the longest period in the cycle (i.e. 5 years or longer). Sticking to this regime will remove the guessing and uncertainty about rates and the above noted study shows that renewing for long terms is the better strategy.

Make sure that you balance the investments first over all terms and maybe keep some back in cash. Why? Because we don't know for sure where rates are going. It is possible that US rates will rise before year end and continue into early next year (their economic conditions are different than ours). Canadian rates may follow this trend, because we have not broken away yet from the US influence, but don't expect it to be a long term situation. You will need to have cash available or something maturing to buy in if the rates move up.

I don't know if you remember or not but in early 1994, 5 year GIC rates bottomed out below 6% but then the US starting raising rates to combat inflation. Canadian rates followed suit peaking to just over 9% for 5 years by early 1995 then falling again. This could happen again but it might not and the height of the rise will depend on how low rates go in the meantime.

If rates do rise take the cash and lock in long term but maintain your balanced portfolio. Remember we don't know the future and possible Quebec separation is still a major market issue.

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