Waiting to see how high or low rates will go could be costing you right now
Last updated: June 2022
Over the last decade, GIC rates have meandered between 1 and 3% – considered very low, with government bonds even lower. That narrative has only recently begun to shift in 2022, with rates now climbing as high as 4.25% in the first half of the year.
Those assuming rates will continue to trend higher are often enticed into placing their money into shorter term investments, often much lower rates, or parking cash in “high” interest savings accounts (with rates often as low as 1.50% or less). In truth, the upper limit as to where rates will eventually plateau is still unknown. As a strategy, guessing is not that sophisticated – particularly when hard facts are in plain sight.
Robert S. Cable is an investment advisor and author of Investing on Autopilot. In a 2011 article in the National Post, Cable posited this question:
“If people armed with the best information and most sophisticated systems have zero ability to see where rates are going, do you think it makes any sense for you to guess?”
He further lays out a simple laddered approach in the article Falling off the Fixed Income Ladder, which he expands upon further in his book Investing on Autopilot – which is, to keep an equal amount of money invested in one- through five-year maturities. It’s a strategy that beats almost any other, 19 times out of 20.
All about Laddering
The ladder is an easily-recommended strategy to most people investing their fixed-income money for four major reasons:
- It’s almost impossible to beat,
- It’s simple and effective,
- It eliminates all guesswork, and
- You’ll end up with more money in your pocket.
Simple to understand and extremely effective – Laddering can take away the guesswork and replace it with higher returns.
This strategy has been tested to work nearly every time. With such seemingly low interest rates in the recent past, it’s been more difficult to keep investors from “falling off their ladder”. Let’s revisit why the ladder makes sense financially with a hypothetical.
Interest rates offered by Fiscal Agents on Guaranteed Investment Certificates in mid-2021 were:
- 1 year 1.50%
- 2 years 1.55%
- 3 years 1.75%
- 4 years 2.00%
- 5 years 2.20%
With a ladder strategy already established, whenever money comes due, according to the discipline, this money is to be invested for five years. This keeps equal amounts always invested in each of one- through five-year terms.
What’s the risk of just going with shorter-term GICs?
Those who “just know” rates have to rise sometimes decide they’ll invest for just one year, and then after rates have eventually risen (surely), they’ll invest longer out. It’s a bad idea, and here’s why.
Assume this investor had $100,000 come due. Investing this money for five years at 2.20% earns them (compounded) $11,495.
Now if they choose to believe (read: guess) interest rates will continue to increase, and invests for just one year instead of five, they’ll have $101,500 a year from now (taking the low 1-year 1.50% rate, in hopes rates would rise). So to catch up to the disciplined ladder investor, over the next four years they’ll have to earn $9,995. (That’s the $11,495 he should be earning minus the $1,500 he did earn.)
If you do the math, you will find that in order to catch up to the $111,495 this investor should have had, guaranteed over the remaining four years, they would require a return of exactly 2.752%.
Looking back at interest rates at the time, we see that four-year rates are at 2.00%. For our “rates just have to go higher” investor who chose to gamble with the one-year GIC, rates do indeed have to rise substantially: From 2.00% now to 2.752% – an increase of 28%!
So in the relatively remote chance that this jump in interest rates does occur, remember – it has to happen in that first 12-month period.
The “fall off the ladder” investor has to be:
- Correct on the direction of interest rates,
- Correct on the magnitude of the increase in the level of interest rates,
- Correct on the timing of the increase in interest rates.
If they somehow manage to get all of this right, what is their reward? They will simply break even with what they would have earned, by simply staying with the discipline of the ladder.
If you’re at all wrong on any single factor, you lose. You have to get everything right just to break even.
You be the judge whether the gamble was worth it – some people will look at these facts and ignore them, because they’re convinced rates have to go up, and fixed opinions are hard to change no matter what the facts say.
What will this investor do a year from now if rates have not risen enough, not risen at all or actually drifted lower? They’ll have another $100,000 coming due from his ladder and have a nearly impossible decision to make on over twice as much money. All from taking a gamble that, statistically at least, was a very poor one.
It’s only natural to think “rates are going up, and so I’ll make more money if I wait”. On the surface, this seems to be a reasonable conclusion. But when you do the math and look at the actual facts, it’s exactly the opposite – you are almost guaranteed to lose.
Think about this and the fact that you’re almost guaranteed to lose the next time you’re tempted to fall off your ladder.
How we can help you:
To further explore the ins and outs of laddering and consolidating a mismatched GIC portfolio, the following two articles below may be of interest.
- GIC laddering offers you flexibility and liquidity
- Thinking about reshaping your GIC portfolio? The path to consolidation: The mix and matching process
If you’d like help towards a redesign of your GIC portfolio, we’re here to help and have the experience to do so. Contact us today and let’s work together.
