Are GICs a good idea for retirement?
As you noted, Rodeen, guaranteed investment certificate (GIC) rates have risen to levels we have not seen in over 10 years. There are one- to five-year rates that are between 4% and 5%. You may not get these rates at major banks, though, where rates are about 2% lower than that, but credit unions and trust companies generally offer a healthy premium.
Are GIC rates going up in Canada?
A year ago, GIC rates were less than 2%. The reason they are so much higher now is worth considering. The May year-over-year inflation rate was nearly 8% so the Bank of Canada (BoC) has raised interest rates to slow down spending and price increases. So, while a 4% GIC rate may seem enticing, it represents nearly a 4% negative real rate of return when adjusted for 8% inflation.
GICs vs stocks as inflation hedges
Stocks tend to be a good inflation hedge but that is not always the case. The S&P/TSX Capped Composite Index was down 10% for the first six months of the year, and the S&P 500 was down 20%. Along with high inflation, there are recession worries and geopolitical risks weighing on the markets.
Stocks are volatile in the short term and sometimes in the medium term but provide great long run returns for patient investors. The longer your time horizon, the less the volatility matters. But obviously, a retiree like your husband, Rodeen, has a shorter time horizon than someone saving for and many years away from retirement. And for some investors, the stress of short-term volatility may not be worth the opportunity to earn higher returns.
As a result, asset allocation—how much to have in stocks versus bonds, or other asset classes—is highly personalized.
If your husband moves out of stocks completely and into GICs, it could result in temporary stock market losses becoming permanent with no potential to recover that principal. So, although there is a risk of further stock market losses by staying invested, since stocks rise more than half the time, and especially so after falling a lot in value, there is also a risk of selling everything all at once.
Although stocks have fallen a lot in value, in terms of their absolute level, both the TSX and S&P 500 are only back down to where they were in early 2021, less than a year and a half ago. Last year was a fantastic year for stocks, with the TSX returning 25% and the S&P 500 returning 27%.
If your husband moves everything into GICs, Rodeen, that will reduce his future return expectations for his portfolio. This may reduce your retirement income or a potential future inheritance for your beneficiaries. As an example, over a 25-year time horizon, a 1% higher return on your investments may increase your pre-tax retirement income by about 11%. It could also increase the future value of an inheritance by 27%, ignoring taxes.
Image and article originally from www.moneysense.ca. Read the original article here.