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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 15 years. There are one- to five-year rates that are between 4% and 5%, and even slightly over 5% if you shop around. You may not get these rates at major banks, where rates may be 1% to 2% lower than that, but credit unions, trust companies and online banks generally offer a healthy premium.
Are GIC rates going up in Canada?
A year ago, GIC rates were just starting to rise but were still less than 3%. The reason they are so much higher now is worth considering. The January 2023 year-over-year inflation rate fell to 5.9%, after rising at a 6.3% rate for 2022. The Bank of Canada (BoC) has raised interest rates in 2022 to slow down spending and price increases. So, while a 5% GIC rate may seem enticing, it represents a negative real rate of return when adjusted for inflation if we see a repeat of 2022. The BoC forecasts inflation should decrease over the year, though, and hopefully return to its 2% target in 2024.
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 6.1% last year, and the S&P 500 was down 12.5% (total return for both, S&P 500 in Canadian dollars). 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 can 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 who is 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 they fall, 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, their long-run returns have been compelling. The total return for the TSX was 7.7% for the 10 years ending Dec. 31, 2022, and for the S&P 500, an astounding 16.1%.
If your husband moves everything into GICs, Rodeen, that will reduce his long-term 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.
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