Laddering your GICs
Trying to pick the right term for a GIC is no easy task. The term of a GIC simply refers to how long you are going to invest for. Typically, financial institutions offer different rates for different terms. Terms are usually quoted in 12 to 60 month terms.
When picking the right term for you, it is imperative that you take into consideration your personal needs and objectives. Knowing when you might need the money is the first question to ask yourself.
Often, GIC investors choose a term based on trying to guess where interest rates are going. When interest rates are rising, investors often default to shorter-term rates rather than locking into longer term rates in hopes of renewing at higher returns as rates move up. The problem with investing based on this strategy is that no one knows the future movement of interest rates. Predicting interest rate movements is no easier than predicting stock market movements.
The laddering strategy.
Many advantages can be secured through a portfolio-management technique know as laddering, or staggered investing. It’s a relatively simple concept where investors’ purposely purchase GICs with differing dates of maturity and thus rates of return.
One of the most common examples of this strategy is the 5-year ladder. Say you have $100,000. The easy way is to divide the investment into 5 equal amounts of $20,000. The first $20,000 would be invested for 1 year, the second $20,000 for 2 years, the third for 3 years, the fourth for 4 years and the fifth for 5 years. After the initial set up, any maturing GICs would automatically be invested for five years.
There are many advantages to this strategy.
- Diversification. Investors who hold a single GIC are limited to accepting whatever rate is offered when their investment matures. There is nothing like that awful feeling you get when most of the conservative component of your portfolio is due for renewal and you realize you are faced with low returns. At this time, you may begin actively seeking alternative investment solutions, which is another source of stress. By ensuring that different terms and different rates exist, a portfolio of GICs is better than simply having one single GIC.
- Eliminating the guesswork. Laddering is simply a disciplined process to investing in GICs. Having this discipline helps to alleviate the risk of interest rate fluctuations. Laddering means that you do not need to guess where interest rates are going. If rates go up, you will be happy because you will always have money coming due every year to take advantage of the rising rates. If rates go down, you benefit by having money invested for a higher rate in a longer term.
- Liquidity. By having money come due every year, investors can have access to money every time a maturity occurs. In the case of the 5-year ladder, you will be able to access one fifth of your capital in any given year without penalties or costs.
- Security. When investing larger sums of money, it is important to know that Canada Deposit Insurance Corporation (CDIC) insures accounts up to $100,000 per institution. If you have a portfolio worth over $100,000, laddering will help you to break up the capital into amounts less that $100,000 for maximum security. Then if you shop for the best rates and invest in different terms with different financial institutions, you will be able to ensure insurance for the total amount of the portfolio. For more detailed information on CDIC, call a deposit broker or refer to www.cdic.ca.
- Controlling cashflow. If you are living off the interest on your GIC portfolio, you can also structure cashflow to meet your specific needs. For example, some investors are face with quarterly income-tax installments. In any case, you can also stagger maturities to ensure that interest income is paid at certain times of the year to manage your personal income 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.
Laddering helps investors by creating a panned strategy for GIC investing. There are many different variations of the GIC ladder. You can create short-term ladders. Some incorporate other GIC products into the ladder like escalating GICs and index linked GICs.
Whatever the case may be laddering is one of the most prudent fixed income strategies. This strategy does not only apply to GIC investments, rather any other fixed income product (like bonds) can be laddered in the same way.
Thank you so much for this article. This feels exactly right for my retirement strategy. So far I’ve been stressing about when to buy a GIC and for how long. Laddering takes the guess work out and a strategy.
I understand the use of a GIC ladder before and after retirement but I’m a bit confused on how it should work in retirement. At the end of the year your GIC expires and you have cash. When do you use the cash to cover expenses? When the markets go down I assume. So if you use it to cover expenses then how do you replenish that amount to reinstate the 5 year GIC ladder? Do you replenish once the markets rebound a bit? Doesn’t this throw off the benefit of annual GIC purchases?
Basically just trying to figure out how to use the GIC ladder for portfolio protection in retirement.