GICs & The Quest For The Riskless RRSP
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This article originaly appeared in the Jan. 1996 issue of the Mackenzie Insight and with steadily declining GIC rates its message is even more important. Once upon a time sailors only felt safe for as long as they could keep the shore-line in sight. Likewise, many RRSP investors cling to the sense of security offered by guaranteed investment certificates, or GICs. The lure of knowing what they're going to get when a GIC matures may seem irresistible. However, the unseen danger for timid RRSP investors is that their quest for the "riskless return" can prevent them from ever crossing over to the promised land of financial independence at retirement. There are three key points to consider when comparing GICs against a portfolio of equity or bond mutual funds. The first is investment risk. GICs have more risk than meets the eye. When RRSP investors purchase a 5-year GIC they are essentially betting that interest rates will not change over the five years. Why? Clearly, if rates go up an investor would have done better by buying a shorter-term GIC, or even a money-market fund, than trading it in for a GIC when rates rose. If rates fell,instead of patting themselves on the back a GIC investor might wish to consider that by owning a bond fund their RRSP would have gone up in value as interest rates fell. In either case, they're worse off owning the GIC. Second,mutual fund portfolios can offer a superior long-term track record of returns. Evidence for this conclusion has been compiled according to a thorough analysis by Garmaise Investment Technologies. They have measured the performance returns of a hypothetical GIC investor, starting in May of 1977. buying a 5-year GIC every month, and regulary rolling it over into a new GIC at the end of its term. For purposes of comparison, Garmaise has constructed a hypothtical RRSP mutual fund portfolio and projected its performance over the same time period. This typical RRSP portfolio was invested 40% in Canadian stocks, 40% in Canadian bonds, 12% in U.S. stocks, and 8% in international stocks. To reduce the possibility of skewing the results, Garmaise chose the returns of the median fund* in each category, and thus calculated these returns after accounting for the management fees. The accompanying table displays the cumulative and annualized rates of return.
The lesson is unmistakable-being a patient diversified mutual fund investor pays! The longer you remain invested the more confident you can be that your performance returns will surpass those available on GICs. A third key point is that many mutual fund portfolios provide international diversification, effectively decreasing the risk of holding just one currency. A GIC portfolio is subject to the ongoing risk that the value of the Canadian dollar may depreciate against foreign currencies. If you expect to be a consumer of foreign goods in ten or twenty years time when you retire, your cumulative currency risk can quickly mount up. GICs do have a place in the spectrum of investment options. They provide a genuine service for investors confronted by short time horizons, or those having an exceptionally low threshold for risk. But, there are three persuasive reasons to pause before "playing it safe" by purchasing a GIC for your RRSP this winter.
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