Dale Jackson

Personal Finance Columnist, Payback Time

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A relief effort has begun for Canada’s debt-burdened households this week after the Bank of Canada announced a quarter per cent cut in three-decade-high interest rates.

With expectations for a series of cuts totalling two per cent, Mortgage Logic’s Robert McLister says the punch bowl is coming back for borrowers as the big banks respond by lowering their prime lending rates.

However, that punch bowl is being taken away from savers who have been drinking in higher yields on fixed income for nearly two years.

Fix income party coming to a close

Yields on one-year guaranteed investment certificates (GICs) remain above five per cent for now, but they will continue to be under pressure as long as the Bank of Canada eases its benchmark rate. 

Posted yields drop as maturity terms get longer, so the window for a decent payday is coming to a close. Other guaranteed fixed income like government bonds have not come close to GIC yields regardless of terms to maturity.  

GICs tended to mimic the benchmark rate as it shot up by nearly five per cent in just over two years. If projections are right, and the central bank rate declines by two per cent, GICs will yield a paltry three per cent.

It’s not as paltry as less than one per cent, which is where they were before the rate hikes began when inflation peaked in 2021. A three per cent yield leaves a bit on the bone for retirement savers who want the safety of fixed income to cushion their portfolios against volatile equity markets. 

Risk on for retirement investors

Lower fixed income yields make it difficult for investors to reach return targets without allocating a larger portion of their portfolios to equities. That can be problematic as they near retirement and need a reliable income stream for day-to-day living. Many retirees simply can’t wait-out a market downturn. 

When the benchmark interest rate was near zero before rates shot up, investors had to attempt to create income streams through stock dividends and income-generating investments such as real estate investment trusts (REITs).

Unlike GICs and government bonds, dividend payouts are at the discretion of the stock issuer. Investors also run the risk of the underlying stock losing value for whatever reason. 

The right asset mix for you    

Targeting return goals while balancing risk between fixed income and equities depends on the individual investor.

In most cases, it’s good to hold a significant portion of a portfolio in fixed income regardless of yield. 

A qualified advisor can help formulate strategies to maximize fixed income returns by staggering maturities within a portfolio to take advantage of the best going yields as often as possible. The most common strategy, known as laddering, ladders maturities over a fixed period of time.

A general rule is to allocate a percentage of your portfolio to fixed income equal to your age. In other words; if you are 50 years old, half of your portfolio should be in fixed income. It’s a way to automatically reduce equity risk as you age.

That could work with GIC rates at five per cent, or even three per cent, but could stall the entire portfolio if they fall too low.

Opportunity from a weaker loonie

One potential benefit for retirement investors from the Bank of Canada being the first major central bank to cut rates is the resulting downward pressure on the Canadian dollar compared with the U.S. dollar.

Investors who diversified to U.S. dollar denominated investments when the loonie was stronger could have the opportunity to convert the cash for cheaper loonies.