Dale Jackson

Personal Finance Columnist, Payback Time

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Judging by the news coverage of the latest Bank of Canada interest rate increase, you would think the world is about to end. 

That may seem like the case for over-leveraged borrowers, but it’s a new dawn for retirement savers with nerve-wracking levels of exposure to volatile stock markets.

You need to go back over three decades to find a time when investment grade bonds did more of the heavy lifting in retirement portfolios; generating decent and reliable returns while lowering overall risk.

In that era, it was normal for investors in or nearing retirement to have a significant portion of their portfolios in fixed income. 

That era could be returning.

A BRIEF HISTORY OF INTEREST RATES

This week’s 50-basis-point hike brings the Bank of Canada benchmark interest rate to 3.75 per cent from 0.25 per cent at the start of the year.

In a continuing effort to lower inflation, the central bank is expected to further hike its rate to 4.25 per cent, but that could change depending on how well it works.

While that may seem high by today’s standards, it is in line with the period between 1995 and the financial meltdown of 2008 when the world’s central banks had to slash rates to keep the system flowing.

From the 1980s to 1995, runaway inflation pushed the benchmark rate to just over 20 per cent, but from the 1950s to 1980 it remained in the six per cent range.           

FIXED INCOME ENTERS THE SWEET SPOT

Fixed-income yields move up and down with the benchmark rate. At last check, Canada two-year bonds were paying 3.9 per cent compared with well under one per cent before the Bank of Canada started raising its rate.

At last check, one-year Guaranteed Investment Certificates (GICs) were yielding up to 4.85 per cent. If they move in tandem with expectations for another 50-basis-point increase, the yield on one-year GICs will reach 5.35 per cent.

Yields on longer-term government bonds, GICs and investment grade corporate bonds could rise faster as the economy stabilizes.   

BUILDING A FIXED INCOME PORTFOLIO

That comes as cold comfort for retirement investors who have had to meet growth goals by venturing out on the risk ladder to find dividend income in tattered equity markets. 

With stock markets down, now is not the time to sell to generate cash for fixed income.

Building a balanced portfolio between equities and fixed income takes time, and that’s where a qualified advisor can help trim equity holdings as stock markets recover and choose the best entry points in fixed income as rates rise.

Many would suggest “laddering” short-term maturities over time to create as many opportunities as possible to take advantage of the best yields as they increase.

INFLATION IS THE WILD CARD

The success of a fixed-income portfolio also depends on how effective the Bank of Canada is at getting inflation closer to its target of two per cent.

Those yummy yields could be eaten up by the cost of living. 

Rates on GICs reached 9 per cent in the early 1980s, as an example, while inflation topped 11 per cent.

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This week’s lower-than-expected hike suggests it’s working. The latest reading on inflation shows the cost of living backed off to 6.9 per cent from over seven per cent in previous months.

The Bank of Canada also lowered its outlook on inflation to come in at 4.1 per cent in 2023 and 2.2 per cent in 2024.

Even in a best-case scenario, the real return on fixed income isn’t much, but finally having guaranteed income in retirement could let retirement savers sleep better at night.