One of the main reasons for investing, especially for the long term, is to receive supplementary investment income. Extra income is always welcome and a passive income source is always better than getting a part-time job.
In the first part of this two part series I will discuss ways to earn investment income from GIC’s and Bonds.
Investment Income: GICs
An old standby from my parent’s generation, a GIC is an investment issued by banks and credit unions that offers a guaranteed rate of return over a fixed period of time, short term – 30 to 364 days, or long term – 1 to 5 years. (Sometimes terms of up to 10 years are offered, but be aware that anything over 5 years is not guaranteed by the CDIC.)
On long term investments interest can be paid monthly, semi-annually or annually. Try to negotiate the best interest rate you can. GICs are locked in for the full term except on the death of the owner and are not transferrable – they can’t be resold to another investor.
If you want to cash a GIC early, you may have to pay a penalty so you may lose all your earned interest and receive less than the face value. They are definitely a “buy and hold” investment for this reason.
Similar investments are Term Deposits and Canada Savings Bonds, which can be cashed prior to maturity and thus offer lower interest rates.
Investment Income: Bonds
Governments and corporations issue bonds in order to raise money. They represent an obligation, committing the issuer to repay the borrowed amount (the principal or face value) on a certain date (the maturity date). In the period before maturity, the borrower pays interest on set dates at a fixed rate called the coupon rate.
Bonds are also issued by foreign countries or denominated in a foreign currency. They can be purchased on the secondary market at a discount (price is lower than par value) or at a premium (price is higher than par value) subject to changes in prevailing interest rates.
Government of Canada bonds are fully guaranteed by the federal government for a term of 1 to 30 years. They are considered to be the safest Canadian fixed income investment you can buy because the Federal Government has the ability to print money to cover its debt.
Because they offer such a high degree of security and liquidity, Government of Canada bonds often have lower yields than other bonds on new issues, but if a higher interest payment is important to you, you can often find attractive interest payments (up to 5%+) if purchased on the secondary market, but they will be sold at a premium. They generally pay interest semi-annually until maturity, when the face value is repaid.
Federal Crown Corporations are entities that are fullyguaranteed by the Government of Canada. Examples are Canada Mortgage and Housing Corporation and the Business Development Bank.
Provincial and Municipal bonds vary according to each province’s or municipality’s financial health and taxation power. Credit quality varies by the issuer so they usually trade at a higher yield, but in most cases the risk is considered only marginally higher than Government of Canada bonds.
Corporate bonds don’t have the benefit of sourcing their income from the tax base. Instead, they rely on the profitability of their business to generate income thus there is a wide variety of safety and credit ratings.
“Investment grade” bonds usually have ratings ranging from AAA to BB (Dominion Bond Rating Service). Anything below BBB is considered speculative and is not suitable for every investor. Make sure you understand their unique features as well as the credit rating and credit outlook of the corporation before buying.
In part two of this series I will discuss several additional ways to earn investment income.