Weekend Reading: Chasing Yield Edition

The recent stock market crash and plunging interest rates may have some investors scrambling for safe havens. Stocks fell by as much as 35 percent (before recovering about half of those losses), while the interest rate on GICs and savings accounts in particular have dropped in lock-step with the Bank of Canada’s emergency rate cuts.

Everyone’s situation is unique. First, we all need to be mindful of our personal finances to ensure we have enough cash flow to get through this crisis

Investors still in the accumulation stage with several years or even decades to go before retirement can confidently stick to a risk-appropriate investing plan. 

Those nearing retirement should consider building a safety buffer of cash and GICs to cover their spending needs in the first years of retirement. 

Retirees have different goals, such as balancing current income needs with the need to continue growing their portfolio to cover future spending.

One caution for investors of any age is to avoid chasing yield. We’re in extraordinary times, when banks and energy companies have dividend yields in the 7-10 percent range.

As attractive as those yields look to income-hungry investors, it’s not hard to imagine any of these companies, even our treasured banks, suspending, cutting, or even eliminating dividends at some point in the future. There’s a long list of nearly 50 companies that have already done so since March of this year.

On the fixed income side, we know that cautious savers want their money to at least keep up with inflation. One reader asked whether market-linked GICs were worth a look:

“With the GIC rates dropping again, and not being interested in investing in the stock market at our age, what is your opinion on market-linked GICs?  Your principal is safe and there’s good upside potential if markets perform well.”

To be blunt, I’m not a fan of market-linked GICs. In fact, you’re most likely better off with plain vanilla GIC.

Remember you cannot have reward without taking risk. The promise of “some market upside” with these products is often mis-sold to investors who think they can have their cake and eat it too.

Banks have pushed market-linked GICs for years as interest rates plunged to historic lows. With this clever marketing gimmick, investors are guaranteed to get back their principal if markets go down, but also get to participate in some of the stock market growth if things go well.

The actual interest rate is linked to stock market returns through a complex formula that requires an advanced degree in mathematics to figure out.

Here’s an example from a few years ago that still holds true today:

Market-Linked GICs

What the consumer sees: “Nice, I can earn up to 8.88% PER YEAR on a GIC! Sign me up!”
 
What this really means: The maximum possible “total” return over three years is 8.88%, which is closer to about 2.96% per year (if the stars align and you hit that target). If the markets tank, you’ll get your principal back, plus a minimum of 0.25% per year on your money. Not a great gamble when you consider the best rate on a standard 3-year GIC is paying 2.25% a year, guaranteed.
 
The reality is, traditional GICs represent the best risk-free return available today. You need to shop around, likely outside the big banks, in order to get the best GIC rates. Try EQ Bank, which offers a 2% high interest savings account, plus many GIC options above 2%. Accounts are CDIC protected up to the $100,000 limit per account.

This Week’s Recap:

Here are my posts from the past two weeks.

Should you postpone retirement amid the coronavirus crisis?

Last weekend I opened up the money bag to answer reader questions about moving to Questrade, investing in energy stocks, and more.

On Wednesday I listed the top ETFs and model portfolios for Canadian investors.

Over on Young & Thrifty I looked at whether now is a good time to invest in stocks.

The market crash last month may give investors an opportunity to crystallize capital losses in their taxable investing accounts. I’m working on a new piece with Wealthsimple to show how the robo advisor handles tax loss harvesting for its clients. Stay tuned for that in the coming week or two.

Promo of the Week:

I’ve received a lot of feedback from readers who are interested in switching to a discount broker like Questrade or Wealthsimple Trade.

You might want to do so if you’re already a self-directed investor with one of the big bank brokerages and are tired of paying fees for every trade (that’s why I switched from TD Direct to Wealthsimple Trade earlier this year).

Another reason to switch is to simply take control of your finances. Many investors are still heavily invested in expensive actively managed mutual funds with a bank sales person or investment advisor, paying 2 percent or more each year on their investments.

By switching to a discount broker and investing in low cost ETFs, investors can slash their fees to the bone. 

Nervous to take the plunge? Try investing in an asset allocation ETF like Vanguard’s VBAL or VGRO, or iShares’ XBAL or XGRO. These one-ticket solutions take the guesswork out of investing because they are automatically monitored and rebalanced behind the scenes so you can focus your time and energy on other activities besides your investment portfolio. Truly a set-it-and-forget-it option.

Wealthsimple Trade is Canada’s first and only zero-commission trading platform where investors can trade stocks and ETFs for free in an RRSP, TFSA, or non-registered account. Sign up for Wealthsimple Trade today.

For most robust investing needs, including for LIRAs, Margin, and Corporate accounts, Questrade is still the king of low-cost investing in Canada. You can purchase ETFs for free and trade stocks for as little as $4.95. Take your savings further with a registered account at Questrade.

Weekend Reading:

Bank of Canada governor Stephen Poloz shares his thoughts on the current pandemic and laying a foundation for the road to recovery.

Rob Carrick is helping his readers through the pandemic with a weekly personal finance update. His latest explains why you should clean out your big bank savings account that’s paying next to nothing in interest.

My Own Advisor blogger Mark Seed explains how he’s preparing his finances for a global recession.

A stark reminder that home equity lines of credit are actually callable loans that can be taken away by your bank in times of trouble.

Carleton associate professor Jennifer Robson offers a great explanation to those of us asking why can’t the government just send everyone a stimulus cheque.

Preet Banerjee has done a great job keeping Canadians informed of federal government stimulus measures, including the most recent changes to the CERB:

Another Carleton professor, Frances Woolley, explains the behavioural economics of the Marie Kondo method. Marie Kondo is the guru behind the best-selling Life-Changing Magic of Tidying Up and Spark Joy.

Morgan Housel asks two big questions – one economic, one more social – that seem crucial to pay attention to as we think about recovery.

Here’s a brilliant thread on Twitter – a Q&A with Costco founder Jim Senegal:

The latest Canadian Portfolio Manager podcast with PWL Capital’s Justin Bender sheds light on his “Light” model ETF portfolios that include the asset allocation ETFs offered by Vanguard and iShares.

Seniors who don’t need all of their RRIF money this year should consider this workaround.

Here’s Millionaire Teacher Andrew Hallam speaking to retired Canadian investors about what to do with the investments during the COVID-19 market crash:

Michael James on Money uses a personal example to explain how rebalancing does its job.

Finally, is it your dream to work from home full-time? Our friends at Credit Card Genius share 20 ways to work from home.

Have a great weekend, everyone!

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6 Comments

  1. Grant on April 18, 2020 at 12:29 pm

    Great minds think alike – I mean you and Ben Carlson. Ben also did this excellent review today of one of the most important concepts in the financial markets – the closest thing to an iron clad rule – “Risk and return are tied at the hip”.

    https://awealthofcommonsense.com/2020/04/the-wild-world-of-yield-chasing/

    • Robb Engen on April 18, 2020 at 4:20 pm

      Hi Grant, thanks so much. I missed this excellent piece from Ben, but I’m glad you shared it here. Wise words, as usual.

  2. Russ on April 18, 2020 at 7:15 pm

    On the market-linked GIC, these work more or less like principal-protected notes. Dan Bortolotti wrote an article years ago in MoneySense about how to make a homemade version by using a strip bond and an ETF. Here’s the link: https://www.moneysense.ca/columns/a-homemade-principal-protected-note/ Because of the way strip bonds are taxed, Dan recommended that this strategy be done in a registered account. I’m inclined to think that a non-registered account might work better if you substitute a regular 5-year GIC for the strip bond. That way, if you do lose money on the ETF, you can sell it and realize a capital loss at the end of the strategy.

  3. Alastair Stewart on April 22, 2020 at 9:57 am

    Hi Robb:

    Quick question on student bank accounts. My son had his first real summer job last summer and we set up a bank account for cheque deposits. Generally speaking, the bank nickel and dimed him to death.

    Have you done any research in this area? Any suggestions?

    Thanks,
    Alastair Stewart

    • Robb Engen on April 23, 2020 at 10:31 am

      HI Alastair, I haven’t done a comparison of children’s savings accounts in quite some time. Honestly, CIBC might have one of the best ones as far as the big banks go. No fees, a paltry interest rate of 0.15%, but your son would get a debit card plus unlimited free transactions: https://www.cibc.com/en/personal-banking/bank-accounts/youth-banking-offers/fees-and-details.html

      Here’s an option that could also be interesting. KOHO is a pre-paid Visa card that comes with an app with money tracking, goal setting, and even cash-back on purchases. Perhaps you could sign up as a joint account with your son with the intention that this be her primary saving and spending tool.

      https://www.koho.ca/

      I wrote a review here: https://boomerandecho.com/koho-review/

      I think we need to forget the notion that kids are going to actually earn any interest on their savings, so instead we’ll have to teach savings habits, proper expense tracking, and goal setting – all which KOHO can do.

  4. Alastair Stewart on April 23, 2020 at 10:42 am

    Agreed. Thanks for sharing and for your column – always a good read (and a perfect length)!

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