Bonds vs GICs

[DanielCarrera]

Does anyone know if, in general, one can expect a higher rate with bonds or GICs?

With GICs you are generally locked into a given term and you don't have a secondary market to sell your GICs as you do with bonds. That suggests that GICs ought to have higher return. But on the other hand, bonds are not insured by the government (CDIC) and so the higher risk should give bonds a higher return.

Any ideas? Additionally, if you can mention any other pros and cons for bonds vs GICs that I should know about I'd be grateful. I'm interested in holding bonds or GICs as the fixed income part of my portfolio, but I'm not really that interested in a bond fund.

Thanks.

[pitz]

A collection of thoughts on the issue:

http://www.financialwebring.org/forum/viewtopic.php?t=107074

[DanielCarrera]

A collection of thoughts on the issue:

http://www.financialwebring.org/forum/viewtopic.php?t=107074

I didn't find that thread very satisfactory. Above all, I am looking some form of confirmation that GICs return more than bonds. I am not sure whether this is true or not. For example:

http://www.rbcfinancialplanning.com/RBC:Q8@q0I71A8QAAVRea2Q/IP-bonds-provide-stability-safety-income.html

Quote: "With a bond the guarantee is only as good as the issuer... Which is one reason why bonds pay higher interest than GICs."

So, I would like more information on what I can expect. It would be great if there was a place I could search for bonds available plus their credit rating so I could look at their actual rates of return and compare them myself.

EDIT: Since I don't have the capital to buy a large portfolio of bonds at $100 each, I have to limit myself to investment-grade bonds.

[AllWheelDrift]

I think the key to a good return on bonds is being able to buy them without crazy markups.

I've mentioned this several times, but through RBC Direct investing I can get the following GIC rates:

1yr 4.01%
2yr 4.12%
3yr 4.37%
4yr 4.57%
5yr 4.77%

Also through RBC direct:
2-5 year Government of Canada bonds are yielding under 3.8%.
2-5 year Provincial bonds are yielding under 4.12%.
2-5 year Municipal bonds are yielding under 4.22%

With corporate bonds it looks like you may be able to beat the GIC rates by a few points but you'll need to be careful about any special terms on the bond (I notice there are a lot of "doomsday" clauses which allow the issuer to call them any time at a fixed premium to the GOC yield) as well as the issuer's credit rating.

[Thalo]

Like bonds more in a balanced portfolio because they're more negatively correlated with stocks than GICs. When the stock market takes a plunge, your GIC portfolio will do nothing to protect the value of your overall portfolio (they won't go up in value). Coupon rate is only part of the potential returns from bonds.

[pitz]

Like bonds more in a balanced portfolio because they're more negatively correlated with stocks than GICs. When the stock market takes a plunge, your GIC portfolio will do nothing to protect the value of
your overall portfolio (they won't go up in value). Coupon rate is only part of the potential returns from bonds.

Not true Thalo.

GICs will most definitely go up in value if the stock market takes a plunge, just like bonds. You just don't 'see' it on your brokerage statement because GICs are typically not marked to market, while bonds are.

In reality, the lack of marking to market on the GICs on brokerage statements is just a convenient fiction. It doesn't really mean that a GIC hasn't gone up (or down) in value.

[Thalo]

It's all theoretical value. A retiree doesn't see their portfolio value plummet when they've got 3yrs left on a 5yr GIC at 2.8% when the going rate for a new 3yr GIC is 4.5%. GICs can't beat a good bond fund in the long run.

[DanielCarrera]

Like bonds more in a balanced portfolio because they're more negatively correlated with stocks than GICs. When the stock market takes a plunge, your GIC portfolio will do nothing to protect the value of your overall portfolio (they won't go up in value). Coupon rate is only part of the potential returns from bonds.

I dispute this. Sure, for some stock market shocks bonds will move in the opposite direction, but when interest rates increase the value of both stocks and bonds go down. That is a positive correlation there. That's why I'm interested in holding to maturity rather than trading bonds (e.g. by holding a bond fund). By laddering bonds or GICs, that part of my portfolio can benefit form interest rate increases to help compensate for the decrease in stocks.

[DanielCarrera]

It's all theoretical value. A retiree doesn't see their portfolio value plummet when they've got 3yrs left on a 5yr GIC at 2.8% when the going rate for a new 3yr GIC is 4.5%. GICs can't beat a good bond fund in the long run.

A bond fund can't beat a stock fund in the long run but we still use them for diversification value. I feel that holding individual bonds or GICs to maturity provides better diversification than a bond fund because a bond fund moves in the same direction as stocks when interest rates change.

EDIT: Anyways, I'm still interested to know whether I can expect a better interest rate from individual investment-grade bonds or GICs. Any sources that clarify this would be very helpful. For example, a page showing current rates for a selection of investment-grade bonds.

[pitz]

It's all theoretical value. A retiree doesn't see their portfolio value plummet when they've got 3yrs left on a 5yr GIC at 2.8% when the going rate for a new 3yr GIC is 4.5%.

Why not? Let me guess -- its because banks don't print real values on the statements -- rather, it prints fiction.

Maybe the customers like it that way, maybe it makes them feel better, but it doesn't alter the truth -- that GICs are just as volatile as bonds, and routinely lose, and even gain value.


GICs can't beat a good bond fund in the long run.

In a flat or rising interest rate environment, I would expect GICs to outperform bond funds if you can buy the GIC at a yield premium to the average yield on the bond fund.

[asdfvcx]

EDIT: Anyways, I'm still interested to know whether I can expect a better interest rate from individual investment-grade bonds or GICs. Any sources that clarify this would be very helpful. For example, a page showing current rates for a selection of investment-grade bonds.

I'm not sure anyone publishes info like that publicly. The Bank of Canada does a bit for federal government bonds, but I'm not sure it's exactly what you are looking for: http://www.bankofcanada.ca/en/rates/digest.html

Brokers should have this online (I know Waterhouse does), but it's only available to clients, I don't believe they make it public. And as already mentioned, the spreads for buying small dollar amounts of bonds tend to be very high.

And even if you could get some numbers for today, I'm not entirely sure it would answer the question. I honestly don't know if the numbers would hold true during the entire business cycle, or whether there are times bonds might be slightly better and GICs better at other times.

And finally you need clarify what investment grade means. :) (Is this list long enough?)

I can see some 5 and 6 year bonds rated BBB yielding over 6% right now on Waterhouse. (Shaw and Loblaws, if you are interested). A lot of investment grade bond fund don't have any problems holding a certain percentage of BBBs.

[DanielCarrera]

I'm not sure anyone publishes info like that publicly. The Bank of Canada does a bit for federal government bonds, but I'm not sure it's exactly what you are looking for: http://www.bankofcanada.ca/en/rates/digest.html

Well, it's something. Thanks. GoC benchmark bonds (3 yr) are 3.25% - 3.29%. That's about 0.7% lower than GICs.

And as already mentioned, the spreads for buying small dollar amounts of bonds tend to be very high.

And even if you could get some numbers for today, I'm not entirely sure it would answer the question. I honestly don't know if the numbers would hold true during the entire business cycle, or whether there are times bonds might be slightly better and GICs better at other times.

Thanks. Oh well, what can you do? I guess I'll plan on GICs and when I have a broker I can keep an eye on bonds to see if they ever return more.

And finally you need clarify what investment grade means. :) (Is this list long enough?)

I was thinking in the AA-AAA region mostly because I don't enough to judge the risk I'm taking with a B-level bond. Maybe later when I know what I'm doing I might grab something else.

[Thalo]

I wish we did publish actual GIC values. It would help convince customers that they are, in fact, taking risk when buying GICs and it wouldn't be such a big step up to get them into mutual funds.

Regarding diversification, I see diversification as matching up uncorrelated investments. Bonds and stocks are generally negatively correlated, with few instances that they both go up (ie: late 2006) and both go down (ie: mid-2007). Usually though, when rates are going up, stocks are actually going up (rates go up when the economy is doing well) while bonds go down in value. When rates go down stocks are slumping and bonds rally.

[cmackie]

I wish we did publish actual GIC values. It would help convince customers that they are, in fact, taking risk when buying GICs and it wouldn't be such a big step up to get them into mutual funds.

Are you saying that if I walked into a bank and invested in a 1 year GIC at 4%, I'd end up with something other than a 4% return at the end of the year? (assuming annual compounding and no service charges)

[pitz]

Are you saying that if I walked into a bank and invested in a 1 year GIC at 4%, I'd end up with something other than a 4% return at the end of the year? (assuming annual compounding and no service charges)

No. What we're both saying is that if you put $1000 into a GIC, its true value fluctuates with prevailing interest rates.

For instance, if interest rates go slightly up, then your GIC is really only worth $9xx. If interest rates go down, then your GIC is worth $10xx.

GICs and bonds are identical in that, if you hold to maturity, you will get exactly the yield to maturity quoted at the time of purchase. The key difference is that there is a (relatively) liquid secondary market for bonds, whereas GICs are usually only traded in back rooms at brokers and banks. This makes selling for a capital gain almost impossible even in a falling interest rate environment.