Marcel Rainville is retired and invests with an adviser who regularly uses GIC ladders as a cash wedge so Mr. Rainville has a steady source of liquidity without having to sell other assets when they might be depressed in price.John Woods/The Globe and Mail
Like most retirees, Marcel Rainville relies on savings to fund his lifestyle. In fact, he and his wife are almost entirely dependent on their savings for retirement income.
"In our particular situation, my wife and I didn't have formal work pension plans," says the 66-year-old Winnipegger. "So preserving capital is very important while trying to earn enough income to meet our established goals."
To ensure they have steady income to fund their goals, including an escape from Winnipeg winters, the Rainvilles' RRSP portfolio is designed to provide income first, to preserve capital next, and finally to generate growth.
To serve all three goals, one of their key strategies is a cash wedge that involves staggering five years' worth of income needs inside their RRSP in guaranteed income certificates (GICs) with maturities from one to five years. This involves a laddering technique similar to a bond ladder to take advantage of the best rates available every year.
In fact, a ladder of government bonds at one time was the preferred investment strategy for a cash wedge. That was before interest rates plummeted to near rock bottom following the 2008 crash.
Today, yields on government bonds are too low to compete with GICs for the same requirement in a retiree's portfolio, says Darell Claeys, vice-president and manager of wealth management at Cambrian Credit Union, also in Winnipeg.
"Over the last five years, GICs have averaged about 2.5 per cent and over the last 10 years about 2.35 per cent," he says. "But a 10-year Government of Canada bond yield is about 1.65 per cent."
Besides superior yields, GIC ladders are often a more suitable strategy for a cash wedge than one using bonds for a number of other reasons, says wealth manager Uri Kraut at Assiniboine Credit Union in Winnipeg.
For one, bond values – particularly government issues – rise and fall with the Bank of Canada rate. "GICs have no pricing variability at all," Mr. Kraut says.
Although a bond's market price is generally not a concern when held to maturity, many retirees are uncomfortable seeing the value rise and fall, he adds.
Moreover, bonds are not guaranteed, while GICs are protected by insurance – such as Canada Deposit Insurance Corp. (CDIC) – if the issuer goes bankrupt, up to $100,000 per depositor.
This market risk-free strategy is ideal for retirees looking for five years of income certainty from their registered portfolio.
Because a GIC matures every year, cash is always available to be withdrawn as fully taxable income from the registered portion of the portfolio. Any remaining cash is reinvested in a new five-year GIC. While the upside is that capital cannot be lost and by reinvesting a retiree always gets the best GIC rate, the downside is if rates remain low, this strategy may not outpace inflation and retirees lose buying power.
Yet Mr. Kraut says that's why a cash wedge strategy involving a GIC ladder is only one part of the overall portfolio allocation in the RRSP.
"Then the rest is designed to restock the cash wedge using capital gains, dividends and interest."
A retiree with $1-million in an RRSP, for instance, could allocate $150,000 to a GIC ladder with $30,000 maturing every year for cash needs. The remaining capital, $850,000, would generate returns to restock it.
While the cash-wedge strategy involves sacrificing a big chunk of capital, it is less likely to result in selling assets – stocks, bonds and fund units – in a down market at a loss for income needs.
"You're basically conceding a piece on the chess board for five years of income certainty," Mr. Kraut says. Although values of market-linked investments feeding the wedge rise and fall, a retiree has flexibility – using dividends, capital gains and interest – when replenishing it.
"We know whenever a market crash occurs, generally things are better five years later, so there should be a moment in the next five years to restock the wedge," Mr. Kraut says.
For some retirees, however, a GIC ladder is their only RRSP strategy for all three goals.
Mr. Claeys says many choose this route even though rates are so low they risk having their money eroded by inflation, forcing them to scale back spending. Of course, they're always looking for risk-free alternatives, he adds.
"We have a lot of individuals asking 'What else have you got?'"
Yet having grown accustomed to GIC rates north of 5 per cent during accumulation years, they often are uncomfortable investing in bonds and stocks to achieve that same return. So by default they invest in GICs using a ladder strategy, even though rates are likely to remain low for years (about 2 per cent or less for a five-year term) and could fall even further in light of the Bank of Canada's recent rate cut.
"We have a lot that choose a GIC ladder only because that's their sleeping point," he says, adding that, for them losing money means losing sleep.
"The GICs work great, but they're not going to see those 8- to 10-per -cent returns like when they might have started saving more than 30 years ago."
While this strategy may work for individuals retired for several years, it's generally not suitable for newbie retirees who need savings to provide income for possibly three decades or more.
That's why the GIC ladder is best used as the cash wedge as part of a broader asset allocation strategy in a registered portfolio, Mr. Kraut says.
While bond ladders can be used for the same purpose, they are usually a better fit for the fixed-income component of the portfolio providing interest to refill the cash wedge, he says.
In this way it functions similarly to a GIC ladder, but staggering bond maturities diversifies holdings over the yield curve to protect against rising interest rates that negatively affect values, Mr. Kraut says.
Furthermore, bond ladders are generally a good fit only for high-net worth investors because smaller investors often face higher commission costs when purchasing individual bonds, as well as limited choice.
"Most good bonds are bought up by pension funds, mutual funds and ETFs," Mr. Kraut says. "So the little guy is getting what's left."
Yet most investors do not need to build bond ladders themselves because most bond mutual funds and ETFs use bond ladder strategies, at much lower cost to the investor.
"For the vast majority of Canadians – the 99 per cent – this is a far better strategy," Mr. Kraut says.
"Sure, you can always buy individual bonds, but will that add any critical value over a bond ETF? Not really. It will just be accommodating a desire to see individual bonds in the portfolio."