The fixed-income universe has rarely offered more compelling options than it does today, writes Kevin Foley.Richard Drury/iStockPhoto / Getty Images
Dividend-paying stocks and laddered GICs both have merit. But using either as the foundation of a fixed-income allocation is a mistake for most investors.
When Canadians search for fixed-income opportunities, these two options are occasionally recommended. One offers a portfolio of blue-chip, dividend-paying equities with a history of payouts compared to bond income, plus the appeal of capital appreciation. The other offers a staggered – or “laddered” – set of guaranteed, government-insured certificates maturing annually, delivering known returns without the daily price swings of bond funds. Both seem reasonable approaches, yet when used as substitutes for effective fixed income, represent meaningful portfolio construction failures.
The errors are different in character but share a common root: misaligned commitment to the essentials of the fixed-income bucket and misaligned return expectations. Fixed income has a specific job to do in a portfolio. Understanding why these two popular alternatives fall short is the first step - because the fixed-income universe has rarely offered more compelling options than it does today.
The problem with dividend-paying stocks
The case for dividend-paying stocks is easy to make. The research supporting them is solid - but their merits as equity investments are precisely why they don’t suit those seeking fixed income. Charles Schwab puts it plainly in its investor guidance: dividend stocks “should not be viewed as a replacement for traditional fixed income investments but rather as a complement to a diversified portfolio.” The distinction matters - unlike bonds, whose coupon payments are contractually defined and reliable barring outright default, Schwab notes that dividend payouts “could be trimmed or eliminated altogether without warning.”
That is not a theoretical risk. In 2020 alone, 68 of the roughly 380 dividend-paying companies in the S&P 500 suspended or reduced their payouts. The income stream that investors expected to provide bond-like stability proved just as cyclical as the businesses generating it – failing exactly when portfolio stability was needed most.
The bond-fund model built for a falling-rate world hasn’t aged well
Morningstar draws the distinction further: dividend funds are better suited for investors who want exposure to the stock market’s growth potential – but crucially, the value of those investments will “bear the market’s ups and downs.” That is distinctly an equity characteristic, not a fixed-income one. Dividend stocks belong in the equity bucket – simply because that’s what they are, even with their expected payout.
Recall that the fixed income part of the standard 60/40 portfolio – 60 per cent in equities and 40 per cent in bonds – is designed to reliably generate income, preserve capital, and dampen portfolio volatility when equity markets fall. Dividend funds don’t achieve that. For example, the largest dividend fund in Canada has a 10-year standard deviation that is roughly 2.5 times higher than the bond index. Its current 2.2-per-cent distribution yield doesn’t meet fixed-income requirements, and in six of the past the 18 years its total return was negative.
The problem with GIC ladders
GIC ladders are near the other end of the risk spectrum, and their appeal is equally understandable. GICs offer principal protection, government-backed CDIC insurance up to prescribed limits, and returns entirely unaffected by daily market movements. After the 2022 bond market drawdown - when the Canadian bond index fell more than 12 per cent - the argument for GICs understandably gained momentum.
GIC ladders are effective capital preservation tools - but solely for that specific objective. A retiree protecting near-term spending needs, or a reserve held against a known liability, may benefit from GIC certainty.
But the structural advantages of non-cashable GIC ladders come with structural limitations. GICs are low-yielding investments that financial institutions cherish as a cheap source of funding. Locked-in GICs cannot respond to changing economic conditions. They don’t appreciate when interest rates decline – lacking the convexity that makes bonds valuable as portfolio ballast during equity market stress. When equities fall and fixed income is required to offset losses and provide liquidity for rebalancing, GICs offer neither.
The most important number in your portfolio
Liquidity compounds the GIC problem. Non-cashable GICs offer higher yields than cashable versions – sometimes a full percentage point or more - but that premium exists because investors own an illiquid security. Unlike bonds, GIC holders cannot rebalance, redeploy capital into market opportunities, or respond to the unexpected. The certainty of a GIC comes at the direct cost of return potential and flexibility.
The empirical record further tempers the case for GIC ladders. Qtrade research found that bonds have outperformed GICs in most years since 2010 – when total return, including yield, price appreciation, and reinvestment, is properly measured. That may surprise some, however it misses the larger point: GICs and government bond-heavy funds represent only a narrow slice of the fixed-income universe, and both have proven suboptimal as complete fixed-income solutions.
For investors constructing diversified portfolios where fixed income must preserve capital, and provide income, risk mitigation, and long-term return potential - GIC ladders are structurally insufficient. They’re like driving 75 kilometres an hour on the highway: safe and predictable yet dangerously behind the pace.
The real job fixed income must do
Income. Capital preservation. Ballast.
The encouraging reality is that GICs and dividend-paying stocks are merely two items on a fixed-income menu that has expanded dramatically over the past two decades. They may have their place - perhaps as a side dish or an occasional daily special - but neither are appealing main courses. Even the very popular index-hugging bond funds, which deliver little more than generic interest rate exposure, haven’t proven particularly fulfilling.
Today, investors have access to a broader and more effective fixed-income universe. Distinct corporate credit exposure, secured-mortgage lending, intentional interest rate risk, private debt, and select real asset investments such as infrastructure and real estate offer the potential for reliable income and structural protections that align with fixed income’s purpose. Constructing an effective allocation is no longer about choosing one fund or a product category - it’s about selecting investments and investment partners capable of delivering stability, income, and resilience across market cycles.
That makes thoughtful manager selection crucial. A proven track record, rigorous risk discipline, experience navigating full market cycles, and genuine transparency are not aspirational – they’re what’s required. Fixed income, done well, is not a commodity. It’s purposeful and accomplished by few. In a total portfolio context, optimizing fixed income might be the most important decision an investor makes.
Kevin Foley is managing director, institutional accounts, at Canadian asset manager YTM Capital, and specializes in credit and mortgage funds. He spent two decades trading and managing fixed income at a major Canadian bank and serves on several Canadian foundation boards and investment committees. Kevin.Foley@YTMCapital.com.