Retirees: Is it better to invest in bonds or GICs?

Four years ago, fixed-income investments such as long-term bonds or GICs offered almost no return at all. That changed when inflation soared in 2022. While interest rates are now off their peaks, they still offer much higher nominal returns than they did in 2020.

But which should retiree or aspiring retirees choose now: bonds or GICs? The answer depends on what happens to inflation rates.

Assume you invest $100,000 of your RRSP portfolio in fixed-income investments over a 10-year period. Your choices are (a) a bond portfolio made up of Canada bonds that mature in 15 years and have a coupon rate of 4 per cent and (b) one-year GICs that currently provide 4 per cent annual interest.

You would sell the bonds off at the end of each year and then repurchase to maintain the 15-year period until maturity. Similarly, you would renew your GICs annually at the then current interest rate. In both cases, the interest earned is reinvested.

In Scenario 1, inflation falls to 2 per cent. As a result, long-term bond yields fall from the current 3.4-per-cent level to 2.5 per cent. Rates on one-year GICs also fall to 2.5 per cent. As the first chart shows, you would be much better off with bonds than GICs because the falling interest rates create a capital gain that GIC holders do not enjoy.

In Scenario 2, inflation stays elevated at the 3-per-cent level. Bond yields rise gradually from 3.4 per cent to 4.4 per cent while GIC rates rise gradually from 4 per cent to 5 per cent. As the second chart shows, you would now be much better off buying GICs.

In other words, if you have faith that governments can show some fiscal restraint, then longer-term bonds are the better choice. If you think inflation rates will stay elevated, however, then GICs will do better.

Frederick Vettese is former chief actuary of Morneau Shepell and author of the PERC retirement calculator (perc-pro.ca)