As the economies of North America continue with their recovery, it’s only a matter of time until interest rates in both Canada and the United States go up. Canada’s central bank is likely to begin raising rates in June, and according to these guys, American interest rates will begin to rise by the end of the year.
In an environment where rates are going up, the last place you want to be is locked in a term deposit paying a rate of interest that doesn’t even keep up with inflation. Take a look at the chart for CPD, the preferred share ETF in Canada. See the sharp sell off in the last month? That’s not because the market is suddenly bearish about the Canadian market.
The market is anticipating rates going up, and quickly. If that’s the case, why would you even think about locking in at less than 2%? I can buy the entire market of preferred shares and make 2 and a half times that. Plus, as preferred shares, they’re taxed much more favorably than any interest income.
Check out the GIC rates in Canada. If you lock in for 5 years at one of the big 5 banks, you’ll barely beat a 2% return. If you shop around you can get above 3%, if you lock in for 5 years. You’re giving up liquidity for 3%!
Yes, you can always pull money out of your GIC. And while I’m not an expert on penalties on GICs, I do know that often you’re looking at forfeiting 6 months worth of a return as a penalty.
If you invest $10,000 in a GIC today, what will it be worth 5 years from now once we strip out inflation? I’d say the best case scenario is right around $10,000, with the worst case scenario being much worse than that.
Cash does have a place in your portfolio. Yet when you lock in your cash, it takes away the main attraction of having cash- liquidity. Cash should always be kept on hand for investment opportunities and in case you win the crap lottery. You should just never have too much of it just sitting around.
The reason this post was titled Take Your Investments out of CDs (or GICs) is that I hardly fault an investor for trying to maximize her return on cash. I just think that perhaps a high yield savings account is a better option than locking into a very non-competitive product.
Which gets me to yet another problem I have with the Simple Dollar. I’m too lazy to go find some of the posts in question, but he advocates people to invest in a ladder of CDs, often calling the returns “nice”. There are so many ways for people to do better on the fixed income part of their portfolio. If investors aren’t comfortable buying bonds or preferred shares of a particular company, the market has created all sorts of products that they can use to diversify their holdings.
So please don’t lock in crappy little returns. Inflation will kick you hard in the next few years. You can thank me by clicking on my ads.