GICs Versus Bond ETFs
It’s a battle many of you have probably been waiting for: In one corner are GICs and in the other are bond exchange-traded funds (ETFs).
Compared to stocks, GICs and bond ETFs are on the boring side. You invest money and earn a little bit of income. And little is the key word since interest rates in Canada and most developed markets are still at or near record lows.
You’ll earn some income with both types of investments, but there’s a possibility bond ETFs will drop in value when interest rates are rising—like they are now—while GICs won’t decline.
The amount the bond ETF will fall depends on when the bonds mature. If the ETF holds bonds with long maturity dates (the expected date you’ll get your principal back), the ETF will decline much more significantly than an ETF with bonds with shorter maturities. And an ETF holding bonds with longer maturity dates will have a higher yield compared to one with shorter maturities.
If a bond ETF declines in value, the yield will increase. But if the ETF rises, the opposite is true. The reason why bonds fall when interest rates rise is because newer bonds will pay a higher interest rate, making the older bonds with lower rates less attractive to buyers. When interest rates fall, bonds paying a higher rate of interest are in demand and will rise in value because new bonds will pay lower rates.
With GICs, the value will never fall and the yield (or in this case, the interest rate) will remain the same until the term ends.
To determine the future return of a bond ETF, you should ignore the current yield. Instead, the best indication is what’s called the weighted averaged yield to maturity (YTM). You can easily find this information on the ETF provider’s website.
GIC rates are also easy to find. Of course, the best GIC rates can be found on this site. If you expect rates to rise and want to get more bang for your buck, you should build a GIC ladder. Instead of investing in one GIC, you can divide the money into equal portions and invest in GICs with different terms. When each portion matures, you buy a new GIC that will likely have a higher rate.
GICs are fairly simple. There are regular GICs (redeemable and non-redeemable) and market-linked GICs. And there are a variety of terms available. On the other hand, there are many different types of bond ETFs to choose from, such as government, corporate, high-yield, and emerging markets bond ETFs.
If you hold non-redeemable GICs and need money immediately, it’s very difficult to access your funds. But if you hold bond ETFs, they can be sold anytime the stock market is open and you’ll be able to access your money very quickly.
The bottom line
If you’re having difficulty deciding between GICs and bond ETFs, invest in what you’re most comfortable with. A short-term bond ETF is the least volatile and probably suitable for most investors. If you decide to buy GICs instead, a GIC calculator will help you estimate how much interest you can earn.
Also read:
- Market-linked Versus Regular GICs
- The Difference Between GICs, Stocks, and Index Funds
- The Pros and Cons of Real Return Bonds
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