If you ask most investment advisors, they will recommend you have a balanced portfolio of equities and fixed income. Nowadays, a 60%-40% split in favour of equities is common, depending of course on age and risk tolerance.
David Trahair disagrees. The author of five books and an accountant by training, he maintains that most people should have an all-GIC portfolio. It’s unconventional advice but definitely worth hearing out. We recently interviewed David, who kindly answered our questions about his GIC strategy.
To back up his argument, David points to average yearly returns of the stock market (via the S&P TSX index) versus 5-year GICs, compounding annually. Citing Bank of Canada data, he observes that the total return of the stock market (i.e. including dividends) over the last 50 years has been 9.16%, not including fees or taxes. GICs, on the other hand, earned 7.21%. But when you subtract the average management expense ratio (MER) of a typical Canadian mutual fund, which is around 2.00%, he notes that you’re in “GIC territory with all the risk”.
In addition, David says that people’s emotions naturally get in the way when investing, so they end up panicking when the market is low and selling. What this means is that many investors won’t come close to the average annual gain for equities over time.
What follows is a condensed transcript of our interview.
RateHub.ca: What kind of GICs do you think people should buy? Short-term, long-term, cashable, non-redeemable?
David Trahair: It depends on the objective of what they’re putting the money in for. If it’s retirement 30 years from now then I think a laddered GIC portfolio of 5-year GICs [is appropriate].
If, say, somebody in their 20s is trying to save for a deposit for a house within 5 years, then they probably don’t want to lock it all in for 5 years…the obvious thing to be totally liquid is just a quote “high-interest” savings account, if people don’t want to feel locked in.
In the 80s, you could get double-digits on a GIC, but what’s the alternative [today]? The alternative is jumping into the stock market. And I think that’s one of the reasons why the market has been doing quite well in Canada and the U.S. is that people see these lousy GIC rates and assume well they better get into the stock market.
RH: Do you think that today’s low interest rate environment alters the merits of the all-GIC portfolio, or should people settle for a guaranteed low return rather than putting their capital at risk?
DT: That’s what I would recommend. I would say look, that’s the way it is right now. The alternative is to risk and possibly lose a significant portion. If you’re in the market, you can’t panic, you need to stay in. The other issue is that what you earn on your savings is really tied to some degree to what inflation is. And inflation is quite low right now. In the 80s, when GICs were making double-digits, inflation was double-digits. So people think, “Oh wow, I wish I could make 10% on a GIC now”. But the cost of that would be that prices would be going up by probably around that amount anyways. So you’re sort of in the net same position.
RH: Have real returns (adjusted for inflation) come down though, since the 80s?
DT: That’s the argument I get against GICs almost every time I talk about them, is the real rate of return. They say, ok, here I can get 2.500% per year, the CPI all-items index is 2.00%, therefore my real rate of return is 0.50% or nothing, why would anyone invest in GICs. I think that’s a bogus argument that is essentially used to trick people into assuming a much higher level of risk with their investments which may do better than GICs and therefore having real rate of return, but you may have a negative return.
When it comes to personal finance, (individuals are) not corporations that go on forever or governments that go on forever. You’ve got a set timeline, which is for many people retirement. And the older you are, the more devastating that problem can be if there is an adjustment (i.e. the market tumbles).
I say, so be it. Interest rates are low but you’ve got guaranteed capital, you’re making at least something, a couple percent. Forget the inflation argument, stick with safety. And work on all the other areas of your life, which is that you’re probably spending more than you make. I’m a big fan of convincing people to track their personal spending. Forget believing the dream that you can keep spending more than you make and some amazing investment advisor or the stock market is going to bail you out. That is probably not going to happen.
Trahair freely admits that he’s a pretty conservative accountant, but doesn’t maintain that everyone should be 100% in GICs, necessarily:
I’m a huge fan of GICs when held in registered products like RRSPs and TFSAs because you don’t lose up to 50% of your money in tax. (But say someone is) 65 years of age, they’re maxed out on their TFSA, they’re maxed out on their RRSP and they’ve paid off all debt and they’re wondering what to do with the extra money. Well, do whatever you want. You’re already in great financial shape.
Trahair notes the exception being if they’re very elderly and can’t afford to take any risk with equities, in which case they should just stay 100% in fixed income.