The risk of rising interest rates has become an obsession in the financial media. Those risks are undeniably real: it’s quite possible that broad-based bond funds will see multiple years with negative returns. (As I illustrated in a previous post, that would likely occur if rates across the yield curve rose 1% annually for three years. This article by Dan Hallett also includes some possible scenarios.) But these risks need to be kept in perspective: if you hold a bond fund with a duration shorter than your time horizon, your capital is not at risk. And if you’re a decade or two from tapping your portfolio, rising rates should even be welcomed.
And yet the bond bears just keep on roaring. The latest example is an advisor featured in a Globe and Mail article this weekend. “For the first time in my entire career,” he says, “bonds are in my opinion riskier than stocks.” He’s recommending his clients abandon the asset class altogether. Whenever articles like this are widely read, I get contacted by worried readers who are ready to follow suit. So here’s my preemptive response to what I believe is dreadful, dangerous advice.
This time isn’t different
To declare bonds are riskier than stocks is just another way of saying “this time it’s different,” long recognized as the four most dangerous words in investing. It’s also impossible to justify. Even if you’ve been investing for only five years you know stocks can lose 50% of their value in a matter of months. It’s inconceivable that a broad-based bond index fund could suffer a loss of that magnitude unless the Government of Canada defaults on its debt or we experience hyperinflation. A brutal scenario (the yield on 10-year bonds rises steadily from just under 3% to 6% or 7%) would likely see modestly negative returns over three to five years. To suggest investors can reduce their risk by allocating more to stocks and less to bonds is irresponsible.
Yet that’s exactly what the advisor is doing. For investors who currently have a target allocation of 60% stocks and 40% bonds, he’s suggesting a shift to 70% stocks. And what should they use for the other 30% of the portfolio? Market-linked GICs. Really?
If you need a refresher, a market-linked GIC guarantees the investor’s original principal over a specified period, often five years. But instead of paying interest, its returns are tied to the performance of the equity market (either an index or a portfolio of specific stocks). “If we have a rocking bull market, I think the upside is low double digits, and the downside is zero,” the adviser says.
But the downside is not zero. There is a real possibility of getting your principal returned with no return after five years. Meanwhile, you can find conventional five-year GICs paying a risk-free annual return of up to 3%. That’s an opportunity cost that can’t be ignored.
Dividend stocks less risky than bonds?
And what if market-linked GICs aren’t available? In that case the advisor suggests using dividend ETFs in place of bonds. Again, replacing bonds with stocks is presented as risk reduction: “I would respectfully say that in this unique context, I am actually taking risk off the table.” That’s an outrageous statement. Dividend stocks tend to be less volatile than the broad market, but not much. Let’s remember the iShares S&P/TSX Canadian Dividend Aristocrats (CDZ) fell in price more than 46% from September 2008 to March 2009. There is no reason to believe such a decline could not happen again. And there is no “unique context” where dividend stocks could possibly be considered less risky than a broad-based bond index fund, let alone a short-term bond fund or a ladder of GICs.
If you work with an advisor who suggests you should reduce your portfolio’s risk by exchanging bonds for stocks or market-linked GICs, I urge you to push back. If you’ve decided you simply can’t stomach the risk of short-term losses in an asset class that is supposed to be “safe,” that’s fine. But the solutions proposed by this advisor are, in my opinion, entirely inappropriate.
If you fear rising interest rates, the prudent strategy is to reduce the duration of your bond portfolio. That could mean using a short-term bond ETF or a ladder of GICs, both of which would allow you to benefit from an increase in rates. If you’re comfortable with a little credit risk, use short-term investment-grade corporate bonds to get a little more yield. Heck, move your fixed income allocation to cash if you really must. But once you go down the road of “this time it’s different,” you’re taking the first steps on a journey to a dark, unforgiving place.
This kind of advice is so scary whenever I see it. My wife’s parents have an advisor who’s suggested that they move some of their portfolio into dividend stocks for the same reasons cited above. They’re 60. They can’t afford to take on the very real extra risk that kind of move is putting on them. It’s very hard for me to believe that a professional with any kind of understanding of the markets could actually think this is a reasonable decision. I just have to believe that it’s purely for the sale.
The biggest risk is thinking you know what the market will do over the next year. If there was a GIC with returns linked to foolish moves based on short-term forecasts it would do very well :)
I’m not in bonds at the moment but it has nothing to do with the risks over the next year or two. I simply don’t find their promised returns over the next decade attractive. I could be wrong but I am very comfortable with taking some short-term pain to get a better result in the end.
One very basic question about bond funds (forgive me if you’ve covered this before, but I couldn’t find it after some digging): do bond fund ETFs rise and fall in price based on demand, or is their value determined entirely by other factors? The reason I’m asking is that I’m wondering whether the price of bond funds would decline in response to all the selling that’s going on, which would then create a bargain buying opportunity for long-term investors.
Further to Brad’s comments about Bond Fund ETF price fluctuations, i would also like to know how dividend’s are affected by rising or falling rates.
I own a short term bond fund, and besides the price dropping, the dividend payment has also dropped recently.
Can i expect dividends to drop further as rates rise?
“But once you go down the road of “this time it’s different,” you’re taking the first steps on journey to a dark, unforgiving place.”
Haha!! This Blog is worth following just for the juicy treats of bon mots you keep on tossing out there to lighten up the solid dietary meat of sound, unexciting but essential financial advice! I just realized good financial advice is very much like the Canadian Food Guide, food pyramid and all. And that your typical sensationalist financial columnist is like the typical Fad Diet du jour — bad advice disguised as exciting news.
A ‘barbell’ bond strategy that splits ones bond allocation between long term (VAB, say) and short term (XSB, say) bonds might be the happy medium for some bond investors.
XSB average duration 2.75 years. VAB average duration 6.9 years. Weighted average duration is between the two. But the convexity will be less meaning less sensitivity to interest rate volatility.
(Nothing like standing firmly on the fence).
Ersh…. Yes, the value of your bonds are down, so sell now–like everyone always does. Sell at the bottom, buy at the top. That’s the way we do things. Go bullish on equities now because they’re all up this year–that means it will go on indefinitely. When they suddenly crash down for 6 months 2 years from now, you must panic and sell those and buy bonds. This is exactly the craziness that results in every single person being their own *worst*financial enemy. Bunch of suckas.
Nobody knows exactly where bonds will go. And if they do, they’re lying or delusional. Nobody could have predicted the year Real Return bonds appreciated something like 16%. 16%?!!! I’ll take that, thanks.
One of the reasons I love the Couch Potato is that it forces contrarian investments. It makes me buy low and sell high. When it comes time to rebalance at the end of this year, looks like I’ll be buying loads and loads of bonds to get things equalized. …And I’m actually looking forward to it. :)
Brad,
Most ETFs’ price movements have nothing to do with demand for the ETF. Their price is driven by changes in price for the underlying security (be it stocks or bonds). That’s the whole advantage of ETFs over other fund structures like Closed End Funds. ETFs have this property because when the price of an ETF deviates too far from the value of the underlying assets, units are either created or broken down by ‘authorized participants’ who make a small arbitrage profit in the process.
I think this is a great point. I’m also skeptical of the current conventional wisdom against bonds. Has there ever been such a universally hated asset class?
I would suggest studying the postwar period leading up to the interest rate peak around 1980. Download the historical interest rates for the 30-year Treasury and the T-bill. Compute two theoretical investments during that period taking into account the respective duration of these two alternatives. You will see that, contrary to being crushed by the long duration of the 30-year, that investment actually outperforms the T-bills. So whereas some other investment (e.g. stocks) may yield more during the period, this is no blood bath. Respect duration and you’ll be fine.
I have a question about holding a bond fund for it’s duration.
Suppose I’m putting money into a bond fund with an average duration ~7 years, and I will need the money in, say, 10 years. The bond fund is a safe choice, since my horizon is longer than the average duration.
However in three years time, my horizon will be shorter than the duration. At this time would the best course of action be to stop adding new money to the fund – perhaps opting for a GIC instead?
Thanks!
There was another example of lousy advice in the financial media today, this time in the Star, http://www.thestar.com/business/personal_finance/2013/09/22/low_interest_rates_in_past_so_whats_an_investor_to_do.html# – this time pushing floating rate notes to replace bonds.
It began with the usual statement about capital loss with bonds or bond funds in a rising interest rate environment, failing to add that there will be no capital loss as interest rates go up if you hold the bond to maturity or the bond fund for the duration of the fund.
At least the article pointed out the risks of floating rate notes (that they can go down when stocks crash), and didn’t suggest replacing all your bonds with these notes, but as the point of bonds is reduce portfolio volatility when stocks crash, and provide a bump up to buy more stock when they are down, it is poor advice to suggest switching bonds to floating rate notes.
@Mike: You have the general idea. The holding period applies to each dollar put into the fund, not just the first dollar. So if you contribute $1,000 annually for seven years to bond fund with a duration of 7 years, only the first $1,000 is guaranteed not to suffer a loss of principal. So as you approach your time horizon, you will need to consider this and adjust the duration of the holdings appropriately. That can mean using short-term bonds ETFs or GICs for new money if you are three or four years away for needing the money, and probably just cash once you get to two years or less.
Advisers will try to make money in good times, AND bad!
Thanks for exposing this stupidity. You should point out that your own strategy of
short term corporate bonds assumes you will hold the bonds to maturity and that you will
get a fair price when you buy them. In my opinion there is nothing shadier in Toronto than the bond market.
There is in fact no market. You simply buy from the inventory of one of the banks. Recently, for a bond I was interested in
I was quoted 105.5 by CIBC- Wood Gundy. One hour later for the same bond TD Waterhouse gave me a price of 103.5.
When I questioned CIBC I was told they made a mistake. No one makes a mistake pricing financial instruments!
Only God and perhaps Mr. Flaherty can protect us from the greed of banks.
Dr. J.
Duration is the key metric to focus on, realizing that rates rising will have a very different impact if you are in a 1-5 years ladder (3 year or so duration) than if you are in a Long Term bond ETF (such as XLB – with over 13 years of duration). The difference in the scenario of 3% going to 6 or even 7% (which is unlikely to happen here unless we are headed Greece’s way and “blissfully unaware of it…”) – could in fact in the case of XLB make you think that your bond ETF has as much volatility as stocks…
Focus on duration risk as you can tolerate it. As for the notion this time isn’t different – I’d argue we are in times that are extremely different from anything we’ve ever seen. Yields have been manipulated extensively, and should all hands be off and somehow the inflation genie come out of the bottle … it could end up being if not different, then painfully reminiscent of other periods when bonds didn’t fare well at all.
Would I want to be locked in at low absolute levels of yields for the next 30 years? Nope. would it be catastrophic for 2, 3, or even 5 years? No, it wouldn’t either…
From what we have seen at Team Eureka, most advisers are using this is an excuse to churn their clients accounts.
For the last few years’ advisers have been screaming about how wonderful bonds did, so they put you in bonds. If you were in mutual funds they probably took your DSC expired or new funds and locked it up for 7 years. If with a broker you got dinged with a trading fee, and if you’re with an IA you probably got fed some story about bonds are “the way to go” in attempt to spin a new exciting story to cover up their poor performance in the last 10 years–meanwhile you’re still paying your yearly % on assets.
Now, they are calling for investors to dump bonds and pick up equities. Another churn? Another trading fee? Another new amazing strategy?
There is only one way to profit off bonds (while holding them) with rising interest rates…short them. Otherwise all you can do is insulate/minimize your losses by changing terms of bonds. BUT insulation isn’t a bad thing. Bonds are lower risk…6-9% downside in worst-case scenarios versus the 30-50% in equities. AND it keeps you diversified. DIVERSIFIED!!
Yes I agree diversification diversification diversification can get boring, but its what keeps portfolios afloat and a keeps that average return up over the long-term.
There will always be a trade off between risk and return, no matter what investing decision you make. Just make sure you are prepared for and understand the risk you take on when adjusting your portfolio because who knows what will happen in the next few months. We have likely see issues with the U.S., China, Europe, Emerging Markets, gold frenzy, interest rate & FED speculation, and don’t forget commodity booms & busts we have to look forward to in Canada.
Don’t put all your eggs in one basket. Stay diversified. Hope this helps.
Kathy Waite, Eureka Investor Guidance
Net Worth Manager (Fee-only financial planner)
http://www.eurekinvestorguidance.ca/blog
When I set up my retirement portfolio a few months ago, I used my emergency fund (some money put away in case of loss of job, unexpected expenses, etc) to purchase a bond ETF (XBB). I thought I could be clever and use the money to contribute to the portfolio as part of the target allocation, and figured that bonds would not significantly lose money. However, after reading the latest CCP posts about bond duration, I realize I was mistaken.
What class of fund (or other investment) would you recommend purchasing with an emergency fund? Should it be considered when calculating the target allocation? My emergency fund is about 10 – 15% of the amount of the retirement fund.
@Martin: Your emergency fund is, by definition, for short-term needs, so it should be considered separately from your long-term investment portfolio. And there is only one appropriate vehicle for that money: a savings account. An emergency fund should never be at risk of falling in value, and should be extremely liquid. Savings accounts are the only vehicle that fits those two criteria.
@Martin Here are some examples of savings you can hold in your online brokerage account (I am assuming that what you have).
RBC investment savings account RBF2001
Manulife investment savings account MIP510
Manulife trust investment savings account MIP710
Renaissance high interest savings account ATL5000
Dundee Investment savings account DYN500
Altamira High interest cashperformer NBC100
TD Investment Savings Account TDB8150
*I am not recommending you buy/sell any of the above. Merely proving facts of what is out there.
http://www.eurekainvestorguidance.ca/blog
Actually depending on what brokerage he has account with will limit type of high interest savings account he can buy. For example I am with TD Waterhouse and therefore can buy only TD Investment Savings Account TDB8150. Other types of high interest saving accounts that you listed were available in the past but not anymore.
Warren Buffett seems to recommend to same approach to individual investors than the advisor who wrote the globe and mail article:
http://video.cnbc.com/gallery/?video=3000166399
http://www.usatoday.com/story/money/business/2013/05/06/warren-buffett-federal-reserve-stocks-bonds-heinz/2138403/
@Gordon … and that’s why TD is loosing most of my business. Moves like that strike me as anticompetitive and are not about providing the best unbiased service they can to the customer. I recall they did a similar thing with Steadyhand. Likely because they didn’t provide a kickback fee.
They can play those games, but I don’t have to play with them.
@Jas What he said was hold enough cash to be comfortable and then invest the rest in stocks. He also said holding long term bonds was a bad investment. He said nothing about short term bonds.
As long as you have enough cash on hand to withstand a 50% drop in stock prices, and have the fortitude to not crumble when this happens, then yes, holding stocks may be the better bet over the long run.
Also, note that when Buffett talks about stocks, he means specific value stocks and not the overall market. He’s a believing in Benjamin Graham’s methods of picking value stocks where earnings growth is (likely) more predictable.
Who knows whether he’s right or not, only time will tell.
@Brian
Actually, Buffett is a strong believer of index funds for the average investor:
http://www.cnbc.com/id/100518304
I don’t plan on touching my bonds for another 15 years. I’m fine if rates rise.
Good post. I enjoyed “This time isn’t different” content.
Before I go…I think individuals that don’t have a pension, should consider GICs, but that’s about it. I suppose it all depends how badly you need some income to pay for your fixed expenses in retirement.
I think we’d all do well when an asset class drops a little to remember:
“Smart investing boils down to two simple rules: 1) Ignore fads. 2) Stop trying to beat the market.” – Jack Bogle
@Jas I judge people on what they do and not what they say. Warren Buffett’s actions are often very different than his words. He’s a master at creating an image. But at the core, Buffett is a Graham value investor who doesn’t invest in the broad market… those are his actions.
@Edward Good quote. It goes along with my current worry that the assumption many people have that we’re in for a rising interest rate environment could be an incorrect one. No one can predict how long we may stay low or even if we may go lower again. One only needs to look at Japan. Look at their benchmark 10 year bond yield over the last 20 years to see an overall decline with a bump up in the middle followed by another decline. Now they are going crazy trying to devalue their currency.
One must invest without assuming you know the future.
RBC Direct Investing has a HISA – RBF2010 that pays 1.2%. At this time, I figure the HISA is better than bonds. Any comments?
@Brian: just like a lawyer or musician can fairly point out that the career isn’t as glamorous as it appears, I believe Buffett when he says most people shouldn’t act like he does. But if you do enjoy spending 10 hours a day reading financial reports and correcting accounting rules that were wrongly applied there is a lot to learn from him :)
@Richard I do enjoy reading financial reports. I’ve even found what appeared to be borderline fraud once by comparing two large companies in the same industry that I was very familiar with. One had very conservative/realistic accounting and the other was very “creative” and was deferring bad news. The market beat up the conservative company for years and the “creative” company was valued much higher by the market because it was “outperforming”. Over the years, this trend reversed when the bad news finally couldn’t be hidden any more. This example is one of the reasons why personally, I don’t believe in the efficient market hypothesis and why my personal investing isn’t strictly indexing.
But finding things like this isn’t easy. I can only do it in industries I fully understand because of experience. It requires tracking the financials over time, knowing what to look for and believing what you’ve found when nobody else seems to notice. It’s not a simple “value” screen using P/E, EPS, etc. and that’s why the vast majority of people will never do it.
Bogle’s strategy is good because anyone can do it because you can be lazy and do well. He’s helped many people do okay.
Buffett’s (and Munger’s) strategy is good but you can’t be lazy to do well. I also think he knows what to look for, age and experience must come into play. He’s also helped many people get very rich.
As a wise man once said, keep an open mind – but not so open that your brain falls out.
“RBC Direct Investing has a HISA – RBF2010 that pays 1.2%. At this time, I figure the HISA is better than bonds. Any comments?”
@Darlene This is an impossible question to answer. You’ll have to define “better”?
Let’s assume we don’t know which direction interests rates are going nor when… because nobody really knows.
If your time horizon is very short, then yes, it may be “better.”
If instead, your time horizon is 20 years then it most certainly would be much worse and won’t even match inflation.
@Darlene I agree with what Brian said above but make sure you look at the risk-return relationship of that component of your portfolio. Will the hisa get the return you require? or does it lower your risk profile too far? In which case you might need to reassess your risk held in your equities, and maybe increase the riskiness in your equities to achieve your balance of risk and return. That being said, if your time horizon is sub 5 years you should probably have an emergency fund (cash you need within the next 5 years) built up which could be held in a hisa. Hope that helps. – Kathy
(*I am not recommending you buy/sell any of the above. Merely proving facts of what is out there. _http://www.eurekainvestorguidance.ca/blog )
What about real return bonds. Is there a place for these in my portfolio?
@Dave: Real-return bonds are an optional asset class: I include them in my Complete Couch Potato. The key point is that RRBs in Canada have very long maturities. The duration of a fund like XRB or XRR if over 15 years, so these really a are a long-term investment. They are also quite volatile: we have seen double-digit gains and double-digit losses in the last several years. These provide a lot of opportunity for rebalancing.
https://canadiancouchpotato.com/2013/07/02/why-diversification-is-a-piece-of-cake/
https://canadiancouchpotato.com/2013/02/28/ask-the-spud-the-role-of-real-return-bonds/
Doug Cronk’s post from a few days ago highlights the benefit of some active strategy in this case, minimizing risk by shortening duration of maturity. The challenge is accessing this at a cost that will not “eat up” the presumed better return. A pure passive approach- the ultimate couch potato – has its limitation. Dan’s comments would be appreciated
@Lawrence: What specifically would you like me to comment on? What limitations do you see in a passive approach to fixed-income investing?
H Dan, thanks for the reply. Please note that I am not a pro, just a newbie who tries to understand how things work. Strategies that I seen/ read about include shortening the duration of the portfolio, the dumbbell approach as mentioned by Doug (who clearly IS a pro) trying to position the duration so that it straddles the point of inflection of the yield curve, looking at corporate not just government bonds etc etc. Obviously all of this comes at a higher MER which might eat up any presumed gain. How realistic are these strategies?
@Lawrence: Adjusting the duration of your bond holdings doesn’t increase the cost: in fact, short-term bond ETFs are cheaper than broad-based funds. (Corporate bond ETFs are a little more expensive than governments.)
I don;t want to speak for Doug, but I think his suggestion was simply to go halfway: i.e. rather than going short-term with all your bond holdings, you would just shorten half of them. This is fine if you want to reduce volatility a little.
Personally I like to keep fixed income as simple as possible. Choose a duration appropriate to your time horizon and tune out the noise.
I very much enjoyed reasons the above comments re bonds versus stocks.
I was wondering if some preferred stocks could provide a higher return with reduced risk? Where would you see Preferred fitting into a portfolio of common stocks and short term bond?
Would appreciate any words of wisdom.
Thanks
Roger
@Roger: Preferred shares are quite sensitive to interest rate increases also, so I’m not sure they offer much risk reduction compared with corporate bonds. You can make a reasonable argument for preferred shares in taxable accounts (especially as an alternative to corporate bonds), but again, I think the main point is that it makes sense to simply establish a long-term asset allocation and stock to it rather than trying to make tactical moves in anticipation of interest rate changes. If you have a long-term allocation to preferreds, fine. But if you;re considering moving out of bonds into preferreds for tactical reasons, then it’s a slippery slope.
@Roger and for everyone who likes to compare preferred shares to bonds, I suggest you chart the total return of CPD and XBB and see for yourself if they are comparable. I do this on txmmoney… just ensure you turn on adjust for dividends and splits to compare Total returns.
You find that preferreds sink with the stocks when stocks plummet (e.g. 2008) and sink like bonds when interest rates rise. The worst of both worlds. LOL.
Hi Dan,
I wonder if you have the same aversion to bond mutual funds as you do to equity mutual funds. I have half of my bond portfolio in PH&N’s bond fund (PHN110). A very reasonable MER (0.61%) and long history of positive returns. Would you still recommend bond etf’s over cheap and proven active management even with the ongoing volatility?
@Brian: I don’t have an aversion to mutual funds: I have an aversion to high-turnover active management and high costs. I’d put the PH&N bond funds in the same category as something like the Mawer Balanced Fund: inexpensive, prudent active management that is pretty hard to argue with. I would not expect the PH&N fund to make any brilliant moves in anticipation of the direction of interest rates, but it certainly isn’t a bad choice for a core bond holding.
PH&N110 seems to maintain a strategic mix of 50% government and 50% corporate bonds, and its characteristics are very similar to those of broad-based bond index funds: average term about 9-10 years, duration between 6 and 7, about 3% YTM. You can get that exposure a bit cheaper with ETFs, but not with index mutual funds.
Interesting. I have learned so much from your site. Thanks.
Hi CCP:
I am a ETF investor and had bonds only at 15%. After reading many a post here I have now increased it to 20% with RBF1340 and will be increasing the bond allocation to 30% very soon with XQB . I was very happy to read your answer to Brain on the PH&N bond fund above. This RBF1340 has a MER of .059%. Also, you have made several references here to “Broad based Bond Index Funds”..etc. What are these broad based bond funds as all my equity is invested also in broad based market cap ETF’s and would like to do the same for bonds.
thank you
Prasanna,Maple.
@Prasanna: By “broad-based bond fund” I simply mean one that holds both government and corporate bonds across many maturities, as opposed to a short-term bond fund, or corporate bond fund etc. This would include VAB, XBB and ZAG.
ok great.thanks for the examples.
Just read a article challenging the decision of large allocation of bonds by this author.
I think a GIC is more prudent at this point with interest rates poised to rise, at some point?
Roll them over every year?
http://www.moneygeek.ca/weblog/2013/06/01/open-challenge-canadian-couch-potato/
Mark, the MoneyGeek author was not opposed to “large allocation of bonds” per se. If you read the link you provided you’ll see that MoneyGeek was specifically opposed to keeping longer duration bonds. He thought that interest rates were going to rise and that the risk involved in holding them was no longer worth it. Also, although he was in favour of not keeping any bonds in your portfolio, he didn’t advocate that for everybody and so created 5 portfolios with various ratios of bonds to stocks which you would choose based on your comfort level.
Here are two direct quotes from his post:
“…our Portfolio 3 will deliver similar returns to that of the Canadian Couch Potato’s but at a lower risk, because our portfolios hold short term bonds.”
“So there you have it. At best, in an unlikely scenario, XBB.TO will return 4.5%/year for the next 3 years. But more likely, it will earn just 2.35%/year or earn nothing, or worse.”
His arguments sound rational…except he was wrong for 2014. According to the iShares website XBB’s total return for 1 yr was 8.46%. If you had followed his advice and switched to a shorter duration bond ETF (XSB), your total return for 2014 would have been 2.8%.
Be sure to read his follow-up post where he tries to save face:
http://www.moneygeek.ca/weblog/2014/07/31/whats-happening-canadian-bonds-xbb/
This is precisely why I am a Couch Potato convert. If the MoneyGeek with his PhD cannot predict future bond returns with any accuracy, what hope do I have of doing so? He even had the nerve to say “Was I wrong? You decide.” Well, he *did* predict XBB was going to return 2.35% or worse….
Mark, there are numerous articles on this website that address your question in depth. GICs are not liquid so you won’t be able to take advantage of rebalancing opportunities should something dramatic happen. Having said that, if you don’t like the way bond prices fall when interest rates go up then GICs will make you feel better — even though you don’t actually lose money if you hold a bond fund for the duration. Another strategy, discussed above, is to shorten the duration of your bond fund/ETF which makes them less sensitive to interest rate increases. However, as the MoneyGeek example shows, if interest rates don’t go up, the shorter term bond fund will have lower returns.
Every time I hear “interest rates will go up in 2015” I think about how interest rates did not go up in 2014 despite all smart people who thought they would. I also think about what would have happened had I followed the advice that was being given at the time. The great thing about being a Couch Potato is I don’t have to think at all about all these predictions — I’ll stick with the plan and accept what the market gives me.
@HeKyLl, for fairness it should be emphasized that the MoneyGeek author only claimed that he would outperform over 3 years. Time will tell if he is right. No investment in stocks or bonds can be fairly evaluated in such a short time frame like 1 year. That said, he hides his portfolio behind a pay wall as far as I can see, so I doubt we can track it, so that is a point in favor of the transparent CP portfolio.
Also, I have some bad news if you think XBB has gone up 8.5%. I claim it has lost about -1% over 2014.
I make it a habit of measuring my investment return in CAD dollars, US dollars and a 50/50 mix. In US dollar terms, XBB has lost money over the year because the CAD dollar has lost about -10% over the year.
I believe it is fair and wise to measure portfolio performance in US dollars because a lot the goods and commodities we consume are effectively priced in US dollars. E.g. food, energy, consumer goods, etc. Anybody who buys groceries knows that the real inflation for food is much higher than the official government CPI numbers! and much closer to tracking the CAD/USD exchange rate plus some inflation.
I’ve wrote on here before that I don’t trust any one currency; especially a small currency like the Canadian dollar. Therefore, I don’t hedge and try to keep my portfolio mixed between currencies including my fixed income. I don’t try to predict exchange rates; instead when I add money to my investments I add it in equal parts between USD and CAD and never convert between USD and CAD again. This approach minimizes currency risk and provides some level of insurance in case CAD plummets or visa-versa. I’ve been doing this CAD/USD split for about 10 years and have seen it work in both directions and I just don’t worry about it… it’s just an insurance policy against currency devaluation which happens more often than one would imagine (E.g. in current years: Iceland, Japan, Russia, Venezuelan to name a few…)
For the last few years, specifically, my fixed income allocation consists of a mix of XSB.TO and US Dollars (cash). In 2013, I looked at XBB and wasn’t comfortable with yield to duration vs. XSB. The risk just didn’t seem worth it. I looked at BND and SHY in the US but the yield curve is so flat that I didn’t like the risk return vs. plain old cash, so I stuck with cash. Given the current even flatter yield curves, I am even more convinced.
This exceedingly conservative fixed income allocation has outperformed XBB in real terms of return/risk. I will be well positioned to buy longer term bonds or GICs when/if interest rates rise. Until them I am more than happy with my decisions and will be sticking with it this year.