The deciding factors around bonds vs. GICs
When deciding which to choose, Koivula says that the two most common considerations are liquidity and simplicity.
“When you buy a five-year GIC, your money’s locked away a long time, and a lot can change in five years,” he says. So, if you need access to that money, even just to rebalance your portfolio to take advantage of a stock-market slump, bonds (or bond funds) are the better choice.
Buying individual bonds, though, can be bewildering compared to investing in stocks. For example, “if you buy the common shares of Royal Bank or Fortis, they’re basically all the same,” Koivula says. “In the bond market, a single issuer might have hundreds of bonds with different terms in circulation. It can get quite complex.”
For that reason, when most investors seek exposure to bonds, they invest in bond funds.
There are exceptions, though. Some Canadian investors don’t like the volatility of bond funds—albeit small compared to those of stocks. When interest rates go up, your bond funds can drop in value to less than you paid for them. If you hold a single bond to maturity, by contrast, you can expect to get paid all your capital back with interest. Another solution to the volatility problem is target-maturity bond funds, which hold a basket of bonds that all mature around the same time.
Should you buy bonds or GICs?
There are a few other factors that might tip the decision in favour of one investment over another.
Diversification benefits
GICs are uncorrelated to equities, but bonds have historically been negatively correlated with equities. That means they tend to go up in value when stock markets crash. Also, GICs are only available in Canada, but you can buy bond funds that hold bonds denominated in U.S. dollars or other currencies. “In Canada, when stock markets go down, typically the U.S. dollar goes up,” Koivula notes. So, if smoothing out your portfolio’s ups and downs is a priority, bond funds may be the best choice, he suggests.
Tax efficiency
The interest paid by most fixed income investments (other than preferred shares) is 100% taxable outside registered accounts. But it is possible to lower your tax bill by buying discount bonds or bond funds that pay low yields and offer more return to maturity in the form of tax-efficient capital gains that may be only half taxable.
