Years ago, my aunt and uncle spent time in a retirement community in Florida with a couple much older than them. “How was it?” I asked. “No one there buys green bananas!” my uncle exclaimed as a way of pointing out that he was younger than most people there.
These days, I find that way of thinking taking over the minds of many of my clients. It becomes noticeable when we are considering investing in bonds and GICs.
Interest rates have, of course, risen a lot, and these investments are much more attractive than they’ve been in years. No one knows for sure if rates will get even higher or if or when they’ll come back down. But I think it’s worth exploring whether some clients should take advantage of what is currently available and lock in some strong future returns.
“Ok, but not for more than one year,” some will say.
“Oh, why is that?” I ask.
“Because of my age” is usually the answer.
It’s worth noting that these people are generally in their seventies. There is nothing wrong with sticking to one-year investments. I just want to make sure they are not passing longer-term investments over unnecessarily. So I try to unpack it.
Is there something that they will need the money for in the near term? No.
Are they anticipating a shift in investment strategy in two or more years’ time? No.
Are they dealing with a health concern that puts their near-term lifespan into question? No. But you never know…. At my age…
I should point out that, unlike GICs, bonds are liquid. They can be sold at any time. So even if something changed in their lives – including death – the bonds could be sold to meet their needs or to be distributed to their heirs. Actually, even GICs can be redeemed prior to maturity when the owner has died. In that way, the bonds are no different than any other instrument in their portfolio, such as stocks or mutual funds.
So why the hesitation to buy a fixed investment, on favourable terms, that matures in 2, 3, or 5 years?
It comes down to the idea that it feels odd for them to make a three or five-year “commitment” as the odds of them being around are worse than they were a few years ago.
I’m having some fun with it here. And I do the same with them as a way of opening their mind about what I believe to be an appropriate investment decision.
I don’t often get into the weeds of investing in this blog, but I am going to now. This is a fake example, but the numbers are indicative of what I’m seeing in the current environment.
A bond issued by one of the big Canadian banks might pay interest of 5.235% on its “par” value of 100. It matures in November of 2026, and it can be bought at a discount to its par value. So every $100 of the bond costs $98.22. In addition to the annual interest of $5.235, the investor would also earn a return of $1.78 when the bond matures, the difference between what they paid and what it matures at. Put that all together, and the bond delivers what we call a “yield to maturity” of 5.87%.
That bond would be good for someone who needs income or is in a registered account such as an RRSP, RRIF, or TFSA.
I say that because in a non-registered account, an investor who doesn’t need the income could buy a bond with low-interest payments (to have less to report on their taxes) but which trades at more of a discount. For example, a bond issued by a big Canadian bank that pays interest of 1.5% may trade at 90 cents on the dollar. The yield to maturity is similar to the example above, but most of the money is made on maturity, and that is considered capital gain. Only half of a capital gain is taxable, so this approach of buying a “low coupon” bond is more tax efficient.
There are other things to consider. The bonds are liquid, as I mentioned, but their prices can fluctuate depending on the direction of interest rates and the strength of the issuer. Assuming the issuer remains capable of keeping their commitment, the return calculation doesn’t change if the bond is held to maturity.
All that to say, there are various ways to approach it and to apply the features to the investor’s situation and to their greatest advantage. There are many things to take into consideration. But a liquid bond that matures in more than a year should not necessarily be out of the question for someone just because of their age.
It’s not that I’m being an eternal optimist here. It’s just that this is not the same as buying green bananas.