GICs Have a Useful Role in Your Retirement Plan
Boomers will remember when interest rates on Guaranteed Investment Certificates were in the double digits. Unfortunately, it was more likely that we were in our borrowing phase at that time with our mortgages and car loans subject to those inflationary rates.
Now that we’re more interested in saving, today’s GIC rates of 2 – 3% seem positively puny and not worth bothering with.
However, GIC’s do still have a useful role in a retirement income plan and can serve different functions.
GICs give you a measure of safety by earning a guaranteed yield. They have no market risk so there’s no loss of capital, and they are backed up to $100,000 by the Canadian Deposit Insurance Corporation (CDIC). Other GICs are backed by provincial insurance programs.
GICs can be a less-risky substitute for (or addition to) bonds in the fixed income portion of your overall portfolio. They can be parking spots for cash you won’t need in the immediate future.
They can help to create an additional stream of income to supplement other fixed pension income sources.
Related: Protecting Your Retirement Nest Egg
The Cash Wedge Strategy
The “cash wedge” made popular by Daryl Diamond, author of Your Retirement Income Blueprint, helps retirees work out their income needs to fund short-term lifestyle requirements.
Once you’re retired, or close to it, having three- to five-year’s worth of expenses in GICs can be used as a buffer so you don’t have to sell the equities in your portfolio in a down market. Nor will you have to reduce your spending, which sounds plausible in theory but in reality can be difficult to do.
(This example assumes that a 4% withdrawal rate matches your additional income needs.)
With this strategy you structure your portfolio to place equal amounts into a GIC ladder with maturities one year apart. When each GIC matures you either put the funds into your chequing or savings account for spending, or you take profits from your portfolio to replenish your cash wedge.
This allows you to keep the majority of your portfolio fully invested to provide growth for future years, and still pull out your desired income.
Not For Everyone
Opponents of the GIC cash wedge strategy claim that having a significant portion of your portfolio in cash is a drag on long-term returns and creates a less sustainable portfolio. It is a form of market timing and you would get better results by taking cash when you rebalance your portfolio.
However, it is my opinion that there are psychological benefits to having an identifiable cash reserve. It is reassuring to know where your spending will be coming from for the next few years.
Holding a cash bucket will always look smart during bad markets and less smart during increasing markets.
The Bottom Line
The truth is there’s nothing wrong with stashing your savings inside the comfort of a GIC. Find the best GIC rates here.
Most retirees will need to withdraw capital from their investment portfolios to supplement government programs like the Canada Pension Plan and Old Age Security, and possibly company pension money for retirement expenses.
In your withdrawal years you need to be careful. When you take income from your investments make a huge difference. If you make withdrawals when returns are low you’ll erode your capital base and it may be hard to recover when markets turn back up again.
If you set up a “cash wedge” you buy yourself some time to weather stock market volatility during a bear market because you’re drawing funds from a more stable source.
What do you think about using GICs in a cash wedge? Would it help you manage your cash flow in retirement?