Bonds vs GICs: Are bonds a better investment than GICs?

Comparing GICs and Bonds: What's the Difference?

Written by John Woodfield Portfolio Manager, CFP®, CIM® and Tiffany Woodfield, Associate Portfolio Manager, CRPC®, CIM®, TEP®

Bonds vs. GICs

Bonds vs. GICs is one of my favourite topics since the choice between bonds and GICs tends to be emotional.

The investments, on the surface, are similar, since they both have interest paid and a maturity date. They both also have some form of “guarantee.”

The difference is that bonds can be sold before maturity, while GICs typically cannot. This difference gives the illusion that GICs are somehow safer than bonds. While it’s true that GICs are sometimes safe, often they are not. This article will go into this topic in detail.

TABLE OF CONTENTS

1. GIC vs. BOND: Which Is the Better Option?
2. Comparing Bonds and GICs Over Time
3. Basics of Guaranteed Investment Certificates (GICs)
4. Understanding Bonds
5. Types of Bonds in Canada
6. The Role of Bonds and GICs in an Investment Portfolio
7. Tax Planning for Fixed-Income Investors
8. Cross-Border Implications
9. Ask a Portfolio Manager: Bond and GIC Q&A

Bond:

Bonds are debt securities that offer a rate of interest and a maturity date. Bonds are issued by governments, municipalities and corporations. You’re lending money to the issuing government or corporation when you purchase a bond. What do you get in exchange? Interest payments and the return of the loaned amount at maturity.

GIC:

A GIC is a savings deposit issued by banks and other financial institutions. When you purchase a GIC, you are depositing money with the bank for a fixed period, in return for the guarantee that you’ll receive your funds back, with interest, at the end of the term.

Bonds and GICs are fixed-income generating investments for those who are seeking lower-risk investments that can provide financial stability.

The choice between bonds and GICs depends on an investor's needs and preferences. Factors such as potentially needing the funds before a GIC matures and in which type of account the holdings will reside (TFSA, RRSP or open account) will affect whether you choose bonds or GICs.

Both GICs and bonds are safe financial products.

People who invest in GICs often want to ensure their money is safe if the financial institution fails. If you purchase a GIC through a Canada Deposit Insurance Corporation (CDIC) member, you're insured up to $100,000.

In addition, there are ways that investment advisors and portfolio managers can purchase GICs in amounts significantly higher than the $100,000 CDIC-guaranteed amount while still obtaining the guarantee. A portfolio manager may use different accounts, such as the RRSP or TFSA, and purchase through multiple institutions. Note that any purchaser of GICs who goes directly to a single bank will be limited to that bank's products.

A portfolio manager can generally access GICs from many different banks and trust companies.

While the CDIC guarantees GICs, a bond issued by the federal or provincial Canadian governments is backed by the respective governing body, and these bond “guarantees” are sound.

Government bonds also offer liquidity, making them a preferable choice for many investors.

Which Is the Better Option?

Neither bonds nor GICs are inherently superior; the choice hinges on individual preferences, risk tolerance, and financial objectives.

One benefit of bonds is that they offer the ability to cash out anytime. However, an attractive benefit of GICs is that they generally do not fluctuate in value due to the inability to sell them during the term without taking penalties.

Utilizing a qualified advisor to guide this decision can be very helpful.

Remember, I mentioned that the CDIC backs GICs while federally or provincially issued government bonds are backed by the government. With government bonds, you can sell your bonds without penalty at any time while still obtaining interest rates similar to GICs. One might argue that your ability to sell bonds at the drop of a hat while still getting similar interest rates gives bonds the edge.

However, there are other factors to consider, and your choice should be based on your circumstances.

Comparing Bonds and GICs Over Time

Features vs. Weaknesses

Bonds may offer potentially higher yields (interest rates) but will fluctuate in value.

GICs provide a fixed yield because there is no market in which to sell the GICs. Thus, investors in bonds can see values fluctuate before maturity, while GIC investors will not see these fluctuations.

The lack of fluctuation in the GIC exists since there is no ability to sell.

Meanwhile, the ability to sell your bonds is a feature, and bond pricing is based on what an investor would secure if they did choose to sell. Keeping a bond to maturity means getting your initial investment back plus the promised interest.

To reiterate this major difference, the liquid nature of bonds (the ability to sell them) on the secondary market is a feature.

The inability to sell GICs due to fixed terms and early withdrawals being subject to penalties is a weakness, even though the stable pricing gives the illusion of safety.

Interest Rate Scenarios

You'll likely be happy if you invest in bonds or GICs when interest rates are high.

With a GIC, higher interest rates mean that the investor has secured a higher rate of return than what is being offered later. However, this higher rate of return does not translate into a profit for the GIC holder since there is no ability to sell.

Meanwhile, selling your bonds as interest rates fall creates a capital gain that is only partially taxable in Canada. On the other hand, rising rates mean that if you sell your bonds before maturity, you could incur a capital loss. However, if you can hold onto your bonds until maturity, you’ll receive the principal back, plus interest, the same way a GIC holder would.

Bond Yields vs. GIC Yields

The yield (interest rate) on GICs tends to be lower than on bonds due to the fixed nature of a GIC.

Meanwhile, Canadian government bonds offer sound yields and the backing of the Canadian government. Investors looking for safety often look at high-quality bonds. You can identify whether a bond is “safe” by reviewing information from the various bond rating agencies.

Liquidity Considerations

The term liquidity is a fancy way of stating there is an ability to sell.

GICs generally have to be held for the term of the GIC, while bonds generally can be sold anytime on the secondary market. Thus, bonds generally have greater liquidity than GICs.

Basics of Guaranteed Investment Certificates (GICs)

GIC Basics and How They Function

GICs involve depositing funds with a financial institution for a fixed term, with a guaranteed return of principal (your initial investment) and interest at maturity. Investors simply go to the bank or institution of their choice and fill out some paperwork or seek out the advice of an advisor who will have access to multiple banks and other institutions.

Fixed Interest Rate and Guaranteed Interest Rate Considerations

GICs provide a predetermined and guaranteed interest rate, offering stability to investors.

Tax Implications for GIC Investors

Interest earned on GICs is fully taxable, and investors should consider tax implications when incorporating GICs into their portfolios.

Understanding Bonds

Bonds and How They Function

Bonds are debt securities representing a loan to the issuer, paying periodic interest and returning principal at maturity. Bond prices and yields are influenced by interest rate movements, impacting their market value.

Bond Market Dynamics

Central banks, like the Bank of Canada, play a crucial role in the bond market, affecting prices and interest rates. Bond price volatility is influenced by various factors such as economic conditions, inflation and demand. Through monetary policy, central banks attempt to adjust the money supply to curb inflation or increase spending. Interest rates are a key tool in the central bank’s arsenal since higher interest rates tend to slow growth and inflation, and lower interest rates stimulate growth and increase inflation—in theory.

It's not uncommon to find that when interest rates go up, the prices of fixed-rate bonds fall. However, remember that, as long as you hold your bond until maturity, you don’t have to worry about this.

Coupon Payments and Periodic Interest Payments

Bonds pay periodic interest, known as coupon payments, contributing to overall returns. The coupon payment divided by the price of the bond gives us the bond’s “yield.”

Types of Bonds in Canada

Various bond types exist, including Canadian Investment-Grade Bonds, Bond Funds, and exchange-traded funds (ETFs). The bond market caters to various risk preferences. Investment grade bonds are explained below and are the highest safety available in the bond market. Mutual funds offer a managed approach to investing in bonds, and ETFs offer a low-cost way to diversify.

The Role of Bonds and GICs in an Investment Portfolio

Both bonds and GICs play a role in diversified portfolios. Bonds offer liquidity, potential for capital appreciation and income. GICs provide an optically stable experience and predictable returns.

Tax Planning for Fixed-Income Investors

GICs offer solely interest income that is fully taxable at the investor's highest marginal tax rate. Bonds offer fully taxable interest and potential for capital gains that are only taxed at half the investor’s marginal rate.

Marginal Tax Rate Implications for Bonds and GICs

A taxpayer's marginal rate is the top level of tax they pay at their income level. Top earners in Canada can have a marginal rate in excess of 54 per cent.

Cross-Border Implications

Canadian residents can easily purchase GICs for their portfolios. However, purchasing a GIC as a U.S. resident is difficult, if not impossible. The U.S. has a similar investment product called a CD (certificate of deposit) that acts in the same fashion as a GIC.

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Ask a Portfolio Manager: Bond and GIC Q&A

Q: Why did bonds significantly outperform GICs during the years following negative bond year returns?

The years that we saw bonds outperform GICs were when interest rates remained steady or fell. Also, if a bond is held to maturity and has a higher interest rate than the GIC, it will outperform the GIC.

During 2022, when interest rates rose, bondholders saw the values of their bonds fall in the secondary market. However, bondholders who did not sell during this time did not incur this loss since, upon maturity, bondholders are paid out. In 2024, we see yields on bonds being very strong, and if interest rates were to fall, bondholders would most likely see nice gains on top of the interest promised.

Q: Do bonds preserve capital?

A: Bonds have a better record of preserving capital than GICs since they can rise in value, creating capital gains. Both bonds and GICs can feel the full effect of inflation, and neither is a great place to be in an inflationary environment.

Q: Do bonds provide better returns?

1. Often, bonds have a higher yield than a GIC, depending on the security behind the bond and the length of the bond’s term. Bondholders also have the potential for capital gains if the bond price rises before maturity.

Q: Do bonds provide more liquidity than GICs?

A: Owners of bonds can sell their bonds in a secondary market. Thus, the liquidity is much higher than that of a GIC since GICs can only be sold if they are marketed as cashable GICs, which carry a lower interest rate than non-cashable GICs.

Q: What are investment-grade corporate bonds?

Many bonds that corporations have issued receive a rating from one of the major rating agencies. Two of these rating agencies are Moody’s, S&P and Fitch. Bonds that have a rating of BAA or higher by Moody’s and BBB or higher by S&P or Fitch are considered investment grade. These bonds generally have a lower yield and higher security than non-investment grade bonds.

Final Thoughts for Fixed-Income Investors

Make sure your decision is well thought-out when choosing between GICs and bonds. Be sure to consider your personal financial goals, risk tolerance, and market conditions.

Summary of Key Points

• Bonds and GICs differ in liquidity and sale options before maturity.
• Bonds may offer higher yields and liquidity than GICs.
• GICs provide stable returns but lack market selling options.
• GICs offer safety through CDIC insurance of up to $100,000. Portfolio managers can access GICs from various banks for higher amounts.
• Government bonds offer liquidity and are also backed by the government, making them a safe and flexible investment option.
• Both bonds and GICs have their advantages, and the choice depends on individual investor’s needs, circumstances, and risk tolerance.
• Professional advice for choosing between bonds and GICs is recommended, considering factors like tax implications, liquidity needs, and investment goals.

NEXT STEPS

If you’re a Canadian resident or are planning on moving to Canada or the U.S. and need assistance with moving and optimizing your investments, estate planning, wealth management and portfolio management, please get in touch. At SWAN Wealth, we specialize in Canadian financial planning, cross-border financial planning and cross-border wealth management.

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ABOUT THE AUTHORS

Tiffany Woodfield is an Associate Portfolio Manager licensed in Canada and the USA, a Chartered Investment Manager (CIM), a Chartered Retirement Planning Counselor (CRPC), a STEP Associate and the co-founder of SWAN Wealth Management, along with her husband, John Woodfield. Tiffany advises clients who live in Canada and the United States and want to simplify their cross-border financial plan, move their assets across the border, and optimize their investments to minimize their tax burden. Together, Tiffany and John Woodfield help their clients simplify their cross-border finances and create long-term revenue streams that will keep their assets safe whether they live in Canada or the U.S.

John Woodfield is a Financial Management Advisor (FMA), a Chartered Investment Manager (CIM), and a Certified Financial Planner (CFP), and in 2007, was inducted as a Fellow of the Canadian Securities Institute (FCSI). As a portfolio manager and CFP®, he works with clients across Canada. John Woodfield’s clients are families, individuals and business owners who understand the importance of comprehensive wealth and investment plans driven by the lifestyle they want to lead.

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