Survival Guide: Investing

From GICs to preferred shares, here's a brief on the outlook for all your options.

The front page of the Brooklyn Daily Eagle as it appeared on ‘Black Thursday’, October, 24th, 1929 (Photo: FPG/Hulton Archive/Getty)

Dave Richardson has always been an equities guy, but even he knows that convincing people to invest in the stock market today is a tough sell. The vice-president of RBC Global Asset Management is convinced that troubled markets offer opportunities. But, he acknowledges, “it’s understandable that people would be nervous about holding equities at all.”

Since Jan. 3, the S&P/TSX composite index has dropped 13.6%, while the S&P 500 has fallen nearly 5%. With Greece on the verge of default, America mired in debt and facing a very real threat of a double-dip recession, there’s a good chance markets won’t improve in the short to medium term. We may even see another crash. But there are ways to protect your capital and earn income without having to take a chance on equities.

Guaranteed investment certificate
One of the safest securities is a guaranteed investment certificate, or GIC, offered by Canadian banks. It’s a good tool for investors who want to avoid volatility altogether, says Richardson. The Canadian Deposit Insurance Corp. protects GICs, so if the financial institution goes under, investors will get up to $100,000 back for certificates that mature in five years or less. Because it’s safe, and interest rates are so low today, investors make almost nothing, though. A 30-day GIC is yielding around 0.5% on an annualized basis; a five-year certificate is yielding 1.85% or less, depending on the bank.

You can also buy a market-linked GIC, which offers some additional money if stock markets recover. Generally, investors don’t get any income on these GICs until the term is up. At the end of the term—market-linked GICs usually have to be held for three or five years—you get a payout that depends on how well the market has done. You’ll always get your principal back, but if stocks continue to fall, you won’t receive any yield.

One drawback to GICs is that they’re not liquid. You can’t trade them like stocks or bonds. To get around that issue, banks created cashable GICs, which offer a lower interest rate than regular GICs but allow investors to trade in the certificate before the term is up. “It’s useful if you think interest rates are going to go higher,” says Richardson. Investors, he says, can cash out if rates increase and buy another GIC with a higher yield.

Bonds have soared in popularity since the financial crisis—Canadian inflows averaged about $1.5 billion per month before the financial crisis and now average about $8 billion. Why the spike? Nervous investors. Whether it’s Government of Canada, provincial or highly rated corporate bonds, fixed income is almost always safer than stocks, and it also provides income. Albrecht Weller, president of Toronto-based Schwaben Capital Group Ltd., suggests sticking with provincial or corporate bonds. “You reduce risk, have liquidity and have a safe harbour for your money,” he says. Provincials and corporates are riskier than Government of Canada bonds, so they come with a higher yield. If you do go the corporate bond route, Weller suggests sticking to investment-grade bonds—BBB or above—and make sure the company has a relatively clean balance sheet.

Preferred shares
Investors who want decent yield but aren’t ready to jump into dividend-paying stocks should look at preferred shares. While preferreds are technically equity instruments, they’re usually considered part of the fixed income family. That’s because, like bonds, interest-rate movements affect payouts—if rates rise, the value of a preferred falls—and they’re assigned a credit rating. The major benefit is the dividend, which is usually higher than an investment-grade corporate bond. “There’s a whole slew of them that have 4% to 6% yields,” says Schwaben Capital’s Weller.

Preferred shareholders don’t have voting rights, but they do get preferential treatment when it comes to dividend payouts. Companies will always cut dividends on common shares before slashing payments on preferreds.

They are usually issued for $25, but sometimes they cost $50 or $100 to buy. The interest rate, says Weller, is based on current interest rates and some spread over Government of Canada bonds; it depends on the asset’s risk level. Weller suggests sticking to preferreds offered by large, high-quality institutions such as banks, utilities and telecoms. Stay away from companies that have credit risks, low liquidity or cash-flow concerns. “You want solid credit worthiness,” he says.

Segregated funds
Investors have long used insurance as a way to make sure that, regardless of what happens in the market, family members will still have some cash coming to them. But insurance companies also provide people ways to get some guaranteed money before they die.

Segregated funds work much like mutual funds. Investors have a suite of funds to choose from that cover various sectors, countries and everything in between. If stocks rise, so do returns. But there’s one huge difference: investors won’t lose their principal if the markets crumble. It’s this downside protection that’s attracting an increasing number of investors, says Peter Wouters, the Toronto-based director of tax and estate planning at Empire Life. “They want the protection and the upside potential too,” he explains.

Seg funds also come with a “lock in” feature, which means, if the investments go up, you can add those gains to the guarantee. For example, if your $100,000 investment rises by $50,000, and you chose to lock in the extra cash, your principal will never fall below $150,000.

There is a catch. Usually, the guarantee kicks in after 10 or 15 years. Plus, the funds come with higher management expense ratios than mutual funds. The more frequently you’re allowed to lock in, the higher the fee will be. While investors are taking a chance with seg funds—if the market recovers, those high fees won’t be worth it—for many frightened investors, principal protection is worth the two percentage points of insurance.

There is another option investors have available to them: keep their money in cash. But as bleak as the global economic outlook may be, think twice before storing your dough under a pillow. “Unless you think the world is about to end, it still makes sense to get your money working for you,” says Richardson. “Money in a mattress won’t do that.”


Our picks

RBC Target 2013 Corporate Bond ETF (TSX: RQA)
This exchange-traded fund is brand new—it launched in September—but Baskin Financial vice-president Barry Schwartz says it’s a good bet. Unlike other bond ETFs, it has a maturity date. When it expires, you’ll get your money back, plus any gains. “It’s like a closed-end fund, but it’s still fully liquid,” says Schwartz, meaning you can still trade it like a stock. The ETF has 52% of its assets in AA-rated corporates, 36% in A and 11% in BBB.

DEX Short Term Bond Index Fund (TSX: XSB)
Investors who want to play it safe should consider this iShares product. Just over 94% of its holdings have a maturity date between one and five years. The short time horizon protects the bond from rising interest rates. It’s also got a mix of government bonds and corporates, with the biggest weighting in federal bonds. With 62% of its holdings in AAA-rated instruments, it’s one of the most risk-averse funds on the market.

ALLY Guaranteed Investment Certificate
Among GICs, Ally offers the best rates around. The interest rate on its one-year GIC is 1.75%, about 75 basis points higher than what the big banks offer. Ally’s terms range from three months to five years. If you want something shorter, Ally has a High Interest Savings account currently paying 2%.

Schwaben Capital Group founder Albrecht Weller is a fan of BCE’s preferred shares. The company, he says, has a solid credit rating. Dominion Bond Rating Service gives it a Pfd-3 (high), which corresponds to a BBB corporate bond rating, and it pays an annual dividend of about 4.5%. Weller says investors should buy preferreds from companies like BCE—large, stable conglomerates with little chance of defaulting.

iShares S&P/TSX North American Preferred Stock Index Fund (TSX: XPF)
This ETF holds preferred shares of both Canadian and U.S. companies, which makes it more diversified than the Canadian-only options on the market, which almost only hold banks. It still has an 80% weight in financials, but also holds other sectors such as telecom, utilities and consumer discretionary. Canadians won’t get the dividend tax credit on the U.S. portion of the ETF, but U.S. shares have a higher yield.