# Fixed income, bond & GIC ladder



## james4beach (Nov 15, 2012)

I wanted to share some info about how I construct a fixed income ladder. I buy individual Government of Canada bonds, and hold to maturity. Thus I'm treating them like a GIC... I know their yield exactly, to maturity, so price fluctuations won't affect me (unlike a bond ETF which could drop in price significantly).

Say fixed income consists of
1) high interest savings accounts
2) bonds (I only go with government and occasional provincial)
3) GICs

#2 and #3 come in large chunks (5k minimum) and should be held to maturity. GICs I do 1 to 5 years, and bonds for longer maturities because this is more efficient for fees.

My process is that I have one large "ladder" spanning many years. I buy the various things from different banks and in different accounts, but enter them on the one big ladder.

Start by drawing out a time line on paper/spreadsheet: 2013, 2014, etc maybe up to 10 years or even beyond.

The idea is to, over time, fill in this ladder such that you have amounts maturing more or less every year and possibly every half-year. You wouldn't buy everything at once, and it doesn't have to be totally filled in, but it's great to space things out. For instance say you buy 2 year GIC today, for $5k. You'd put $5k in the 2015 box of your grid.

If you've got an enormous amount of money, buy the bonds in $10k units because you will get higher yields.

Here's some of my ladder (just listing instrument and yield to maturity in each case)
2013: gic 2.9%, gic 1.9%
2014: gic 2.7%, gic 3.1%
2015: gic 2.0%, bond 3.2%
2016: gic 2.3%, bond 2.8%
2017: gic 2.3%, bond 2.3%
2018: gic 2.7%
2020: bond 1.9%
2023: bond 2.2%

Notice that although these investments are all locked in, I've got cash coming mature all the time! And as they mature I buy new things into the ladder. Also notice how high some of the interest rates are, because they were 4 or 5 year GICs at time of purchase.

My average yield is something like 2.5% which is higher than XBB after fees, and with less risk - since the GICs all have deposit insurance and government bonds are the safest debt. This is why I do this ... higher yield, *and* less risk than a bond fund.


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## ChrisR (Jul 13, 2009)

What advantage do you gain by holding the long bonds?


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## AltaRed (Jun 8, 2009)

It may no advantage but if you are aiming for a 10 year ladder, then you have to hold one-tenth of your holdings in 10 year bonds. Many analysts say the sweet spot today is about 6-7 years, but there is no assurance at all this will hold, or has any merit.

Basically I operate with a 5 year ladder based on GICs and investment grade corporate bonds. Try to buy bonds at least at the $10k level and preferably $20k level for better pricing (yields).

I also have a lot of ST cash sitting around at rates between 1.25 and 1.9 percent waiting on opportunities. Remember, cash never goes bad so keep the trigger finger under control.


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## favelle75 (Feb 6, 2013)

Moving your cash around to the various 3% savings accounts would give you a better return without locking up all your $$.


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## fatcat (Nov 11, 2009)

i don't know what kind of money you are talking about here james
but for the life of me i can't figure out why you place money maturing in 2023 for 1.9 percent ?

for small investors the yield curve is both bottomed out and fairly flat

i understand the concept of a ladder quite well but when you can place money for 18 months at 2.30 and have your capital again to reinvest in 18 months .... in this environment for small investors there is no basement ... we are at the bottom ... it makes no sense to me to build a ladder unless you have a yield curve that is steep enough to make it worthwhile

you are locking 5-year money at 2.7 when you can get 2.3 in 18 months in an environment that may well have a much steeper curve and higher rates and you have capital to place fresh

i do have a 2 year ladder in 6 month increments but see no reason to go any longer 

are you anticipating a full on japan style flat curve for the next 20 years or what ?


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## james4beach (Nov 15, 2012)

fatcat said:


> i don't know what kind of money you are talking about here james
> but for the life of me i can't figure out why you place money maturing in 2023 for 1.9 percent ?
> . . .
> i do have a 2 year ladder in 6 month increments but see no reason to go any longer


I understand the critique. But really you can ask the same question to any bond fund manager. "Hey, XBB manager, the guy with $1.8 billion under management... why on earth do you have an average 10 year maturity, including some bonds maturing 2050?"

Part of my answer is the same any bond fund manager would give you
- it's part of a process, and assumes you can't forecast interest rates
- interest rates could potentially stay the same, or decline, in this period

In my case I'll also add to my answer
- my weighted average maturity is only 3 to 4 years, so that's my actual exposure
- that maturity is much better than any typical bond fund's usual 10 yrs, by fatcat standards

The ladder is just the process. In my case I'm at the 3 to 4 year average maturity. Yours is less than 2 years. Others (like all the bond funds out there) go for 10 years.


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## james4beach (Nov 15, 2012)

favelle75 said:


> Moving your cash around to the various 3% savings accounts would give you a better return without locking up all your $$.


Unless the Bank of Canada rate is cut further, in which case you may wish that you locked up money at higher interest rates.

To be clear here I'm just illustrating this as an alternative to the usual bond fund or bond ETF investment. Maybe I should have stated that right from the start.
I think this method is far superior to using a bond fund / ETF. Higher rates of return, less risk. More direct control. Much higher quality collateral in case you want to borrow against the portfolio or pledge it as collateral for anything.
What's wrong with that?

If you're someone with 0% fixed income exposure, or want all your fixed income exposure to be in cash/savings account form, you can probably ignore the whole thread. If you're confident that the Bank of Canada is going to raise their benchmark rate, then it makes sense to keep all your fixed income in cash form.


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## james4beach (Nov 15, 2012)

ChrisR said:


> What advantage do you gain by holding the long bonds?


Same reason any bond fund holds them ... slightly higher yield.

As far back as 2004 and 2005 it was considered common knowledge that you'd be crazy to hold longer maturity bonds. Common wisdom was that you should keep money in cash and short term bonds. This was an attempt at interest rate forecasting, and many people got it wrong... they *would* have been better off locking in money even at those "unacceptably low" rates which were around 5.0% on the 10 year government.

Similarly if interest rates stay exactly where they are, you would be better off buying a long bond or 5 year GIC.

Or here's another scenario, if the economy weakens dramatically (say housing crashes or Europe collapses), the Bank of Canada cuts the benchmark rate, the stock market drops and starts giving negative returns .... then you're really going to wish you too had bought a 10 year government bond @ 2.2% (it would actually be more like 2.45% if you bought today).


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## birdman (Feb 12, 2013)

While I generally agree with ladders I use a modified approach and invest heavily at the long end when rates are at their high end and invest short when rates are at their low end. When rates were falling I invested heavily in 5 yr and still have one term deposit at 5.50% (unfortunately it matures this month) and have another pretty good chunk at 4.25% which I believe has 3 yrs to go. Over the past year or so I have been going out a max of 2 yrs. My reasoning here is that clearly interest rates are at or near their low point sby being aware of the economic cycle we areo why invest long at this time? 
Sure, they could go down a touch but odds are they are going to go up. Also, the yield curve is not very attractive with 2 yr Term rates around 2.20% and 5 yrs at about 2.60%. 40 bps is not much for increasing duration by 3 yrs. Also, I believe someone posted that Peoples Trust had a 3% rate on a tax free savings acct. which beats a 5 yr term. In my opinion ladders are fundamentally sound but returns can be improved by being aware of the economic cycle we are in.


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## Ihatetaxes (May 5, 2010)

My 5 year GIC ladder has an average of 2.79%. Not great but its 10% of my portfolio that I don't have to think about. I will increase that percentage a little each year.


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## fatcat (Nov 11, 2009)

james, there is virtually no crawlspace under us on rates ... you have convinced yourself that these kind of rates will just continue and they can't

you have created a 10-year ladder with a very low average weighted return, even if your duration is short etc

you can get 1.9% in a cdic insured savings account
you can get 2.3% from home trust for 18-months
you can get 2.11% from bridgewater bank for a 1-year gic
(and this will take care of 300K under full cdic "eligibility")

and have all your capital returned guaranteed fresh to re-invest in 18 months (in brand new inflated money)

so you think that in 18 months you'll only be able to get what 1.75% in a 1-year gic ? ... the 5 year will drop to what 2.1 or something ?

you are over-preparing for disaster and under-preparing for success

for small investors that don't have lots of money to place, the best alternative to any bond fund right now is a short gic ladder (assuming your cash management is in order since gic's are locked)


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## andrewf (Mar 1, 2010)

Fatcat, the difference is reinvestment risk.


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## fatcat (Nov 11, 2009)

it seems to me that the price he is paying to mitigate that risk is too high ...


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## andrewf (Mar 1, 2010)

I don't disagree.


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## james4beach (Nov 15, 2012)

fatcat said:


> james, there is virtually no crawlspace under us on rates ... you have convinced yourself that these kind of rates will just continue and they can't
> 
> you have created a 10-year ladder with a very low average weighted return, even if your duration is short etc
> 
> ...


Valid criticisms here. Well the good news it that I have two maturities this year and another two next year, so plenty of chances to re-invest into something better.

A big reason for the low average return is that I hold government bonds which have lower yields than GICs for equivalent periods. I like the govt bonds because of their amazing liquidity, and I'm willing to accept a lower yield for the privilege of that liquidity.

I take it that you're saying (at today's rates) that the better buys are those GICs in the 1 to 2 year range?

I don't fully understand the recommended action. Are you saying you would lock it in for 1-2 years, and you expect that rates would be higher at that point, such that in 1-2 years you would then go and buy a longer maturity GIC?

Basically: how would you fix the ladder I've got here (if the goal is to stick to a 5 year range)? With the two amounts coming due in 2013, would you immediately put them back in to 5 year GICs, or ...?



> for small investors that don't have lots of money to place, the best alternative to any bond fund right now is a short gic ladder (assuming your cash management is in order since gic's are locked)


I agree with this. People should ignore my 10 year example and just do the 5 year GIC ladder, which is the simplest and best alternative to a bond fund.

Also I'll point out again that although the farthest maturity date is 10 years, I'm concentrated in the 1-5 year range and am deliberately keeping the maturities short.

Government bonds, though lower yields, offer some interesting advantages: liquidity, and high loan values in case you want to borrow against the account. If you had an account fully composed of govt bonds, you could borrow 95% of the account value like a giant "line of credit", if you ever needed it.


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## fatcat (Nov 11, 2009)

i am saying that as long as rates are just barely above inflation
historic inflation in canada averages like 3.22 percent
current inflation is say 1.2%

and the yield curve is basically still pretty flat
it makes no sense(to me) to place money for longer terms when you can place money for much shorter terms and lose only a few basis points

i understand the concept of a ladder and re-investment risk
but i think it only makes sense if the yield is reasonably steep _and_ there is no financial repression

neither of those things is occurring

it is all a matter of risk/reward and i believe the r/r for building a short ladder is much better than a longer ladder at rates that don't even come near historic inflation and barely rise above current relatively low inflation

i believe that "ladder theorists" have an answer for this since the concept of the ladder is designed to mitigate rates being low and high and produce a smoothed curve

i just don't see how, in this environment at these rates, this makes any sense

perhaps if you have access to good corporate bonds yes
but in guaranteed money like gic's and government bonds

it just doesn't present a favorable risk/reward (to me anyway)

i am actually as conservative as you in a lot of ways
at my age i am not making any losses back

but i am very afraid of inflation
even though it is currently quite low 

it can break out quickly and be very destructive 
and you do not want to have your money locked at long terms for such low rates

in the current environment, i believe a short ladder is best (and short bond fund durations like xsb, if that is your poison) in gic or govt bond ladders


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## AltaRed (Jun 8, 2009)

I think XSB is one of the poorest investments one can make. Yield is low due to MER costs and capital is at minor risk. It makes sense only for some liquidity. I would, and do, use a combination of HISA and 5 year GIC ladder.


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## fatcat (Nov 11, 2009)

AltaRed said:


> I think XSB is one of the poorest investments one can make. Yield is low due to MER costs and capital is at minor risk. It makes sense only for some liquidity. I would, and do, use a combination of HISA and 5 year GIC ladder.


it does provide liquidity which is why i mentioned cash management in an earlier post 

when you lock money in gic's you have to have your cash management in good order

a lot of investor problems are due to poor cash management and liquidity problems

xsb does provide liquidity

in todays environment i wouldn't own it myself

especially when we small investors have 1.9% cdic hisa's


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## andrewf (Mar 1, 2010)

Alternately, a GIC ladder and a floating rate bond ETF like HFR or XFR.


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## james4beach (Nov 15, 2012)

fatcat said:


> it makes no sense(to me) to place money for longer terms when you can place money for much shorter terms and lose only a few basis points
> 
> i understand the concept of a ladder and re-investment risk
> but i think it only makes sense if the yield is reasonably steep _and_ there is no financial repression
> ...


I see what you're saying now... in the current environment you prefer the short end of the curve as there's not much benefit for going out farther in the curve.

I agree with you and would advise people of the same thing. Even if you're doing a ladder, make sure you have plenty in high interest savings.

Separate from my ladder, I do have lots in cash (savings acct, credit union, etc). I haven't done this before but I'm going to combine everything (two ladders + all savings, which I'll call 0 years). Curious what I've got, all-in fixed income.


```
Years Weight
0     22%
0.5   8%
1     13%
2     14%
3     11%
4     9%
5     8%
6     8%
7     7%
8     -
9     -
10    3%

weighted avg maturity = 2.7 years
```
fatcat, I don't think I'm too far off what you're advising. I've got 30% of my fixed income under 1 year maturity (mostly high interest savings). Only 17% of money is past the 5 year mark, all bonds since there's no CDIC insurance > 5 years.

So maybe we're more similar here than we thought. Does this new picture look better to you?


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## james4beach (Nov 15, 2012)

AltaRed said:


> I think XSB is one of the poorest investments one can make. Yield is low due to MER costs and capital is at minor risk. It makes sense only for some liquidity. I would, and do, use a combination of HISA and 5 year GIC ladder.


Agreed, XSB is no good at these rates. 1.49% yield after MER leaves this yielding less than many savings accounts with deposit insurance!


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## james4beach (Nov 15, 2012)

I also wanted to address a critique CanadianCapitalist had in another thread. Regarding the ladder, I wrote "price fluctuations won't affect me (unlike a bond ETF which could drop in price significantly)."

But CC is right, the market value of the ladder portfolio (containing bonds) will fluctuate. It's possible to see price declines and I should have mentioned this. For instance checking one of my bond portfolios, there was a period this summer where the portfolio was down -1.5%. Just like a bond fund would do.

So the value can fluctuate, but they're still non-realized losses since by holding to maturity you always get a guaranteed result.

If drops in portfolio value bother you, then you're better off purely in GICs. This is a superficial difference though because the only reason you don't see a drop in price is that there's no market quote on the GIC  For all intents and purposes, an insured GIC is equivalent to a government bond - in a tax sheltered account.


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## fatcat (Nov 11, 2009)

yes, the market value of the ladder will indeed fluctuate but of course the fundamental premise of a ladder is:

a) an ongoing "average" of rates by rolling maturing bonds at prevailing rates
b) a steady and predictable cash flow and return of capital 

the idea of "market value" in the context of a bond ladder sort of makes no sense because the premise is that by spacing maturities you (theoretically) shouldn't need to sell ahead of maturity

as cc says there are better ways to target specific capital needs like zero coupon bonds

as in so many things cash management is key

james, you seem like are weighted toward a short duration overall 

i just see little value in going out much beyond 2 years in the present environment, if we start to go back to a "normal" yield curve then i would start to build the ladder out


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## james4beach (Nov 15, 2012)

fatcat: I agree those are the ladder benefits, and the market value won't matter when you hold to maturity (unless it's a corporate bond in which case declining market value could indicate it's going to default)

That being said, sure if you have a big portfolio containing bonds you may see market value declines and that can be distressing to people.

Yes apparently I'm very short term exposure too. I would love to see a normal yield curve and higher rates, so I can start loading up longer maturities.


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