The Bank of Covid

Lost in the fog of war (the election) was the recent choice of the Canadian CB to leave interest rates in the ditch. It means savers continue to be hammered and borrowers get a stay of execution.

The official Bank of Canada benchmark rate is a quarter of one per cent. Almost nothing. It was driven to this point by Covid, of course. Monetary authorities dropped the cost of money when troubles hit the economy in 2020, hoping you’d borrow your brains out. And, yes. You stepped up. Canadians did it. Mortgage debt shot heroically higher. We now owe more than $2 trillion. Crap houses cost a million. What patriots.

Now that the economy’s mending, the virus is (sort of) retreating and assets have inflated wildly, why do we still have stupid-low interest rates? After all, they’re murdering poor retirees who depend on safe stuff to support them, since pensions are dying.

As a Bloomberg piece points out, never in modern times have so many people been so bereft of a retirement lifeboat. Four decades ago almost half of the employed men in Canada (and 35% of women) had a DB pension spelling out years in advance what retirement benefits would be. Now little more than 20% of men (and 29% of women – who make up the bulk of public sector workers) have a defined benefit plan. Many others have glorified group RRSPs full of dodgy insurance company mutual funds, subject to both market whims and bad choices.

So what? So it’s never been more important to save and invest for your own future. And yet, it’s never been harder. Inflated real estate costs on one hand have sucked off vast amounts of family income, and low rates on the other hand mean saved money is devaluing. Inflation is 4% (officially – in reality, far higher), but bank accounts pay a quarter of one per cent. Bank GICs are not much more. Most Canadians meanwhile lack the financial literacy or the courage to have a balanced, diversified portfolio of ETFs.

First, what are the pointy heads at the central bank thinking? After all, these rates have made houses unaffordable and savers apoplectic. Why keep them?

Simple. Covid’s still here. The bankers are being cautious. They’re waiting for more jobs to be restored, plus they just got spooked by a quarterly drop in GDP when there was supposed to be growth. Nothing will change for a while, we’re told. Maybe a year. The decision has been made to let inflation run hot (tomorrow the US will announce it’s 5% there), so combined with carbon taxes and the coming April tax hikes (if you-know-who wins) more challenges await the GIC crowd.

So, given the reality of monetary policy, consider this:

• Getting a mortgage? Then pray the CB is right about inflation being transitory so rate hikes can be modest and gradual. The best way to borrow in a world like this is probably with a hybrid home loan. You can get one for 1.8% or so (half a point higher than variable) which is tres cheap and it yields diversification. Half the mortgage is fixed and half VRM. How can you lose?
• No gold-plated DB pension? Well, saving to finance the last 30 years of your life probably won’t cut it, so you should invest. The 60/40 B&D portfolio constantly yakked about on this site is an obvious choice. If markets careen lower (as they did when C19 arrived) you get protection with the fixed-income stuff. When growth takes off (the last year) you participate strongly. Volatility is corralled and this sucker has delivered 7% over the last decade, which was not exactly peaceful. Stuff your TFSA. Feed your RRSP. Income-split and don’t be silly enough to pay off a 1.5% mortgage.
• But wait. Aren’t stocks too rich and destined to fall? A bunch of analysts have been warning of a correction in the Dow or the S&P for months now. But remember two things: Unless you plan on withdrawing funds soon, who cares? And, second, a B&D portfolio is not a stock market proxy. It contains a mess of stuff, much of which goes up when equities go down. Finally, I like what analyst Cam Hui published on Monday:

We expect a period of choppiness and market volatility for the remainder of the year. Long-term investors should remain fully invested. Downside risk shouldn’t be more than a normal 10% correction, which represents typical equity market risk. There are many open questions about market leadership. A prudent course of action would be to hold a diversified portfolio as a way of addressing near-term uncertainties.

• And what should you do with your GICs? Retreat, probably. Remember that to get even a 2% rate (which means you’re losing to inflation exactly what you are earning – zero return) you must lock in for a few years. You can’t live off cash flow that doesn’t exist, since these things don’t pay distributions. Also, unless held in a registered account (where all withdrawals are taxable), GIC interest is 100% taxed – every cent is added to income. Compare that with earning capital gains, where most investors will keep 85% of the proceeds even in a non-registered account. Most people would be better off collecting dividends from a preferred shares ETF than interest from a GIC. The rate of return is four times higher and the tax hit lower. Plus you’ll make a cap gain when interest rates start to rise.

Ah, it would be nice to see rates normalize. Houses would cost way less for the moisters. The wrinklies could have more income and less stress. Inflation could abate. And politicians would be forced to spend less, cut borrowing and be responsible.

When pigs fly. Or Monday. We’ll see.

About the picture: “Hi Garth, meet our grand-dog Cooper,” writes Catherine. “Coop’s mom was a Chocolate Lab and mystery dad is rumoured to be a German Shepherd (as a former Shepherd owner I don’t see it — Great Dane?). He recently moved from a condo to a house and yard with legroom for hobbies like barking at squirrels and keeping rabbits out of the carrot patch. Many thanks for the life-changing financial wisdom you provide on the blog!”