Bonding with your bank
By Ron Tarter
Considering an investment as a gift for someone special this holiday season? Well, think before you buy.
During the holiday season, companies attempt to suck the consumer into purchasing their products. The Government of Canada is one such corporation.
Canada Saving Bonds are purchased by millions of Canadians every November, many for the purpose of Christmas gifts. Although they are 100 per cent guaranteed by the federal government, these bonds are possibly the worst investment available to the public.
Other government-guaranteed investments do exist in the financial markets, however. These investments offer identical safety, but higher rates of return, liquidity, tax advantages and the potential for capital gain.
Similar to a CSB is a Government of Canada bond, which sounds alike but is different in structure. A GOC bond is a government-guaranteed, marketable security. Unlike a CSB, a GOC is transferable, so its underlying value fluctuates in the open market. Because GOCs are constantly being traded, its yields are always changing. Yesterday afternoon, a three-year GOC, maturing March 1, 2001, had a yield of 4.73 per cent, compared to a CSB that only offers a return of 3 per cent during the first year.
There are advantages to CSBs though they guarantee an increasing return for the next seven years. Furthermore, they can be cashed on the first day of any month. Because CSBs are not transferable, they do not fluctuate in a market. This attribute eliminates the possibility of a capital loss in a period of rising interest rates. For this reason, a small investor should not buy a GOC that matures in the long term. These advantages do not outweigh the disadvantages of other guaranteed investments. Even Guaranteed Investment Certificates offer a higher rate of return than CSBs.
There are also several tax advantages to GOCs. Because interest rates presently are relatively low in comparison to prior years, GOCs are trading on markets at a premium. For example, the GOC that matured on March 1, 2001 has an interest rate of 7.5 per cent and was sold on the bond market at about $108, or $8 more than its original value. While the owners of these bonds receive a 7.5 per cent annual return, the $8 loss at maturity offsets the higher interest rate to give a yield of 4.73 per cent. This capital loss can be deducted from taxable income upon maturity in 2001, lowering taxes significantly.
Another government-guaranteed investment is a Strip Coupon. A coupon is an interest payment of a GOC that is sold prior to its maturity date, at a discount. The yield of a strip coupon is generally higher than a GOC, but not by much.
CSBs are the worst guaranteed-fixed-income investment on the market. If safety, liquidity and returns are important concerns, look at other government-guaranteed investments such as GOCs or strip coupons.