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All I want is 10% Guaranteed!!!

With the markets as volatile as ever, it can be difficult to stomach the ups and downs as you try and have  a portfolio generate enough income or growth to last a lifetime. I know of many clients who talk about the days when they could get 19% on Canada Savings Bonds, 20% or more on Term Deposits, and those lucky few who annuitized and locked in 16% for life.

Of course inflation was running rampant in double digits and with higher tax rates, you were lucky to break even. Over the last year, while the Fed and the Bank of Canada have lowered rates to stimulate the economy and try and avoid recession, rates on corporate debt and preferred shares have gone up significantly. The spreads between bank debt and government debt are the widest they have been in over 20 years.

You could argue that Canadian banks are going to collapse so the risk of investing in a bank guaranteed bond or preferred share is too high. Looking at things objectively, the likelihood of one of our banks going bankrupt and the common share price going to zero are remote.

If you are on the same page as me and believe that a bank failure in Canada is not likely, there is an interesting opportuntiy that awaits. Preferred shares issued by corporations in Canada are eligible for something called the dividend tax credit. Because Canadian corporations have already paid tax on their earnings, the dividends that flow through to individual investors are subject to a reduced level of tax.

As I look at my stock screen today, I see that CIBC and Laurentian Bank have perpetual Preferred shares currently yielding approximately 7.25% per annum with the dividends paid quarterly. So, how do I come up with 10% when they are paying 7.25%. Interest earned on GIC’s is fully taxable. The preferrential tax treatment on dividends and preferred shares equates to just under 10% for a Canadian in the highest marginal tax bracket on an interest equivalent basis.

Some would argue that there are further write downs to come and that interest rates in Canada are going to rise since inflation is going up. I would agree that government bond rates will probably rise over the next 12 months. Nobody knows how much, but, I would argue that while government rates go up, the spread between government and corporate bonds could fall which means that you wont be able to get 8%, 9% or 10% on these preferred shares next year and that this deal will look like the annuity that we should have locked in at 16% for the rest of our lives.

What are your thoughts on interest rates and corporate debt? Your opinions are more than welcome.


2 Responses

  1. Mr. Rothenberg:

    I need a monthly income paid by my investment that uses a dividend tax credit. I have been living on my investment monthly income as I am between careers at the moment. Would like to bring my income back up. I am concerned that I would have to cash in investment income that I can ill afford to reduce. What to do? thx.

    Gary Coultis

  2. Hi Gary,

    Could you give me an indication as to what your investments are currently invested in and I will be able to give you a better idea as to what you should do?


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