Myth 5: Fixed income, a safe haven?

Fixed income investments are often seen as ideal for retirees, or people approaching retirement, because they provide a steady and safe stream of income. But, there are two catches.

The first catch has to do with inflation. In the five years between November 2001 and November 2006, if you invested in short-term fixed income securities, you would have earned 3.12% each year. If, for that same time period, you invested in long-term fixed income securities, you would have earned 7.38% each year.

That may not sound so bad. However, during the same time period, the Consumer Price Index, representing inflation, ate away at the purchasing power of those returns by 2.2% annually. As a result, on your short-term investment, you would have actually earned .92% while a longer-term investor would have earned 5.18%. That doesn’t sound so good anymore, does it?

Myth 1 Myth 2 Myth 3 Myth 4 Myth 5 Myth 6 Myth 7 Myth 8 Myth 9

Then, to compound the issue of inflation, fixed income investments distribute interest income which is the most highly taxed form of income. While capital gains and dividends from Canadian companies both enjoy favoured tax status at the Canada Revenue Agency, interest income is taxed at 100% of your marginal tax rate. That can mean a big tax hit if you’re holding your fixed income investments in a non-registered account. So in this example, if you’re taxed at a marginal tax rate of 43%, the top tax bracket, short-term investors would realize a real rate of return of 0.40%, while longer-term investors would realize a real rate of return of 2.23%.

Safe haven... or dangerous harbour?