Thursday, September 24, 2009

Small Investing Edge Brings Big Money over Time

In a provocative interview titled “Buy GICs. Only GICs.”, Author and Chartered Accountant David Trahair advocates saving for retirement in GICs and avoiding the stock market altogether. His argument is that the gap between GIC returns and S&P/TSX returns has been small and GICs carry no risk.

In his book Enough Bull: How to Retire well without the stock market, mutual funds, or even an investment advisor, Trahair ignored dividends from stock returns in his comparison with GICs. In the interview, Trahair quotes both returns with and without dividends. However, because the returns without dividends are irrelevant for comparison, we’ll ignore them.

Trahair quoted the following return figures over decades ending August 31, 2009:

Past 10 years: 3.35%
Past 20 years: 5.11%
Past 30 years: 7.28%
Past 40 years: 7.71%
Past 50 years: 7.35%

S&P/TSX Composite Total Return Index:
Past 10 years: 9.41%
Past 20 years: 8.86%
Past 30 years: 10.76%
Past 40 years: 9.77%
Past 50 years: 9.80%

Stocks do perform better, but the gap does appear to be modest. However, it can be misleading to compare average returns over long periods like this. What actually happened to real money invested over this period?

The following chart shows what would have happened to $10,000 invested solely in GICs or solely in the TSX index with dividends reinvested:

Over one decade, an initial investment of $10,000 in GICs grew to $13,900, but stocks ended at nearly double this amount: $24,600. For periods of 20, 30, and 40 years, the final value of stocks was more than double that of GICs, and for 50 years stocks gave more than triple.

As the chart shows, the seemingly small average advantage of stocks added up to a big difference over long periods of time.


  1. What % returns did you use to do the calculations to get the graphs? Is it the %s he quoted or from somewhere else?

    Also does investing in the tsx with dividends being reinvesting => investing in a tsx index fund or etf or in specific stocks?

  2. Anonymous: The graphs are based on Trahair's own return figures as I listed them in the body of this post. TSX with dividends means investing in a TSX index ETF and reinvesting any received dividends back into the index ETF.

  3. I have a problem with any comparison over long periods of time because it doesn't work like that in the real world.

    Say I invest $100k for retirement. Chances are I'm not putting $100k in on day 1 and seeing what happens 30 years down the road. I'm more likely contributing $10k/year for 10 years, and that may be broken down even further to monthly contributions. Over those 10 years, I'm buying at highs and lows and all points in between, so measuring from my initial >$1k investment in month 1 isn't a valid comparison. A cost average needs to be used.

    Also, when are those dividends reinvested? If RY pays out quarterly, was the price of RY at those paydates used? Or was it just retroactively added at the day 1 price?

    Same holds true for GICs, but chances are I'm making a $10k lump-sum ever year for 10 years instead of monthly contributions.

    My point is that a real-world comparison of numbers is more complicated than saying "50 years ago, $100k in the index would buy this much, and today it's worth this much."

  4. Great post. This is a great example of how most people do not appreciate the enormous difference an extra one or two percentage points makes. It's not surprising that so many Canadians dismiss their 2.5% MERs as no big deal, when in fact, that extra 2.5% can mean the difference between meeting your investment goals and running out of money in retirement.

  5. so are you doubling the return for the second decade of years by adding Year 10 and Year 20

  6. Can you post the calculations you used?

    I want to duplicate it.

  7. never mind...figured out the compound over 10 years

  8. Astin: I agree that a life of investing is more complex than just plowing a big sum into an investment once and waiting several decades. The main takeaway from my analysis is that the few extra percentage points of advantage that stocks have had over GICs make a big difference over the long run. This was true even for real life cases of periodic investing of new savings and received dividends.

    Kiran Sohi: The calculations are simpler than that. For the 50 years of GICs we start with $10,000, and increase it by the compound average return of 7.35% (from the table) 50 times. This is $10,000*(1.0735^50) = $347,000. For stocks we use 9.80% to get $10,000*(1.0980^50) = $1,071,000.

  9. Zeroguy00: You're right that MERs add up over time in the same way. After a lifetime of investing, MERs can easily chew up more than half of your money.

  10. People investing in a low cost diversified portfolio and buy and hold will likely do better than people investing in bonds/GIC over the long-term as you have showed. Unfortunately very few people invest this away.
    Most people invest in equities via MF. Substract a MER of around 2.5% and the people gained nothing by investing in equities at all as compared to GICs. Therefore I guess for most people it would be indeed better to just invest their money into GICs.

  11. Michael: If I thought that GIC investors would stick to their guns for the long term, I'd agree with you. But, if you factor in the GIC investor who jumps into stocks just once at the height of some mania and loses 40% in a year or so, suddenly the average GIC returns don't look so good either. It's possible to be stupid with any investing approach. The real answer for any investor is to learn a little bit and pick the best option.

  12. The comparison GIC vs TSX as presented is not a valid comparison for the simple reason that two elements are missing: transaction costs and taxes.

    In the case of stocks, whether bought individually or through mutual funds, the fees can materially reduce the relaised gains.

    In the case of GICs, if bought from a bank or even government bonds, are generally low cost or have no transaction costs associated with them.

    Taxes is a more complex area, but assuming the holdings are in an RRSP, tax issues do not apply, and one is left with the fees and transaction costs of stocks vs GICs. Here Trahair comes pretty close to the mark.

    To say that there are low cost index funds available - as some argue - ignores the fact that they have not been available to retail investors for a large part of the comparison period. Time will tell if in the future the results bear out the past results.

  13. @Anonymous: GICs most certainly do have fees. It's just that they are built into the offered return. The smaller the GIC the smaller the return is generally. I've helped family members negotiate GIC rates and we get higher returns for larger investments.

    It's true that there are fees associated with buying a stock index. However these fees can be miniscule -- smaller than the fees built into GICs. The problem comes when people are sold expensive mutual funds instead of buying a cheap index.

    If we are going to use stock mutual fund fees as a basis for comparison because investors often don't know any better, then we should also use GIC rates posted by banks for comparison because these same investors wouldn't know enough to negotiate for a better rate.

    As for the tax issue, tax rates for GIC income are higher than tax rate on capital gains.

  14. Canadian Capitalist made the following comment on 2009 Sept. 24:

    I'm glad to see David Trahair is now making valid comparisons -- between TSX total returns and GIC returns. But he is still pretending that GIC returns are "competitive". Your post clearly shows that what initially appears as a few extra points advantage over time compounds into a truly staggering difference.