Over the years we have discussed the “buckets” as a simple approach to allocating your money based on when you need to use it. This means that money you need in one to two years stays in bucket #1 in the form of cash, cash equivalents or GICs. In contrast, bucket #3 is for monies that you don’t need to access for five to ten years, or even longer – these are long-term growth investments such as dividend paying equities, your business, a rental property or some other private equity (they will always fluctuate in value).

So what about bucket #2? The second bucket covers the funds that are needed in three to five years, making it ideally suited to our Income Note Strategy, which strives to pay monthly interest payments (coupons) in markets that are rising, flat, or that decline up to 30%. This can be very attractive for families who need income regardless of market direction.

In the video below, which was produced when interest rates were near zero, we mentioned that our goal would be to build a portfolio that generated 8% before fees. At the time we felt this would be attractive, but things have changed as five year GICs now pay up to 5%, and income notes have seen potential coupons rise as well, where we are now building portfolios in the 10 to 12% range. In light of this, we have revised our target return on this strategy to be 4 to 5% greater than a five year GIC (gross of fees), which offers a more suitable target return since income notes are not GICs and have a very different investment risk profile.

Again, what makes income notes attractive is that they can generate 4 to 5% more than a five year GIC in markets that are flat, rising, or that decline up to 30%, but what are the risks?

• First, in any month that the sector being tracked by the notes has fallen by more than 30% from issue no coupon payment is paid that month
   
• Second, if the note matures below its protection threshold of -30% you will lose some capital

As shown in the grid below, over the past 10 years, of the 493 notes issued that tracked the banking index, 96.1% of the notes paid all their coupons and the average annualized note return (read: coupon) was 8.0%. Likewise, for pipelines, of the 136 notes issued, 94.1% of the notes paid all of their coupons and the average annualized note return was 12.1%. There were also no capital losses at maturity, but there is no guarantee either this or the yields will hold true in the future; regardless, in our view, these risks are more than offset by the fact that the Income Note Strategy pays a very healthy monthly interest payment in markets that are rising, sideways, or that decline up to 30%, and depending on the level of protection we price in, interest payments can still occur in market declines of up to 40%.

 

The Income Note Strategy is suitable for 15 to 20% of the consolidated total value of most portfolios, and with many families sitting on excess cash as interest rates have risen we would suggest the following:

• Watch the video: Click here to play the recording
   
• Keep your near-term needs in cash
   
• Keep your five to ten year money in disciplined equity or stock strategies
   
• Consider income notes for the portion of your cash that is best allocated to bucket #2

Don’t hesitate to reach out if you have any questions for us regarding the Income Note Strategy, or any other financial matter that’s important to you – we’re always happy to chat!

Randy and Ian

Grid source: BMO Cross Asset Solutions, BMO Structured Notes, Performance Report 2022 Achieving Your Financial Goals
Yields/rates are as of February 28, 2023 and are subject to availability and change without notification. Minimum investment amounts may apply.
For GIC terms of one year or less, simple interest is paid at maturity. For GIC terms of greater than one year simple interest is paid annually or compound interest is calculated annually and paid at maturity. For more information about this product, please contact your Investment Advisor.