How to Talk to Your Clients About Cash

As Advisors know, the fixed income landscape has changed significantly over the past two years. For many, these are uncharted waters. This may be the first time in newer Advisors’ careers that they’ve ever seen interest rates increase. Even financial professionals nearing the end of long careers have never seen rates rise this rapidly.

With short-term rates being as high as they are, there’s a newfound sense that clients don’t need to take much risk in order to meet the return targets specified in their financial plan. Imagine this scenario: a new client meets with their Advisor and says “I’d like to know when I can retire. Here are my debts, my family situation, my income, and what I think I can save.” The Advisor then draws up a plan that specifies a target rate of return to enable the client to meet their goals—say 5% per year over the next 30 years.

This is the first time in nearly a generation that clients have been able to get that 5% essentially risk-free.

This dislocation in the market, including a deeply and persistently inverted yield curve, makes the short end of the curve very attractive. As a result, many clients are de-risking their portfolios—taking money out of stocks and shifting to cash and cash equivalents like high-interest savings accounts (HISAs), GICs, and ultra short-term bonds. After all, why expose assets to market fluctuations when clients can meet their objectives with virtually no risk? It’s a reasonable conclusion to draw, but it’s also important for clients to know that not all cash-like instruments are created equal.

GICs vs. Ultra Short-Term Bonds

One-year GIC rates are currently approaching 6%, which understandably makes them an attractive option for investors. Consider, however, the benefits of an ultra-short-term bond strategy like the BMO Ultra Short-Term Bond ETF Fund.

The BMO Ultra Short-Term Bond ETF Fund invests in a diversified portfolio of investment-grade federal, provincial, and corporate bonds, all with a term to maturity of less than one year or reset dates within one year. It is an ideal place to park mid-term cash—anything that’s earmarked for expenses between 3-6 months and 18-36 months out. For clients, it is a great way to earn a high rate of return similar to a one-year GIC, but in a liquid strategy.

With ultra-short-term bonds currently trading at a discount, the Fund also offers a tax advantage in comparison to GICs, as demonstrated below:

Source: BMO Asset Management, as of October 13, 2023. Assumes an income tax rate of 53.53%; top marginal tax bracket will differ depending on province of residence.

This comparison between the Fund’s underlying ETF (ZST) and a 1-year non-redeemable GIC shows an after-tax difference of 0.76%—meaning that given current market conditions, an investor can generate an approximately 27% greater return with the BMO Ultra Short-Term Bond ETF Fund versus a GIC. This is because a portion of the future return from the basket of bonds that the Fund (and underlying ETF) invests in will come from price appreciation (the difference between the discounted price and the maturity value of $100), which is treated as a capital gain for tax purposes. In comparison, 100% of the return from GICs—and HISAs, for that matter—comes from periodic interest, which is taxed as regular income.

This benefit is especially attractive for corporate assets. An increasing number of my conversations are with clients who have retained earnings in their corporation; for instance, someone who has sold their business and now has a holding company, or a professional like a veterinarian or a dentist who has retained earnings from the business activities inside of a professional corporation. For those types of investors, the fact that the Fund’s returns are 50% taxable as income and 50% taxable as capital gains makes the strategy really stand out relative to fixed-price products.

Client Questions About Cash

In my discussions with Advisors and clients about cash and cash equivalents, one question I often hear is: what’s the next best alternative? In other words, what is the opportunity cost of investing in short-term cash or cash-like strategies?

The rapid rise in interest rates has pushed stock prices down and an argument can be made that it’s an excellent entry point for longer-term investors at attractive valuations. It all depends on the client’s needs, goals, and risk tolerance. It’s possible that interest rates could still be in the current range a year from now, but it’s more likely that they will have softened somewhat. As inflation cools and short-term rates ease back to their long-term average, clients will have to take on some equity exposure once again—depending, of course, on the details of their financial plan.

For investors with a longer-term investment horizon, a strategy like the BMO Canadian Banks ETF Fund may make sense. As it invests in an equal-weighted portfolio of Canada’s ‘Big Six’ banks, it offers dividends comparable to short-term cash and cash-like instruments and may also benefit from a surge in equity markets if and when interest rates are cut.

There is no one-solution ‘silver bullet’ for every client’s needs, which is why I often emphasize the importance of what I call ‘layering’ the client’s money along the curve. On the shortest part of the curve—spanning from a few weeks to maybe three months—is a mutual fund like the BMO Money Market Fund. A bit further out is the BMO Ultra Short-Term Bond ETF Fund, which is designed for the client who intends to hold their money for three months or longer but wants it to remain liquid. Further along the curve may come other bond strategies in the 12–36-month range, as well as longer-term equity holdings.

Alternatively, there’s a ‘barbell’ approach. Rather than holding fixed income securities that mature at various points along the curve, an Advisor might instead pair a short-term exposure like the BMO Ultra Short-Term Bond ETF Fund with a longer-term exposure like the BMO Aggregate Bond ETF Fund.

Either way, the BMO Ultra Short-Term Bond ETF Fund’s attractive yield, tax efficiency and liquidity make it a versatile strategy suitable for a wide variety of client portfolios.

Please contact your BMO Global Asset Management wholesaler for any support and guidance.

¹ Yield to Maturity (YTM): The total expected return from a bond when it is held until maturity – including all interest, coupon payments, and premium or discount adjustments. YTM is calculated gross of fees.

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