Think of a Guaranteed Investment Certificate (GIC) as a parking spot for your money — at a really clean garage where the police never ticket. That’s because a GIC is one of the lowest-risk investments out there. The financial institution that holds the GIC guarantees your principal. Even if the institution should fail, deposits and GICs are insured up to $100,000. However, there’s no such thing as a free lunch: the flip side of such security means that returns can be lackluster, sometimes even lagging behind inflation.
What is a GIC?
A GIC is a financial product that allows you to lend money to a bank at a fixed interest rate for a predetermined amount of time. The bank pays you a higher interest rate the longer you let them keep your money. The only difference between stashing cash in a regular savings or chequing account and a GIC is that your interest rate doesn’t fluctuate and you don’t have access to that money. (GICs that allow you to “break” your investment will either offer you a lower rate or charge a penalty when you withdraw your money early.)
GICs used to be exceptionally popular. In the 1980s, for example, banks were handing out double-digit interest rates with virtually zero risk. Canadians with cash on hand could sit back and let the money roll in. Of course, inflation was skyrocketing, so it kind of evened out. The thinking was, why invest in the stock market, with all the horror stories and number crunching involved, when buying a GIC required no more energy than walking inside the bank and negotiating a rate? But as interest rates plummeted to near-historic lows in subsequent decades, so did demand for GICs.
Market-linked GICs
To increase the appeal of GICs, some banks have begun offering products tied to stock market benchmarks. Called “market-linked GICs,” these products spice up what was previously a very staid investment. They guarantee your principal and, sometimes, a tiny interest rate. On top of that, there’s the possibility of earning a return that can beat inflation. Each market-linked GIC’s performance is tied to a different benchmark for a specified period of time. For example, you could buy a five-year GIC tied to the S&P/TSX 60 Index, which follows some of the largest corporations in Canada. If it rises over five years, so will your return.
It’s hard to say exactly how much you could earn, since the banks calculate the payout in different ways and aren’t very transparent about it. You can either earn a percentage of the benchmark’s posted gains, or be limited to a maximum return. Make sure to check the fine print to see which formula your GIC uses.
If the index drops over those five years, you’ll still get your principal back, but its purchasing power will have decreased. Of course, you could also skip the GIC part and just buy the index yourself to capture the entirety of its returns, but then your principal is not guaranteed.
How do GICs work?
Once you purchase a GIC, your interest is paid at regular intervals (the frequency depends on the kind of GIC) or rolled back and compounded into your investment and paid at maturity. When the term is over, you can choose to automatically invest in another GIC or have the money deposited into your account while you figure out your next move. For such a simple product, GICs have a language all their own. Here are definitions for some of the more popular terms:
Term deposits: another form of secured investment
Term length: how long your investment is, usually three months to five years
Principal: the amount of money you initially invest
Maturity: this refers to the end of the term length. If you buy a GIC for two years, for example, your GIC “matures” at the end two years.
Redeemable/non-redeemable: If you can get your cash out, even with a penalty, the GIC is “redeemable.” If your money is locked in your GIC, it’s considered “non-redeemable.”
Cashable/non-cashable: same as above — if you can get your cash out, even with a penalty, the GIC is “cashable”. If your money is locked in your GIC, it’s considered “non-cashable.”
Simple interest: the bank pays out the GIC interest on a regular schedule into your savings account.
Compound interest: the bank continually adds the interest to your principal. You end up earning interest on your interest. Over time, this snowball effect can help amplify your returns.
Benefits of GICs
The main benefit of a GIC is how safe it is. You’re insulated from rate-dive shocks — if you buy a five-year GIC at 4%, that’s exactly what you’re getting, no matter if rates have plunged to 2.5% during that period. Unless something catastrophic happens to Canada, like our entire financial sector and democracy collapses, your principal of up to $100,000 is insured by the CIDC or by a provincial insurance company. It’s an easy way to maintain, if not accumulate, funds.
Seniors, for example, may not want to put their money through another stock market cycle, may choose to leave money in a GIC. Those saving up for a down payment may also like the fact that some GICs lock up money tight and won’t let you dip into it. Otherwise high-risk investors may also appreciate that at least a portion of their portfolio is safe. In short, GICs are boring: predictable, prudent, conservative, and safe. But in investing, boring can come with exciting advantages.
Risks of GICs
The biggest limitation of the GIC is the very thing it’s prized for: stability. Rates are meant to keep pace with inflation, but not beat them. Truthfully, the rates rarely even keep pace, but are usually limping along just behind. That means your money is actually losing purchasing power every year. Stability, like anything else, has its price.
Even if your rate does beat inflation, taxes are likely to take a big bite out of the rest — interest is taxed at your marginal rate, up to 53.5% in some places in Canada. You could easily avoid this by holding a GIC inside a registered account, but then you’d be taking away room from other, perhaps more worthwhile, investments.
The five biggest drawbacks to GICs are:
Interest-rate risk: rates could rise when you’re locked into your GIC.
Liquidity risk: it’s hard to get your money out.
Opportunity cost: by tying up your money, you may miss out on higher returns elsewhere.
Interest: unlike dividends and capital gains, interest is taxed at your marginal rate.
Competition: from the rise of liquid, high-interest products that are also fully insured and equally low-risk.
How to buy a GIC
GICs can be purchased at many financial institutions — banks, credit unions, trust companies, and some brokerages — and can be held in both registered and non-registered accounts. All you have to do to get one is agree to the terms with an institution and deposit your money. Traditional GICs are simple to buy and require no prior investment knowledge.
