Danielle Kubes is a trained journalist and investor who has written about personal finance for the past six years. Her writing has been published in The Globe and Mail, National Post, MoneySense, Vice and RateHub.ca. Danielle writes about investing and personal finance for Wealthsimple. She has a Bachelor of Humanities from Carleton University and a Master of Journalism from Ryerson University.
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 lowest risk investments out there. The bank guarantees your principal—and if the bank or credit union should fail, deposits are usually insured up to $100,000. But there’s no such thing as a free lunch. The flip side of such security means returns are generally lackluster, lagging even behind inflation.
What is a Guaranteed Investment Certificate (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 to stashing cash in a regular savings product 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 will charge a penalty.) GICs used to be exceptionally popular but have recently have fallen out of favour. 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? Over the last two decades, as interest rates plummeted to near-historic lows, so did demand for GICs.But GICs still have a role to play as part of a larger, more diverse portfolio.
How to open a GIC
GICs can be purchased at almost any financial institutions—banks, credit unions, trust companies and some brokerages—and can be held in both registered and non-registered accounts. Traditional GICs are simple to buy and require no prior investment knowledge.
How do GICs work?
Once you purchase a GIC, your interest is paid out to your savings account 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—not a great idea since you won’t get the chance to compare rates across all institutions—or have the money deposited into your savings account while you figure out your next move. For such a simple product, GICs have a language all their own. Here’s some clarity to that fancy bank-speak:
another way to say GIC
how long your investment is, usually three months to five years
the amount of money you initially invest
his 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.
if your money locked in your GIC, it’s considered “non-redeemable.” If you can get your cash out, even with a penalty, the GIC is “redeemable.“
the same as above
the bank pays out the GIC interest on a regular schedule into your savings account
the bank continually adds the interest to your principal. You end up earning interest on your interest. Over time, this snowball effect can really hike your returns
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 also 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. If the index, which follows some of the largest corporations in Canada, 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 obviously decreased. Of course, you can just buy the index yourself at a DIY brokerage and capture the entirety of its returns. Or you can check out a robo-advising brokerage, which provides portfolios that hold and rebalance a bunch of index funds across asset classes (stocks, bonds, real estate etc.,) giving you the safety of diversity. Both options are just as effortless as purchasing a market-linked GIC, but have a higher downside. If you can’t stomach the thought of losing a cent, than a market-linked GIC product may be a good compromise for investors that want to dip their toes in the market but aren’t quite ready to dive right in.
Limitations of GICs
The biggest limitation to 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. Inflation is currently around 1.5%, so if your GIC rate is less than that, your money is actually losing purchasing power every year. Stability, like anything else, has its price. And 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 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. Plus, if you invest money in a GIC it means you’re not investing it elsewhere. Canadians, for example, now have massive mortgages. Can they really afford to let their money sit there, making 1%, when they can be chipping away at their debt, which is costing them 3%? GICs, along with bonds, used to be the stalwarts of the fixed-income scene. But banking is in the midst of democratizing. Whereas there used to be just five major banks, a whole host of branchless institutions have cropped up, and Canadians across the country can now open accounts at credit unions in any province. These less traditional institutions offer high-interest saving investment accounts with rates and flexibility that beat the GICs. To sum it up, 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 are you missing out on higher returns elsewhere?
Interest, unlike dividends and capital gains, is taxed at your marginal rate
Competition from the rise of liquid, high-interest
that are also fully insured and equally low-risk
Advantages of GICs
The main benefit of a GIC is how safe it is. You know exactly how much interest you’ll earn and when to expect it. You’re insulated from rate-dive shocks—if you buy a five year GIC at 2% that’s exactly what you’re getting, no matter if rates have plunged to .5% during that period. And 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, who don’t have time for 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 offer peace of mind. But in investing, boring comes with some really exciting advantages. If you’re looking for a more, shall we say, exciting venture, why not check out WealthSimple’s automated investing service? It minimizes risk while maximizing rewards by investing your money across the entire stock market using Exchange Traded Funds.
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