What is a GIC? And why would I want one anyway?

Written by Ian R. Whiting, MONEY® Canada Limited || MONEY® Magazine

 GIC is an acronym for Guaranteed Investment Certificate. These are available to Canadian investors through banks, trust companies, credit unions, caisse populaires and some life insurance companies. When an investor buys a GIC they are loaning the financial institution a sum of money for a pre-determined period of time and in exchange will be paid interest. The “guarantee” behind a GIC is that the principal (the initial amount invested) is protected by the seller and will not lose any value over its term.

When it comes to investing, there is no “one size fits all” solution. Investment options – like Guaranteed Investment Certificates (GICs), mutual funds, bonds, and stocks – all have different growth potential and risk. Investments range from totally secure with limited growth to highly volatile with maximum growth.

GICs are on the safer end of the spectrum, in terms of protecting your principal and a fixed rate of return. Any money you deposit in a GIC is guaranteed by the issuing financial institution to provide a known rate of return, which makes it easy to figure out how much money you’ll have when the term is completed. GICs have a wide range of terms and flexibility. Some are non-redeemable, which means that you can’t move the money out until the end of the term. Generally speaking, the longer the term, the better the interest rate available.

GICs are also available in registered investment vehicles such as RRSPs, RESPs, or TFSAs. If you invest in a GIC within one of these registered plans, you may benefit from tax savings and/or deferring tax payments until you withdraw your money from the plan.

3 reasons to choose a GIC:

  1. If your savings goal is short term (like within the next 1-3 years, or sometimes more).

You can’t predict when markets will rise or fall, so if you won’t have enough time to ride out a potential market slump, a GIC—with its guaranteed rate of return—is a safe investment option.

  1. If you absolutely cannot tolerate any drop in value of your investment.

With some savings goals, you know how much money you will need and when you’ll need it—for example, you want to buy a car in two years and that car will cost $15,000. With the right initial contribution and rate of return, a fixed-term GIC will ensure you build that savings amount. A guaranteed rate of return is also good if any kind of risk makes you extremely nervous—a GIC may be what you need to sleep at night.

  1. If you want to take advantage of tax savings (in an RRSP, for example) but aren’t ready to commit to a more aggressive savings strategy.

In most cases, GICs aren’t a great vehicle for retirement savings—with long-term goals, the rates of return just aren’t high enough to allow for the real benefits of growth to take effect. But if you can’t handle even a minor fluctuation in the market and want to use GICs as part of your RRSP, you may want to consider a laddered strategy—which involves purchasing GICs of different terms and renewing them when they mature. An investment advisor can explain this strategy in more detail.

 

Keep inflation in mind

If you are earning a lower rate of return over a longer, fixed period of time, you should consider the effect that inflation may have on the value of those savings. Recently, Canada’s inflation rate has averaged about 2 per cent. That means that something for sale in 2014 will have a price tag 2 per cent higher in 2015, 4 per cent higher in 2016 and so on. If you’re saving for retirement, you may be saving for purchases that you’ll make 20, 30, or even 60 years down the line. Imagine the impact inflation will have in that amount of time. To keep up with inflation, your long-term investments need to grow at least 2 per cent every year.

Inflation and your portfolio

To make sure the money you invest will have greater purchasing power in the future, you have to understand the impact of inflation on your portfolio. For example, its common sense that a 6% annual return is better than a 3% annual return, but the difference between the two is even more significant when you consider recent inflation of about 2%. That means that the first 2% of real purchasing power on your investment dollars will be lost to inflation – and, as such, the lower-paying investment returns just 1% more than the inflation rate itself. Over the long term, if your investment returns barely cover the inflation rate, the compounding effects of 2% annual inflation translate to more groans at the gas station and grocery store.

To have greater purchasing power in the future, your investments have to outpace inflation. By building a portfolio with investments that resist the effects of inflation, you can hold on to your purchasing power. Investing in the stock market has its risks, and for “risk-free” investment products (like holding cash), the biggest risk is inflation. As a result, when it comes to reaching your retirement goals, playing it safe isn’t usually the best strategy.

In short…

Depending on your savings goals and attitude towards risk, a GIC may be a good addition to your investment portfolio. Their guaranteed rates of return provide stability and a reliable source of funds at the end of your term. Most people are familiar with the concept of going to a bank and asking for a loan. That loan will come with a set of conditions such as the amount of interest that will be charged and the date by which it must be repaid. Purchasing a GIC is essentially the same thing but in reverse. Instead of someone borrowing money from a bank, in this case the bank is borrowing money from you.

GIC Minimum Purchases and Interest Rates

Usually a minimum of $500.00 is required to purchase a GIC, although there may be exceptions depending on the term and the financial institution involved. The interest rate is determined at the time of purchase and may be fixed or be varied over the term. The rate is generally better than a regular savings account but usually offers a lower rate of return than many other kinds of less secure investments. This will be clearly defined at the time of purchase and will likely vary among different financial institutions.

Terms of GIC Purchases

The term of a GIC can be as little as one day or as long as 10 years, depending on the financial institution involved and the products they offer. In most cases the term is pre-determined at the time of purchase. The final day of the term is known as the maturity date and in most cases, the longer the term the higher the interest rate.

Generally speaking, once a GIC is purchased it must be held until maturity and can only be redeemed early under special circumstances. Early redemption may result in the loss of any interest earned to that point and may also be subject to a penalty fee. One exception is a cashable GIC which can be redeemed within the term at the discretion of the holder, but while they offer greater liquidity they also tend to offer a lower interest rate.

Advantages and Disadvantages of Investing in GIC’s

GIC’s are a low risk and simple investment to own. In most cases they provide stable and predictable income and are not greatly affected by market fluctuations. The principal is also usually guaranteed by the financial institution selling it and even in the event of default, the CDIC (Canada Deposit Insurance Corporation or similar such entity for credit unions, caisse populaires and life insurance companies) offers additional insurance of up to $100,000.00 (however be sure to confirm this before any purchase is made because it is not always the case).

On the down side, most GIC’s do not offer a great deal of liquidity and it can be hard to free up those funds in the event of an emergency. As well, although the interest rates offered are usually superior to a regular savings account, this type of investment may still give back a relatively low rate of return, and if held outside of an RSP, the interest is subject to income tax rate.

There are many different types of GIC available in an effort to cater to different investor needs and goals and it is important to fully understand the conditions attached before making a purchase. Remember to always consult a professional investment advisor or financial planner before making any kind of investment.

The many benefits of GICs
Whether you’re looking for a low-risk investment or an effective way to diversify your portfolio, there are many benefits to GICs:

  • Growth – Your investment is guaranteed to grow, regardless of how the markets perform.
  • Dependability – your interest rate is guaranteed not to fluctuate throughout the term.
  • Security – your original investment will be returned with interest at maturity, guaranteed.
  • Flexibility – inside or outside your RRSP, you can choose the term and interest options that are right for you.
  • Simplicity – an investment that’s guaranteed to grow – what could be simpler?

 

With courtesy to:
Alberta Treasury Branch
Manulife Financial
Wikipedia

 

Ian Whiting

Ian R. Whiting CD, CFP, CLU, CH.F.C., FLMI (FS), ACS, AIAA, AALU With more than 40-years of experience in the industry, Ian has qualified 3 times for MDRT, completed LUATC in 1979, the LUAC Financial Planning Skills Course and attended numerous Schools in Agency Management and Sales Management through LIMRA. He obtained his CLU in 1987 while also completed his IFIC qualification and completed his Fellowship in the Life Management Institute with a specialty in Financial Services in 1988. In 1989, he completed qualifications for his Chartered Financial Consultant designation. In 1992, he qualified as an Associate of the Academy of Life Underwriters (Head Office underwriter qualification) and in 1993 he completed his Associate, Customer Service designation program through LOMA. In 1997, he qualified as a CFP and also completed his courses and exams to obtain the Associate, Insurance Agency Administration designation. In 1999, he completed the study and examinations to qualify as a Trading Officer, Partner and Director for Mutual Funds with the BC Securities Commission. As a result, he is also qualified as both a Branch Compliance Manager and Head Office/Provincial Compliance Officer. He served for nearly 18 years with the Canadian Forces (Air) Reserve (reaching the rank of Captain) primarily working with Air Cadets and was award the Canadian Forces Decoration (CD) in 1982. Long known as a maverick and forward thinker in the financial services world, Ian enjoys the challenge of learning new material and planning for the future evolution of his chosen profession.