What is a GIC?

Why a GIC?

It’s always wise to diversify a liquid investment portfolio to include safer securities. With a GIC you lock your investment in for a set period of time, whatever you find acceptable. It ranges from less than one year, to up to 10 years. And interest rates can vary, currently reaching as high as 5%, all depending on the institution and the duration of the term. Usually, the longer the term, the higher the interest rate one gets on a GIC.

GICs are also cashable and redeemable. Customers can withdraw their money before the end of the term, in case of an urgent need. Most cashable GICs tend to have a short locked-in period of about 30 to 90 days before users can access the money without any penalty. Redeemable GICs, meanwhile, do not have this waiting period, and people can have access to the money anytime.

But there are certain things GIC investors need to know first.

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Registered GICs

You can invest in registered GICs as part one of Canada’s various registered savings plans, such as the Registered Retirement Savings Plan (RRSP) or Tax-Free Savings Account (TFSA). A registered GIC is regulated by the federal government and allows users to grow their savings without applying taxes on the money earned through interest rates upon maturity. However, within these registered accounts, there is a maximum allowable contribution, and if people need to withdraw some of their money, depending on the account, there may be hefty fees.

For instance, a TFSA can hold different investment vehicles, including GICs or mutual funds. The amount you can put into a TFSA every year is limited, with a limit of $6,000 for 2022. But the contribution room accumulates over your lifetime, starting at age 18. Online calculators can help you figure out how much you can invest in your TFSA.

Non-Registered GICs

As the name suggests, non-registered GICs are not held in a registered account, and don’t come with any tax breaks or incentives. However, users don’t have to worry about age or contribution limits. You can invest as much as you’d like in a non-registered GIC.

There are also different types of GICs.

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So what types of GICs are there?

A guaranteed return or fixed-rate GIC

Think of fixed rate GICs as the classic, most well-known, GIC product.

When investors go fixed, they are expecting to receive a defined amount of interest payable at specified periods during the term that they choose.

So, if someone has invested $1,000 in a one-year fixed-rate GIC at 1%, they will be getting $1,010 on the maturity date.

Floating or variable-rate GICs

This is when your GIC saving is linked to the financial institution’s prime rate. So if that rate goes up, you make more money. However, the opposite is also true.

Market- or equity-linked GICs

This type of GIC is linked to the performance of an underlying stock market index. Market-linked GICs bring greater returns if the market performs well. The rate of return is not determined until maturity in these GICs. So if your GIC is linked to the S&P/TSX 60 index and went up over the three-year contract period you chose, the GIC’s return will reflect the exchange’s performance, up or down.

Market-linked GICs are locked, meaning you won’t be able to access your money before the term is up. But your principal remains guaranteed. However, taxation applies here. Money made through interest is taxed at a higher rate than capital gains. And no dividends are earned through market-linked GICs, which is an entitlement you would have if you had invested directly in the stock market.

Foreign Exchange GICs

In Canada, the most common foreign currency GICs are U.S. dollar-denominated.

This idea is if you have an itch to make profit on foreign currency fluctuations, then you should go the foreign exchange GIC route.

This option is great if you are planning to visit the foreign country associated with the currency while earning interest on top. For example, if you are planning to visit the U.S. and stay there for a couple of months and you want to cut your inflation losses, then this could be a good option for you.

WARNING: Foreign currency GICs are not covered by CDIC insurance. There is no guarantee you would get your money back in case the bank or credit union fails. Also, with this type of investment, the bank will be buying slightly below the market rate and selling slightly above. This is how banks make money on this — through what’s known as a “spread.” And there is the possibility that the currency the GIC is in can fall, leaving you with less money in Canadian dollars. All of this makes this type of GIC riskier than the others.

Disadvantages of GICs

It’s time to look at some of the downsides of GICs.

1. Your money is tied up for the duration of the term you chose, meaning, if you want to reap the full benefits, you can’t tap into it at all until the end of the term
2. What if inflation is higher than the interest rate on the GIC you chose? In that instance, your money will lose purchasing power over the course of the GIC’s term.
3. Like with all investments, the riskier the investment is, the higher the rewards are. And remember, the currency exchange GIC has no guarantee that your principal is covered.
4. Your interest earnings on a GIC will be taxed, if it’s not in a registered investment vehicle like an RRSP or TFSA.
5. Usually, there’s a stipulated minimum amount to invest in a GIC. That can be a problem for someone with only a small amount of savings.

GICs might sound like a straightforward concept, however, there are many nuances. As with any type of investment, do your homework again and again.

The formulas financial institutions use to determine your final investment value may be complex. So you need to know the details of how you get paid on your GIC.

For example, a market-linked GIC is promised for a maximum return at 9% over a three-year term. But this could mean that the maximum of 3% a year is made only if the market performs well. So that 9% isn’t fully guaranteed.

A major tip on how to be a smart GIC investor

There is one strategy some veteran investors use with GICs, and it’s called the “GIC ladder.”

You divide a lump sum of money into, let’s say, five GIC accounts with different rates of maturity for each year.

For example, the money in “rung one” would be invested in a GIC for one year, the second rung for two years, and so on until the fifth rung is invested in a five-year GIC, which would most likely have the highest interest rate.

This gives you a little more flexibility to access your money than you would have with just one GIC.