The lure of rising rates and market-linked returns
Current 5-year GIC rates are being advertised as high as 3.50%. Given that most savings accounts offer much less than 1.00%, some investors have been wondering whether it’s time to move funds into GICs as part of their risk-free allocation. Others go a step further and are considering GICs linked to a market index that, according to the marketing sheets, offer much more than 3.50%. Have GICs become a good investment choice now?
According to the rate monitor website ratehub.ca, you’ll currently see five-year fixed-rate non-registered, non-cashable GICs being offered at an annual rate of between 3.00% and 3.50% at the top end of the range. At the low end, you’ll be offered the awesome return of 1.25%.
Guaranteed Investment Certificates (GICs) are really a type of locked-in deposit. Because the financial institution gets the use of your money for the specified term, it will offer a slightly higher rate than you’d get with a totally liquid deposit such as a savings account, a money market fund, or a short-term Treasury bill.
GICs are offered with many term lengths, depending on the financial institution. Terms range from six months up to as long as 10 years. Most popular are five-year terms. The annual interest rate offered remains static for the term of the GIC, and interest may be paid monthly, quarterly, semi-annually, or annually, depending on the financial institution and the conditions of the GIC. Your money is locked in until maturity, and you’ll pay a penalty if you decide to cash out early.
Some financial institutions will offer redeemable (that is, cashable with no penalty) GICs. However, these GICs offer a (usually much) lower annual rate than the non-redeemable version for the same term.
Another variation is the market-linked GIC, whose rate of return is variable and linked to a market index of some type, for example, the S&P/TSX 60 Index or the S&P 500 Composite Index. Interest will typically be paid at maturity, a crucially important point to remember if you’re considering this type of GIC. That’s because it’s impossible to predict how the linked market index will do over the term of the GIC.
While the principal amount of your investment in the GIC is protected, at maturity, you may also receive a lump sum if the market has performed well, or you may receive a pittance – or even worse, nothing at all – if the market has underperformed or tanked. The end return is usually calculated by the financial institution based on a complicated formula that typically looks like an equation from an astrophysics textbook.
With market-linked GICs, you don’t get a regular income, and your ultimate return is tied to a market index, the future performance of which is unknowable. So this type of GIC has lots of drawbacks and is in effect a high-risk bet on a market-linked return sometime in the future. Most advisors stay away from these kinds of products, looking at them as neither fish nor fowl, but some awful combination of the worst characteristics of both.
The principal amount (but not the interest) of a GIC investment is covered by the Canada Deposit Insurance Corp. or in the case of credit union GICs, by a provincial equivalent, to a maximum of $100,000 per institution. Check the terms of your prospective GIC to determine your specific coverage.
Investors looking for income should look for GICs that pay interest more frequently, perhaps monthly or quarterly. If cash flow isn’t a problem, and you don’t mind having your money tied up for a longer term, opt for less frequent payments, perhaps annually or semi-annually.
Another strategy to help deal with cash flow is to buy GICs with staggered maturity dates, often called a GIC “ladder.” For example, you’d buy a GIC maturing in one year, another in two years, another in three, and so on. That way, you’ll have a regular income stream, but you’d also have access to some of your principal every year and decide at each maturity date whether to keep rolling over the ladder or deploying the maturing principal amount in other investments.
Buying GICs is one way of allocating part of your portfolio to risk-free assets, but it does tie up those funds for a set term, with no penalty-free access until the GIC matures. Before committing to a GIC allocation, speak to your advisor to see whether the strategy fits with your overall plan.
© 2018 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited. This article is for information only and is not intended as personal investment or financial advice.