Graham Christian, Content Strategist
For many years, GICs have been viewed as a safe-but-not-terribly-exciting option for those who didn’t want to play the rollercoaster game of ups and downs associated with stock trading. After all, they’re not much of a gamble - once their term expires, CDIC-insured GICs (also known as Guaranteed Investment Certificates) are guaranteed to return the same money you put in with the prescribed interest rate on top. While there are no hard losses due to market volatility, that assurance typically comes at the expense of liquidity and the greater yields possible with higher-risk stocks and bonds.
This year, however, interest rates are continuing to rise in the face of growing inflation, and we’re seeing that trend spread to GICs - something that’s getting the attention of financial experts and investors alike. Even for those stuck with inaccessible funds in long-term GICs, the now-flattening “yield curve” is allowing investors to shorten their terms without giving up any of their yield. It’s no longer necessary to commit to a five-year term just to get the best interest, as three and four-year terms are now offering comparable rates.
Oaken Financial, an online bank launched in 2013, announced last week that they would now be offering 5% interest on five-year GICs, increasing the rate from the previous 4.45%. Not only that, but their one-year rate is jumping to 4.05% as rates for two, three and four-year GICs rise as well.
That may not seem like a lot given previous years, but as stocks and bonds continue to suffer through a post-lockdown swan dive that’s left their yields in the mid single-digits, many Canadians are looking at the now-competitive rates and added security of GICs and considering a move.
So how do investors take advantage of this new development?
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The ladder strategy
Because of the high interest currently available on GICs and general unpredictability of inflation and interest rates in the near future, experts recommend something called a “ladder strategy”. Using this method, you would invest equal amounts in one, two, three, four or even five-year GICs as opposed to putting everything in the traditional five-year term. Structuring your investments this way means that one of them will reach maturity with every year, giving you the ability to either reinvest or cash out.
The logic behind it? Because you’re only reinvesting one year at a time, you’re reducing the impact of unpredictable interest rates on your funds. If inflation recedes and interest rates go down in another year or two, only a small amount of your money is affected. The rest is still making four or five percent interest in your locked-in GICs. Another benefit is the ability to increase the liquidity of your GICs. As each one matures, you can make the decision to simply get your money plus interest if desired.
Building a GIC ladder
If GIC laddering sounds like a solid plan to you, here’s a step by step plan of how to get it started:
Split your funds into multiple GICs
To illustrate, let’s say you have $20,000 to invest in GICs.
Instead of investing the whole thing into one five-year GIC, you’re going to “ladder” it by putting $5,000 into one-year, two-year, three-year and four-year GICs.
To demonstrate the benefits of a GIC ladder, let’s use the current GIC rates for Oaken Financial:
- One-year: 4.05%
- Two-year: 4.50%
- Three-year: 4.60%
- Four-year: 4.65%
When you add up these interest rates (they total 17.8%) and divide by the total number of investments you made (four), you get your average annual return for the first year (4.45%).
A one-year GIC in our example would only earn 4.05%, which means the laddering strategy will put you 0.40% ahead.
Reinvest upon maturity
Your one-year GIC is going to reach maturity after 12 months, bringing your $5,000 investment up to $5,202.50, including interest.
Now you’re able to reinvest those funds into another four-year GIC, losing the one-year GIC from your ladder as you increase your average yield.
If we assume the rates stay the same after a year, your total interest will now be 18.4% (4.50% + 4.60% + 4.65% + 4.65%)
If they’ve increased, even better news. And if they’ve gone down, you’ve only lost a fraction of your investment.
Going back to our example, divide that 18.4% by your four investments and you’ll get an average return for your second year of 4.6%. At this point, you’re now 0.15% ahead.
Repeat, repeat, repeat
As one of your GICs will reach maturity each year as a result of laddering, you’ll be able to roll the funds back into four-year GICs or cash them out according to how interest rates behave.
Are there any drawbacks to investing in GICs?
As with anything, there are always some caveats. Because the guarantee of GICs is so iron-clad, it does require a commitment on your part. Money you put into these investments is meant to stay there untouched for the entirety of the term, so while you can remove them before they’ve reached full maturity, you will get hit with a fee for doing so.
The other thing to note is that GICs also aren’t inflation-proof, so while your nominal return may be what’s promised (your principal plus interest), the “real” return (what your money is worth now) could have eroded over time. That being said, they’re still the safest places to invest your money right now.
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The last word
While there are many economic factors that make it challenging to say when inflation will ease or interest rates will drop, those more interested in protecting what they have than taking a gamble may get the best of both worlds by investing in high-yield GICs right now. Not only will you benefit from a better-than-average return without locking yourself into a long GIC term (as even short-term GICs are offering comparable interest), your funds will be more protected during this period of instability than they would be with regular stocks and bonds.
How do you feel about GIC laddering, and what’s your prediction for the next year when it comes to interest rates and inflation? Let us know in the comments below.