Market-linked Versus Regular GICs

by Jordan Lavin July 13, 2017 / No Comments

When you’re looking to make an investment with virtually no risk of losing your money, GICs are a popular option to consider. GICs let you earn interest on your savings, and you’re always guaranteed to get back at least the money you put in.

There is a type of GIC known as a market-linked GIC. Rather than paying a set interest rate, these GICs pay returns based on market performance. If you’re not sure which type of GIC to invest in, here’s a brief comparison to help you decide.

The basics

Regular GICs are financial products that pay a fixed rate of return in exchange for locking in your money for a period of time. You agree to a GIC interest rate, deposit your money for a certain length of time, and you get your money back with interest. You know in advance exactly what your return will be.

Market-linked GICs are financial products that pay a variable rate of return, but also require you to lock in your money. Rather than having a set rate up front, the market-linked GIC will be tied to a particular stock index or mutual fund. For example, your market GIC could be linked to the S&P/TSX 60 Index, which is measures the performance of 60 of the largest companies listed on the Toronto Stock Exchange. Your principal is still guaranteed, but you won’t know how much money the investment will earn until after the fact.

Investment safety

Regular GICs are the safest investments available in Canada. When you buy a GIC, you can be certain of the amount your investment will be worth when it matures. There’s virtually no risk of losing money on the investment. And at many banks, your initial deposit will be covered by CDIC insurance up to $100,000 in the event the financial institution fails.

Market-linked GICs are also relatively safe because your initial investment is guaranteed. Even if there’s a big drop in the stock market, you won’t lose money on a market-linked GIC. On the other hand, you may not earn money either. CDIC insurance applies to these types of GICs as well.

GIC term lengths

When you invest in a regular GIC, you can choose from a variety of investment terms. The longer term you commit to, the bigger return you can expect. Short-term GICs range from 30 days up to nine months, while long-term GICs are anywhere from one to five years (and sometimes longer).

When you invest in a market-linked GIC, short-term options likely won’t be available because your investment needs time to grow. Expect to lock in for three to five years when you invest in a market-linked GIC. And remember with either option you won’t be able to access your money until the term is up.

GIC returns

Regular GICs pay an advertised rate up front, so you’ll know exactly how much money your investment will earn. If you invest $1,000 in a one-year GIC with a rate of 2%, you’ll receive $1,020 when the GIC matures. The longer GIC term you invest in, the higher your GIC rate will be. GIC rates are loosely tied to inflation, so rates tend to be lower. As of the time of writing, the best GIC rate on the market is 3.25% for a five-year commitment.

Market-linked GICs have the potential to earn much higher returns because they’re tied to stock performance. For example, the S&P/TSX 60 Index has produced a 9.15% annualized return over the last five years (as of May 31, 2017). That said, there’s also a chance the market could trend down over the course of your investment. In that case, you wouldn’t earn any money at all on your GIC investment.

Market-linked GIC controversy

Some financial experts have criticized market-linked GICs because investors don’t actually get as much out of them as they would have if they invested directly in the market. Not only do GIC investors miss out on dividends they would have earned by investing in stocks, they also lose out on compounding interest. Market-linked GICs often have maximum returns that are lower than the return of the market they’re linked to. Some are capped at a set percentage (5%, for example) and others are capped at a percentage of the index’s return (50%, for example). Furthermore, money earned in market-linked GICs is technically paid as interest, which is taxed at a higher rate than capital gains (the type of investment income you’d make by investing directly in stocks).

Choosing between regular and market-linked GICs

The choice between a regular and market-linked GIC comes down to your personal preference. If you want the possibility of earning a higher rate of interest than a traditional GIC but you can’t accept any risk that your investment will lose money, a market-linked GIC may be a good choice for you. But be warned you’ll likely earn a smaller return and pay more tax versus investing directly in the market.

If you want to get started with investing in stocks and mutual funds, a fee-only financial advisor can help you identify investments that are geared toward your goals and suit your risk tolerance.

A regular GIC is the better option if you want to earn a predictable interest rate with virtually no risk. These GICs also offer more options when it comes to term length, with commitments as short as 30 days available.

As with all investments, the choices you make need to be geared toward your saving goals. Think about what you really want to get out of your GIC—likely a steady return with no risk—and seek out the option that works best for you.

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