GICs get a bad rap in today’s low interest rate environment. When stock markets are reeling like they have been this summer, investors often seek save havens to wait out the storm. Cash is king for those who don’t have the stomach to watch their portfolio plunge in value, and GICs at least offer the promise of a modest return.
I remember February 2009, when the global financial crisis had almost reached its nadir, I had purchased a five-year GIC after scrambling to meet the RRSP deadline. In hindsight it was a costly mistake; the Toronto Stock Exchange surged ahead for the next five years, earning annual returns of 9.52%, while my five-year stepper GIC from TD Bank earned an average return of 2.75% per year.
Instead of turning my $7,000 contribution into nearly $10,000, I had just $7,800 to show for my decision. But I thought it was a smart move at the time because I had to make a quick decision on what to do with my contribution, and the stock market looked downright nasty.
The truth is, there’s nothing wrong with stashing your savings in a GIC. Here are four times when investing in GICs just makes good sense:
- When your entire portfolio has been sitting in cash for years, waiting for “the right time” to get into the market.
If you’re the type of investor who can’t ignore the doom-and-gloom economic headlines, someone who’s convinced that a market meltdown is always imminent, maybe the stock market isn’t right for you.
Having your retirement savings constantly sitting in cash and earning nothing is like sitting on the fence and being paralyzed to move for fear of making the wrong decision at the wrong time.
A GIC ladder, which might involve purchasing equal amounts of one, two, three, four, and five-year terms, will maximize your risk-free returns and still give you the option of dipping your toes in the market each year when a term comes due.
- When your investing strategy boils down to chasing last year’s winning stocks or mutual funds.
If you’re the type of investor who’s constantly looking for the latest fad, you might be falling victim to the behaviour gap: the difference between investment returns and investor returns.
Consider that, according to DALBAR, from 1991 to 2010 the S&P 500 Index averaged 9.14% a year, but the average equity fund investor earned just 3.83% a year.
When you think about our poor investor behaviour coupled with sky-high mutual fund fees (at least in Canada), those investors who just can’t help themselves might be better off parking their savings in the best five-year GIC.
- When you just can’t stand the thought of losing money in the stock market.
Some investors simply can’t stomach the fact that a stock portfolio may drop by up to 50%. They can’t handle the volatility and can’t stop listening to pundits and economists who constantly push the fear button.
There’s no sense trying to convince this type of investor of the merits of investing in stocks for the long run. A nervous investor is the type to bail when the going gets tough.
A GIC could be better for peace of mind. One caveat is that you’ll have to save a lot more in order to make up for the lower returns of an all-GIC portfolio.
- When you’re retired (or close to retirement) and need to keep a portion of your portfolio in cash or guaranteed products.
Having all of your retirement savings in the stock market might make sense at age 30 or even 40, but once you’re retired or a few years away from calling it quits, you’ll want to keep three-to-five years of expenses in cash or GICs.
An investor who hopes to retire in a year could structure his or her portfolio in a way that places equal amounts (like one year of expenses) into a five-year GIC ladder. The first rung of the ladder matures the year the investor retires, which then gets cashed out and put into a chequing or savings account to cover living expenses. Rinse and repeat each year, pulling one-year of expenses out of your stock portfolio to replace the five-year tranche of your GIC ladder.
I was quite happy to cash in my $7,800 GIC when it matured and put that money to work in the stock market, but many people are perfectly content with all or a portion of their money in an ultra-safe GIC.
GICs can play a role in your investment portfolio, no matter what age and stage you’re at in life. Ultimately you need to do what’s best for your portfolio, compare GIC rates to know what you’re getting into, and invest in whatever helps you sleep better at night.
Flickr: Horia Varlan