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When do GICs make sense for investors?

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Let's face it: GICs haven't always been the most exciting investment option out there. Customers would make their initial deposit, then get all their money back as promised with a bit of interest sprinkled on top. While that may sound like a knock against GICs, it’s not, and the fact GICs are simple, straightforward, and low risk are their biggest advantages. Plus, raised interest rates nationwide have allowed GICs to become competitive for the first time in a long while, offering more competitive yields alongside their other benefits.

Let's get into some basic information about GICs and show some examples of when they make the most sense for investors.

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  1. 5.30%$265 total return based on$5,000 investment
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What is a GIC?

A GIC (Guaranteed Investment Certificate) is a financial product that will give you a guaranteed return when you invest your money for a set term. Typically, the longer term you agree to, the higher interest you'll receive at the end. This is because the provider you purchase the GIC from will use your money (along with that of others who have purchased GICs) to provide things like mortgages and personal loans for other customers. The higher interest rate for a longer commitment acts as a sort of "thank you" for trusting them with your money.

When your term is over, you'll get your principal investment back, guaranteed. Banks are legally obligated to return your full amount, and in the rare event that your financial institution dissolves, your money will still be protected by the CDIC (Canadian Deposit Insurance Corporation) or a provincial organization, depending on where you made your purchase.

When it comes to your rate of return, that largely depends on whether you select a fixed or variable-rate GIC.

Fixed-rate GICs deliver their promised interest regardless of market conditions. The yield you agree to is guaranteed and protected, no matter what happens. While this means you may lose out on the bigger wins associated with stocks and bonds, it's a safe and predictable choice for those who are more risk-averse.

The interest on variable-rate GICs, however, is tied to a financial institution's prime rate and can change at any time. While this means a bigger return if the markets are doing well, it also could result in a weaker payout if things are on a downward trend, so be prepared for the possibility that you may not get the interest you thought you would.

 

How to choose a GIC

While there are several different kinds of GICs available (including redeemable/non-redeemable GICs, market-linked GICs, and more), you'll typically want to ask yourself a couple of standard questions before making a decision.

 

How soon will you need your money?

This is a very important question, as it will affect your chosen term length as well as whether or not you select a redeemable or non-redeemable GIC. Perhaps you're only comfortable locking your money away for a moderate period of time, such as one year. In that case, a short-term GIC would be the smart move. Or maybe you're fine with a longer term, but still want the ability to take your money out early without paying a penalty. In this case, a redeemable GIC would give you that flexibility. Just be aware that in both cases you'll be getting a lower interest rate than you would with a longer-term, non-redeemable GIC.

 

How risk-averse are you?

Another question to ask yourself when shopping for a GIC is your tolerance for risk. While GICs in general offer more security than any other investment product out there, they still contain different levels of risk. Highly conservative investors who simply want their principle back along with its promised interest would be wise to choose a fixed-rate GIC, which delivers exactly that. Those who wouldn't mind leaving their yield up to chance, however, can select a variable-rate GIC. These GICs still guarantee your initial investment returned to you, but your yield will depend on the bank's prime rate. If it rises during your term, your interest will go up as well. If it falls, the same will happen.

Those who want a bit more excitement in their GIC investment can also purchase a market-linked GIC, the interest of which is linked to a stock market index and will rise and fall alongside it.

 

Other things to know about GICs

  • You typically need a minimum investment of $500
  • Most GICs will pay a fixed rate of interest for a set term
  • There are generally no fees attached to GICs
  • If you absolutely need to access your money before your term ends, you may be subject to penalty fees
  • You're able to hold GICs in RRSPs and TFSAs

 

So when does a GIC make sense for you? Let's explore some scenarios below.

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When GICs make sense for investors

 

You have a short investment horizon

If you haven’t heard the term before, an investment horizon refers to how long you plan on keeping your money invested before you cash it out.

If you have a long investment horizon – think 20 or 30 years – funnelling most of your money in a high-risk stock portfolio can be worth it since you won’t need access to your money anytime soon and can weather market fluctuations. But, if you have a shorter time horizon or are working towards a specific goal for the near future, a more conservative investment approach can be the better move.

With a GIC, you’re guaranteed to see returns and won’t have to worry about the risks of cashing out your investments too early or at the “wrong time” when the market is down.

You may have a short-term investment horizon if you’re:

  • Saving for a down payment and plan on buying a home within the next five years or less
  • Setting aside money to pay for an upcoming wedding
  • A parent whose child is in high school and you’re looking to provide them with some financial support as they head to college or university
  • Planning to make a big purchase (i.e. a car) in the near future by a set date
  • Close to retirement and will need access to a significant amount of your investments as cash

Time horizons should play a key role in informing your investment approach. Putting your money in stocks for only a short period of time can be riskier, and while it’s possible you could end up with a lot more money than what you started with, there’s also the possibility you could lose a chunk of your savings when you need the money most.

A good strategy is to hold multiple investments, each with different time horizons and unique goals – like setting aside some money in a GIC for an upcoming home purchase, while, at the same time, investing some of your cash into a high-risk investment to build up your retirement savings

 

You don’t want to be tempted to spend money

If you've come into (or saved) a large sum of money and want to resist the temptation to spend it on something frivolous, there's no safer or better place for it to grow than a GIC. Not only will you get a better interest rate than you would in a regular savings account, but your funds will also be protected by your bank and either the Canadian Deposit Insurance Corporation (CDIC) or a provincial organization.

It's also worth nothing that if protecting your money from yourself is the highest priority, a non-cashable (or non-redeemable) GIC is your best bet. Unlike cashable (or redeemable) GICs, which can be withdrawn early if desired, a non-cashable GIC will force you to pay a penalty if you want to take your investment out before the end of your term. Using this as a deterrent, you'll hopefully win out in the end with the interest added to your initial deposit.

 

You don’t want to lose any money/take investment risks

With the current state of inflation causing market instability nationwide, you may feel that it's not the right time to throw your money into stocks and bonds. In cases like this, the heightened security of a GIC can be an attractive option as you're guaranteed to get your money back plus the promised interest. Plus, interest rates for GICs have never been higher, with some rising to levels of 4-5%.

And for those who like the idea of a GIC but still crave a bit more risk, a market-linked GIC is the perfect compromise. While regular GICs guarantee your principal investment back plus an agreed-upon interest rate, market-linked GICs are tied to a specific stock index or mutual fund. This means that you'll still get your initial deposit returned in full, but your earnings on it will depend on how well its stocks or bonds have performed. In this way, market-linked GICs tend to have one foot in the GIC world and one in the market.

 

You want a portion of your money in fixed income

GICs and bonds are considered to be types of fixed-income investments. Allocating a portion of your portfolio to fixed income can help reduce risk and volatility. GICs are easy to understand while bonds can sometimes be a little more complicated. You should ideally buy a variety of bonds to reduce your interest rate risk and credit risk. An alternative is to buy a bond mutual fund or a bond exchange-traded fund. Both are diversified and very liquid investments.

 

You're retired and want a quicker return

While younger investors have plenty of time to endure the stock market's peaks and valleys as they patiently wait for a recovery, retirees don't always have that luxury. That's why GICs are perfect for older investors on a fixed income. Your money will be locked away for a period of time that you decide, and you'll always be guaranteed to get it back with the promised interest attached.

 

Unlike savings accounts, GIC rates are guaranteed

GICs and high-interest savings accounts have quite a bit in common. Both are extremely safe investments that offer guaranteed (albeit, modest) gains while ensuring you won’t sustain any losses.

However, the two differ in some respects.

For one, the rate on a savings account isn’t guaranteed and can change at any time, even after you opened the account. We’ve already seen it happen in the midst of COVID-19, as cuts in the Bank of Canada’s prime rate has had knock-on effects leading several financial institutions to lower their savings account rates for new and existing clients. With a GIC, you won’t have that same problem, as your interest rate will be locked in from the time you opened the account to however long your term lasts. In short, rates on a GIC are guaranteed so you won’t have to worry about abrupt changes, especially in an ultra-low interest environment.

That said, savings accounts do offer the advantage of flexibility by letting you withdraw your funds at any time, while with a GIC, your money will be locked in for a set period of time (anywhere between 90 days to 5 years, depending on the terms of the GIC you open).

 

The bottom line

GICs can have a place in your investment portfolio, depending on what your savings goals are. If you’re buying a home, they’re a good option. But if you’re trying to save for retirement and you’re young, you might want to consider whether holding GICs makes sense.

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