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Long-Term GICs
Long-term guaranteed investment certificates (GICs) are simply GICs with terms that are one year or longer – typically 1, 2, 3, 4, 5, and sometimes 7 and 10 years. Financial institutions guarantee the principal (the original investment) plus an advertised rate of interest, and usually the longer the term, the higher the interest rate.
Why invest in long-term GICs?
Long-term GICs are appropriate if you want to invest your money for an extended period of time and you don’t want to run the risk of losing your original investment. Compared to short-term GICs, long-term GICs tend to offer higher interest rates. And if you consider yourself a conservative investor, long-term GICs can be part of the fixed income component of your portfolio; they don’t offer high returns, but they are a safe investment, because the principal is guaranteed.
Case Study: Short-term vs. long-term GICs
Rebecca is looking to put $10,000 in a GIC for about 5 years, and is considering buying either five consecutive 1-year GICs @ 1.30% or one 5-year GIC @ 1.90% compounded annually. She chooses the 5-year GIC option, because she assumes the 1-year GIC rate will stay at 1.30% for the entire 5 years – and she’s right. (This is a hypothetical situation, as no one can predict what will happen in the future.)
How has Rebecca benefited?
Rebecca passed up the idea of buying five consecutive 1-year GICs at 1.30% and, instead, bought one 5-year GIC at 1.90% that compounds annually. Assuming the 1-year GIC rate stays at 1.30% for 5 years, Rebecca would obviously earn more interest with her one long-term GIC, but let’s see exactly how much.
Strategy 1: Buy Five Consecutive 1-Year GICs at 1.30%
| Year | Principal (end of year) |
Interest |
|---|---|---|
| 1 | $10,130.00 | $130.00 |
| 2 | $10,261.69 | $131.69 |
| 3 | $10,395.10 | $133.41 |
| 4 | $10,530.24 | $135.14 |
| 5 | $10,667.13 | $136.89 |
| Total | $667.13 |
Strategy 2: Buy One 5-Year GIC at 1.90% (Compounded Annually)
| Year | Principal (end of year) |
Interest |
|---|---|---|
| 1 | $10,190.00 | $190.00 |
| 2 | $10,383.61 | $193.61 |
| 3 | $10,580.90 | $197.29 |
| 4 | $10,781.94 | $201.04 |
| 5 | $10,986.80 | $204.86 |
| Total | $986.80 |
As you can see, Rebecca’s decision to choose a 5-year GIC at a higher rate, over five 1-year GICs at a lower rate, helped her earn an additional $319.67 in interest over the life of her investment.
$986.80
Total Interest in Scenario 2
$667.13
Total Interest in Scenario 1
=
$319.67
Amount Gained
Features and restrictions of long-term GICs
Unlike short-term GICs which mature very quickly, long-term GICs mean parting with your money for an extended period of time; this brings with it a few potential risks to consider before investing:
- Something unexpected in your life may come up and you could end up needing that money sooner than you had originally anticipated. Depending on the conditions of your GIC, cashing out mid-contract may not be possible.
- If interest rates rise during the course of your term, you may not be able to take advantage of the new higher rates, because your money is locked away at a lower rate. However, the penalty to withdraw your money may be worth considering.
- Any substantial rise in inflation before the GIC matures will eat into your purchasing power, as explained here.