Illustration by Melanie Lambrick
GICs have been in the news in 2022 as interest rates rise in response to inflation. In fact, there has been a surge in demand for GICs thanks to favourable rates that might just be the best in more than 20 years. But what is a GIC, how does it work, and is it the right choice for your investments?
What is a GIC?
GIC stands for guaranteed investment certificate. It’s an investment tool whereby you lend money to a bank or other financial institution for a specific duration of time (the “term”) in order to earn interest. GICs can have either fixed or variable interest rates, and in general, the longer the term, the higher the rate. Depending on the product, interest might be paid out monthly, annually, at maturity (the end of the term) or on another time frame.
GICs are considered a safe investment – unlike with stocks, you don’t risk losing your money. And even if something were to happen with your bank, the federal government – through the Canada Deposit Insurance Corp. (CDIC) – guarantees the GIC’s combined principal and interest payments up to $100,000.
Where can GICs be purchased?
You’ve probably seen ads for GICs from the big banks, but while they’re a major seller of these products, they’re not the only place to buy. Numerous other financial institutions such as trust companies, smaller banks and credit unions offer them as well. It’s often worth shopping around for the best options before you buy – don’t be surprised to find higher interest rates outside your regular bank.
A note about insurance: Through the CDIC, GICs from banks and trust companies are insured up to $100,000; GICs from credit unions and caisses populaires are insured provincially.
How do GICs work?
In some ways, GICs seem like a savings account – you leave some money in the bank and it pays you a percentage in interest. The major difference is in liquidity. Most GICs are non-redeemable, meaning you’re committing that money to the issuer for a specific period of time. If you put $5,000 into a five-year GIC, for example, that $5,000 is locked in until the five years are up.
Non-redeemable GICs are hard, if not impossible, to cash out of before maturity. If there is a way to exit early at all, you should expect a penalty fee. However, there is an alternative for investors who need liquidity: the cashable GIC. You won’t get the same rates as with a standard GIC, but you might still be able to beat the rates on high-interest savings accounts.
You can hold a GIC inside a registered account such as a tax-free savings account, registered retirement savings plan or registered retirement income fund, or in a non-registered account.
What is a market-linked GIC?
Market-linked guaranteed investment certificates are promoted by sellers as offering the best of both worlds: the guaranteed income and lack of risk standard in a GIC plus the promise of more earnings should the stock markets perform well. Interest rates are lower than regular GICs, though, and unlike with stocks, your principal is locked in for an entire term.
Rob Carrick, The Globe and Mail’s personal finance columnist, is not a fan of these products. “They are financially engineered to produce profit for the bank while paying investors returns that could easily be worse than a regular GIC,” he says. “The latest spin on this product is GICs linked to the performance of socially responsible companies. Socially responsible banks would kill these products dead.”
What are some pros and cons of GICs?
The biggest pro is in that G: guaranteed. GICs are considered a safe investment choice for people who can’t – or don’t want to – take risks with their money.
The downside that comes with that, though, is that the money is usually locked in, meaning it’s not liquid – you can’t take it out if you need it without paying a penalty. Not having access to the money is its own kind of risk, depending on your situation, and you might also be missing out on opportunities to earn higher interest (should rates go up) or better returns via a different investment vehicle.
‘Laddering’ investments and auto-renewals: Tips for investing in GICs
If you’re thinking of putting some money into GICs, it’s a good idea to look at both interest rates and terms. Typically, the more years you lock in your money for, the higher the interest rate. That makes it tempting to pick a longer term, but it might not be the best choice, notes John Heinzl, who writes The Globe’s Investor Clinic column: “If interest rates continue to rise – as many economists expect – you’ll be stuck collecting the same yield for the next five years.”
One way to deal with this is “laddering,” a way of distributing your GIC investments so you have access to some of your money every year and can take advantage of rising interest rates. (Laddering also exposes you to falling interest rates, but that doesn’t seem to be in the cards right now.)
Mr. Heinzl suggests laddering your GICs across terms of, say, one, two and three years. When the one-year GIC matures, reinvest the cash in a new three-year GIC. A year later, do the same with the proceeds of the maturing two-year GIC. And so on.
Another thing to watch for is auto-renewals. While some GIC sellers will contact customers at the end of a term to find out what they want to do with their funds, others are automatically renewed upon maturity, meaning your money will be locked in for yet another term.
The danger of auto-renewals lies in forgetting about your maturing GIC. Imagine having a five-year GIC auto-renewed a year ago for five years, just as it started to become clear that rates were headed higher as a result of stubborn inflation. A one-year term would have been a good call.
Or, you might find better rates at another bank or credit union and want to transfer your maturing money there. Some GIC issuers are consistently competitive with returns, while others may rarely or intermittently offer strong rates.
Before buying, ask whether your GIC will be automatically renewed on maturity unless you say otherwise. And make a note somewhere to get in touch with your GIC issuer a month or so ahead of maturity to provide instructions.
Are GICs worth investing in?
If you’ll be needing your money to make a major purchase in the next few years, says Mr. Heinzl, or if you can’t tolerate any market volatility, then by all means consider GICs for the certainty they provide. But if you’re investing for the long run, you may be better off looking at stocks or exchange-traded funds, which have a long track record of beating inflation, albeit with more volatility along the way.