A retired money manager confessed something to me this week. “I never thought it would come to this,” he said, with the embarrassed look of a fitness instructor caught digging into a tub of rocky road ice cream. “I finally did it, though. I broke down and bought a GIC.”
For my friend, a guaranteed investment certificate is a symbol of professional surrender. He has spent several successful decades picking stocks both for his former employer and for his own portfolio. He is a staunch believer in the long-term benefits of stock ownership.
But a few months ago, he decided he was simply not seeing many areas of the Canadian or U.S. stock markets where the potential reward over the next year outweighed the risk. So he edged away from his lifelong love affair with equities and put a portion of his portfolio into one of the safest, most boring investments imaginable.
Many other people are also discovering the allure of GICs. Since the start of the year, Canadians have pumped roughly $120-billion into “fixed-term deposits” at chartered banks. The total amount of money invested in GICs and their ilk stood at nearly half a trillion dollars in September – an unprecedented level, according to Bank of Canada statistics. If my friend is anything to judge by, the trend is only picking up speed.
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Why have we become GIC nation? The most obvious reason is the powerful attraction of rising yields. The recent flood of money into GICs has closely tracked the sharp rise in interest rates over the past year. After two decades of miserably low payoffs, the 5-per-cent yields now available on some GICs look positively titillating.
But are those yields actually as tantalizing as they appear? In many ways, the new-found appeal of GICs is a money illusion.
Yes, some GICs now sport a 5-per-cent yield. However, with total Consumer Price Index (CPI) inflation running at 6.9 per cent at last count, you are still bleeding purchasing power in real, or after-inflation, terms.
This lacklustre performance is not a new phenomenon. Viewed in after-inflation terms, GICs had their heyday in the 1980s and 1990s.
A lucky investor who bought a five-year GIC in late 1984 could have locked in an annual return of 13 per cent while inflation was running around 4 per cent – in other words, a 9-per-cent real yield.
A decade later, inflation had subsided to around 2 per cent but an investor in 1995 would still have been able to find long-term GICs yielding 6 per cent or more – a real return of at least 4 per cent.
Since the turn of the millennium, real returns have trudged steadily lower. A 2015 analysis by Ratehub.ca concluded that investors in five-year GICs had made an average real return of less than half a per cent a year on their GICs between 2005 and 2014. Those who bought one- or three-year GICs did even worse.
As dismal as those real returns were, the results were even uglier in terms of the amount of purchasing power that would have actually found its way into someone’s pocket.
GIC payments have none of the tax advantages that are enjoyed by dividends or capital gains. The nominal interest income you earn on GICs is fully taxable if you hold these investments outside of tax-sheltered accounts. Take the tax bite into account and GIC returns over the past 20 years for many investors were downright pitiful.
GIC yields today are continuing this underwhelming tradition. They are paying substantially less than the current inflation rate and, in real terms, are delivering even less than they did a decade ago.
So why are people stampeding into them? It may be nothing more than the beguiling effect of higher nominal yields. Or it may be the hope that inflation will subside quickly over the next year, making current yields on longer-term GICs look far more attractive in real terms. Or it could simply reflect a desperate yearning for certainty after a year in which stocks, bonds and real estate all incinerated people’s wealth.
The most compelling rationale for GICs, at least to my mind, is the cleanest-dirty-shirt argument. My friend, for instance, is like many other investment analysts in expecting corporate profits to tumble over the coming year as the economy slows. This may not be good for share prices. Meanwhile, he expects central banks to keep edging interest rates higher, making bonds an iffy proposition. (Bond prices move in the opposite direction to interest rates.)
Compared with these alternatives, one-year GICs do hold substantial appeal. I will confess to buying some myself this year on similar reasoning to my friend’s. But it is difficult to argue with their long record as thoroughly mediocre investments. Investors may want to keep that record in mind before locking themselves into longer-term commitments.
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Ian McGugan