What does GIC stand for, how does it work and why is it one of the most popular investments among Canadians?
You can find all the answers in the article below, plus some factors to consider before making GICs part of your investment portfolio.
What Is a GIC?
GIC stands for Guaranteed Investment Certificate. It is an investment product that can be purchased from banks, credit unions or other financial institutions.
When you’re buying a GIC, you are basically agreeing to lend money to the bank or financial institution for a predetermined period of time and a fixed interest rate.
As the name suggests, GICs offer a guaranteed return of the principal at the end of the term, regardless of the state of the market. In other words, even if the bank or credit union that issued the certificate goes out of business, you won’t lose any money. This is because GICs are insured either by the Canada Deposit Insurance Corporation (up to $100,000) or by the province where you purchased the GIC, making GICs one of the safest investments for Canadians.
How do GICs work?
As stated above, when you buy a GIC from a financial institution you are lending money to the establishment that issues the certificate. Your money will be held with the borrower until the term expires, after which the financial institution will return your principal with interest.
For instance, if you buy a one-year GIC with a 3.50% interest rate and deposit $10,000 into the certificate, you would get $350 in interest every year, or earn $10,350 when the term ends.
Terms generally go from 30 days to ten years—the longer the term, the higher the interest you can earn.
You can get started with as little as $500, while there is no maximum limit to how much you can invest in a GIC in Canada. There are no extra fees or charges involved since these expenses are already calculated by the bank in their GIC rates.
One of the drawbacks of GICs, though, is that your money will be tied up for a longer period of time. Since the funds you invested are already being used by the borrower, you cannot access your money until the end of the term. Should you withdraw the funds before the term is up, you might have to pay an early withdrawal penalty.
Note: GICs work differently for international students arriving in Canada. You can learn more about International Student GICs here.
Types of GICs
Most GICs pay fixed interest throughout the term, usually every six months, once a year or once in two years.
The interest paid is based on the length of the term and the amount you deposit. Thus if you invest $1,000 in a one-year GIC with a 2% interest rate, you would get $1,020 when the term ends. If you invest $2,000 in a five-year GIC with the same fixed interest rate of 2% you would receive $2,208 upon maturity.
Some GICs offer variable interest rates that fluctuate throughout the term. The interest paid is based on the prime rate of the financial institution you lend money to or the performance of a benchmark, such as a stock market index (also known as Market Linked GICs).
While you can’t lose money with a variable interest rate (the return of your principal is still guaranteed), you can earn less in interest over time if the market underperforms. On the other hand, you could end up earning a lot in interest if rates rise—generally, Market Linked GICs offer the highest returns but are the least accessible.
Redeemable vs non-redeemable GICs
Most GICs offered are non-redeemable (you can not withdraw the money before the end of the term), however, some GICs are cashable (you can access the money after 30 days) or redeemable (allowing you to cash in early at a predetermined rate).
These types of GICs, though, tend to offer lower interest rates than non-redeemable GICs (usually 3% compared to 4.45% on a one-year GIC, respectively).
If you want to access your money without paying an early withdrawal penalty, but still take advantage of higher interest rates, look into GIC laddering.
By building a GIC ladder you are splitting your investment into several GICs with different terms instead of putting money in one certificate.
When the first GIC matures, you can assess the market—if interest rates are favourable you could reinvest the principal (and the interest) into another GIC. If they are not, you can cash out or put the money in another asset.
Let’s take a look at a practical example:
Say you invest $20,000 in five GICs with terms starting from one to five years ($4,000 each). When the first GIC matures in 12 months, you can reinvest in another five-year GIC (provided interest rates are high). Repeat the same strategy when each GIC matures and you will be able to maintain a consistent portfolio.
What to Consider Before Investing in GICs?
GICs may sound like a great investment, but there are a few factors to think about before you put your money into one.
1. Choose a term
Terms can be as short as six months or go up to 10 years so you need to consider your long-term financial goals when picking a term. Remember that short-term GICs offer lower returns, so if you want to grow your investments, opt for a long-term GIC.
2. Can you afford to lock in your money?
Are you having any big expenses in the next few years, such as a wedding or a baby? Maybe you are saving for a new car or a down payment for a house. If so, go with cashable or redeemable GIC which gives you more flexibility when it comes to cashing out.
You can hold GICs in registered and non-registered accounts.
Registered accounts, such as a TFSA or RRSP, as well as RRIFs and LIRAs, allow you to grow your investments tax-free although some exceptions apply depending on your age and the amount you contribute to the account.
On the other hand, GICs held in non-registered accounts do not come with tax breaks., which means that you have to pay tax on all interest earned. On the plus side, though, you won’t have to worry about contribution limits.
4. Do you need regular income from your investment?
Make sure you choose a payment plan that matches your income needs, i.e. quarterly, semi-annually, or annually.
If you are trying to save for your child’s education or future or don’t want to be tempted to spend regular interest contributions in your account, choose to be paid at the end of the term in full.
5. How to choose the best GIC?
When it comes to choosing GICs, it’s best to compare several providers and find the best rate. Alternatively, you could engage the services of a deposit broker. A broker will be able to find the best interest rates for you, although they might charge management fees.
However, if you are inexperienced or lack the confidence to choose a GIC on your own, hiring a professional is money well spent.
Bottom Line: Are GICs Worth It?
GICs have been a popular investment product for years, usually among conservative investors. However, with a recession looming and rising interest rates, Canadians have expressed a renewed interest in GICs.
While GICs are still one of the safest investments out there, they might not be the ideal choice for every investor. GICs are a low-risk but low-payoff option so they are not suitable for people who are interested in high and quick returns.
Another big drawback is that the money is inaccessible for a fixed period of time—should you find yourself in an emergency, you will not be able to withdraw the funds without paying a large penalty.
That said, if you are financially stable, have contribution room in your registered accounts and have enough savings in other high-interest savings accounts, GICs can be a great long-term investment.
Yes, GICs are insured either by the CDIC or a corporation in the province or territory where you bought the certificate.
Which organization insures your deposit depends on where the GIC was purchased. Certificates bought through a CDIC member are insured for up to $100,000, while GICs purchased through a credit union or caisse populaire are insured by a corporation in your province or territory. For instance, Ontario investors who buy a GIC from a credit union are insured up to $250,000 through the Deposit Insurance Corporation of Ontario (DICO).
Despite being a safe investment vehicle, there are a few drawbacks to GICs, such as
- Your money may be locked away for up to 10 years.
- Most financial institutions require a minimum deposit of $500 to buy a GIC, while some might ask for $1,000 or more.
- Returns are not incredibly high so you can only use GICs to supplement your income rather than as a source of revenue.
- Interest rates may not beat inflation. So if interest rates rise significantly while your GIC is still locked in at a lower rate, you may miss out on higher earnings.
- Any interest you earn will be taxed if the GIC is held in a non-registered account.
Buying a GIC is simple and easy since most financial institutions in the country offer them, including some of the biggest Canadian banks. You don’t even have to be a client of the bank or credit union to buy GICs-simply contact the issuer or talk in person with an advisor at one of the bank’s branch offices.