Guaranteed Investment Certificates (GIC) are a low risk investment were you lend banks, trust companies and credit unions money for a defined time frame and get a certain interest rate in return. This interest rate is based on the length of time you agree to lend the money and what the current interest rates are like at that time. While many of us with mortgages think of low interest rates as a good thing, when you’re investing in GICs you’ll be hoping for interest rates to rise up quickly.
The risks when investing in Guaranteed Investment Certificates
GICs have a guaranteed interest rate and the principal is insured by the CDIC. However, inflation rates and lack of preferential tax treatment are risks associated with Guaranteed Investment Certificates. Inflation rates can potentially be higher than the guarenteed interest rate of the GIC you invest in. This would actually mean you are losing money after adjusting for inflation. GICs are taxed at your marginal tax rate, so you may want to consider placing them in an RRSP, TFSA or RESP to shelter the interest you earn.
How to invest in Guaranteed Investment Certificates
Since GICs provide higher interest rates when locked in for a longer period of time, you may want to consider building a Guaranteed Investment Certificate ladder. To do this, you split your money available to invest into five equal portions and invest those amounts into 1, 2, 3, 4 and 5 year GICs. From that point, you are set to decide each year whether to reinvest your annual amount for another 5 years. If rates are good, you could continue reinvesting for 5 year terms. When rates are low, you may decide to move your annual amount to a different investment. By building a GIC ladder, you have the benefit of the long term high rates and the flexibility of access to a portion of your investment each year.
While not very attractive with the current interest rates available today, rates will eventually come back up to the pre-recession levels. Once interest rates have moved back into normal territory, you might decide that Guaranteed Investment Certificates would be a worthwhile addition to your portfolio leading into retirement.
I have about 1/2 of my RRSP in GICs. Even with the low, low rates of the past several years they have done much better than any of my investments in mutual funds or index funds over the past decade.
This maybe the exception rather than the rule of investing but it help soften the blow when the markets crashed.
Hindsight being 20/20, I wish I had invested 100% in GIC’s.
I would really like to know how GICs compare to short term bond ETFs over the long term on a risk adjusted basis. Any financial whiz out there willing to take me on?
From 1950 though to the mid ninties a portfolio of rolling 5 year GIC would have out performed the DAX Long bond index. Over the past 15 years the bonds have caught up and passed the GIC returns due to the falling interest rate enviernment. Overall since 1950 the bonds index returned 7.4% and GICs 7.0% but that is the return of the index, an index fund or ETF would have the return lowered a bit due to the MER so they end up pretty even. If you compare to short term bonds then the GIC would have done better. The main benefit of useing bonds over GICs is that they get about the same retun and your funds stay liquid allowing you to access funds more easily. The CDIC insurance is a bonus for the GICs that the bonds do not offer. You can view historical rates of various investment though ANDEX website
http://www.andexcharts.com/c_ewall.asp
Great chart Ryan, thanks for pointing it out.
One thing I’ll disagree with you on – you say that when you’re investing in GICs, you want interest rates to go up quickly. That’s not the case – if you already have a guaranteed investment certificate then the interest rate stays the same. Therefore if interest rates rise, your GIC’s value will drop relative to the market. You want rates to increase, then make your purchase, then for rates to drop again so that you can can sell your vehicle and make a profit. Either that or you can just hold it until maturity. This is for fixed rate GICs, of course.