Low Risk, Low Return - GIC (Guaranteed Investment Certificate) 101
For those of you that have never invested your money in anything whatsoever to date, a GIC may be a good first step to dip your toe in the water. A GIC is also known as a Guaranteed Investment Certificate and is a Canadian thing (kind of like Tim Hortons, maple syrup, toques, The Tragically Hip…the list goes on). There is most likely a similar investment product in whatever your country you live in and the principles would be the same – low risk and low return. A GIC is most often issued by a bank, trust company or credit union. With a GIC, you are essentially lending the bank your money for a set term in exchange for some interest and you are guaranteed to get your original amount back at the end of the term, hence the term “Guaranteed Investment”.
You buy the GIC by going in to your bank and indicating you would like to buy one. You will fill out the necessary forms to buy it and have the money transferred from your bank account. This is why in most cases, it makes sense to buy from your own bank as it is easier and probably less costly, fee wise, than moving money over from another bank.
Once purchased, a GIC provides you with a guaranteed rate of return over a fixed period of time (1yr, 5yrs, etc.). The rate of return you receive is higher if you purchase a GIC over a longer term (this means the bank gets to keep your money in its hands for longer and utilize it as they see fit). Once the term is up, the money is transferred back into your regular bank account unless you choose to keep renewing it further. The bank would give you advance notice that your GIC was coming due and you would be able to make a decision at that point. GIC’s are called fixed income investments because they have a fixed maturity date and a fixed rate of return.
So, what is the catch you may be thinking? Why doesn’t everyone go this route and avoid buying riskier stocks or bonds? Well, the answer is because the risk of losing your money is so low with a GIC, (almost non-existent as the GIC is backed by a bank) the rate of return you get on your money is dismal. Like, really dismal!
You can get the interest rates payable for Canadian GIC’s by simply Googling “GIC interest rates” and various sites will come up listing the current rates. CIBC (Canadian Imperial Bank of Commerce for the non-Canadians) has a handy GIC Calculator on its site where you can get a sense of what a GIC is worth using various initial investment amounts and terms. Here is a screenshot of the calculator page:
For the above example, a $1,000 GIC for a 3-year term was purchased in a non-RRSP account. I also chose, for the purposes of the example, that I would not be taking it out before the 3 years was up (there are GIC’s that allow you the option to take the money out before, perhaps for an emergency, but the interest rate is even lower in those cases). The calculator indicated that at the end of three years (on November 16, 2020), I would have $1,038.00! I would have only made $38 over the entire course of three years.So, as you can see, the return on a GIC is extremely dismal but also extremely low risk. Slightly higher rates may be available for more money or longer terms but in general, at this point in time, you are not likely to get anything even near 2.5%.
It is interesting to note that the rates on GIC’s were not always this low. When I was a young girl back in the early ‘80’s, my parents and grandparents were big into GIC’s, like really big and now I can see why. The return on a 5 year GIC in 1984 was around 11.9%! The return on a 10-year Government of Canada bond was 12.4%! That is unheard of now and those rates are even difficult to obtain from the much riskier stock market. Who wouldn’t have taken advantage of such low, low risk investments with such high returns? Many people did and it would have set them up very nicely for retirement or whatever other financial goals they may have had. Subsequent generations are not so lucky; although our mortgage interest rates are much lower now so maybe it evened itself out?! That’s a whole other post!
Now, inflation must be factored into the equation to get the real return on those figures. Inflation is what a broad basket of consumer goods would cost you and if that amount is high, your dollar has less purchasing power. Inflation was a bit higher back then, so the real return on the GIC would not be quite near 12%, but still, the rate is still much higher than today. To put it in perspective, that same $1,000 GIC bought in 1984 for a 3yr term at a rate of 11.9% (interest compounded annually) would net you $1,401 at the end of those same 3 years! That is a big difference from the $38 you would make now in the above CIBC example.
To sum up, here are some other main points about GIC’s:
1. Simple v. compound interest payment options: This concept is actually not complicated. Simple interest means the interest is always calculated on the original amount or principal and that interest is paid to you each year on the anniversary date of the GIC. Compound interest is calculated on the original amount PLUS any interest that has already accrued. No annual interest payments will be made to you under this option BUT it will add up to more in the long term because the interest is being paid on a larger amount of money. When the term is up, you will receive your original amount plus all of the compounded interest amounts. Monthly, quarterly or semi-annual interest payments are also an option. You receive the interest payment in one of those installments.
2. A GIC term may range from one month to 10 years. Only GIC’s with a term of less than five years qualify for insurance from the Canada Deposit Insurance Corporation. This means that if the bank or entity you bought the GIC no longer could pay you out, the CDIC would cover your amount owing automatically. Of course, it is extremely unlikely a major bank would be unable to cover your amount in any case. Check to see what the insurance provisions are when buying your GIC as some entities have their own insurance, not through the CDIC.
3. Minimum amount: Check with your bank but $500 is a typical minimum amount required to buy a GIC.
4. Redeemable v. non-redeemable v. cashable v. laddered: Check with your bank as to the various options available in this regard. Redeemable GIC’s allow you to take the money out before the term is up while a non-redeemable GIC will likely not allow you to take the money out without a serious financial penalty. Cashable and laddered GIC’s offer different redeeming options. Now that you have a basic understanding of a GIC, you will be able to consider all of those options easily!
5. Interest rates: The GIC may have different interest rate options including fixed rate (the interest rate is set at the time of purchase as does not change throughout the term), variable rate (the rate will change according to the bank Prime rate for example – going up or down) or step-up rate (the interest rate will increase each year).
6. RRSP/RESP/TFSA/RRIF registered accounts: GIC’s are eligible investments for these registered accounts.
7. Tax considerations: Any interest you earned in the year (but perhaps not received, i.e. the compound interest scenario above where you won’t actually get it until the GIC term is over) and any interest paid to you will be taxable (on a T5 Income Tax slip).
GIC’s can be an important part of your investment portfolio. It certainly may be a good way to get into investing in a low risk way and can offer a short-term way to save money. However, your money will not be put to work for you in any significant way as the interest rates are currently so low. This is why you may want to consider other options that provide a greater rate of return for the long term.
** Top photo by Dom J for Pexels