A GIC is a low-risk deposit investment that earns interest, similar to depositing money in a savings account, with the return of your principal guaranteed.
What is a Guaranteed Investment Certificate (GIC)?
A Guaranteed Investment Certificate, commonly referred to as a GIC, is a term deposit that earns interest for the period with rules attached to early withdrawal of your deposit.
The principal amount invested is guaranteed by your financial institution and a second layer of protection via the CDIC is also available up to $100,000.
How do GICs work?
When you invest in a GIC, you’re agreeing to lend money to a bank or financial institution for a guaranteed return.
Essentially, you are locked into that investment for a period of up to 5 years, with some financial institutions also offering terms of up to 10 years.
It is common to earn more interest based on prevailing interest rates for longer terms.
Upon maturity, the investor receives the original deposit amount and the accumulated interest over the deposit period if the interest was not paid annually.
Advantages of GICs
1. Low Risk
Investors with short-term investment objectives like purchasing a house within the next year can deposit their funds into a 1 year GIC without adding substantial market risk.
2. Guaranteed Growth
Despite modest interest rates that GICs fetch in the current interest rate environment, investors can benefit from the certainty that a guaranteed investment certificate provides in terms of receiving a known investment return for a given period.
Such investments can represent a flight to safety in a volatile market environment and outperform risk assets in periods of large equity drawdowns such as the Great Financial Crisis or the Pandemic crash of March 2020.
One of the most attractive features of investing in GICs is their simplicity.
Most investors appreciate the ease of managing these investments and the predictability these investments bring to their portfolios.
Disadvantages of GICs
1. Lock-in Periods
A GIC is simply a termed deposit with a certain rate of return.
While some GICs can be broken early by paying early withdrawal fees, certain types of GICs are locked in and unredeemable until the term ends.
2. Minimum Deposit Amount
Unlike exchange-traded products, most GIC investment offerings have a minimum threshold.
Investors can only invest in these products if they invest the necessary minimum amount.
3. Fixed Income Risk
Fixed income products face a couple of essential risks – Interest rate and Inflation risk.
If the underlying interest rates increase, the investor essentially has locked in a guaranteed rate and will not benefit from this bump in short-term rates.
Secondly, if inflation picks up, the investor will lose on account of a decline in the purchasing power as the fixed return won’t keep up with the underlying inflation.
Types of GICs
With investor demand for innovation in the short-term deposits space, financial institutions are offering various categories of GICs to enhance yields on these products.
1. Fixed-Rate GICs
Fixed-Rate GICs are standard cookie-cutter time deposits that earn a fixed return over a specified time.
These vanilla products are what everyone thinks of when considering investing in GICs.
2. Variable GICs
Sometimes GICs have a floating interest rate based on an underlying benchmark.
Usually, these deposits have the bank’s prime rate as the underlying reference rate.
These investment offerings can be useful in periods of rising interest rates to keep up with the current interest rate expectations.
3. Market-Linked GICs
Market-linked products often bear additional risk in terms of performance but only to the extent that the principal component stays guaranteed.
Depending on stock market performance, this GIC can outperform the fixed-rate GIC but can also yield no returns if equities flat line or go down in value.
These products guarantee principal safety by investing in fixed income bonds that mature to principal deposit amount and take the remaining amount to invest in the stock market.
4. Redeemable or Cashable GICs
Cashable GICs are popular instruments as they can be liquidated without incurring any extra fees or penalties after a specific lock-in period elapses.
Usually, these products are long-term and have a fixed 30 to 90 day period lock-in period.
As a tradeoff, these deposits fetch a lower return than non-redeemable time deposits in return for the additional flexibility offered.
5. Foreign Currency GICs
The US and other foreign currency-denominated time deposits are a unique product offering that are often not mentioned in financial media.
While these may not fetch any higher rates, they are great instruments to park excess foreign currency for future use and have those funds earn interest while not being used.
One disclaimer would be that these products are not insured like conventional bank term deposits.
Are GICs a Good Investment?
GICs are a good place to begin saving money and getting started on the investing journey.
They can be a good tool for liquidity management and parking funds before deploying into investments.
However, there are other ways to add diversified fixed-income investments to your portfolio that may outperform GICs.
Frequently Asked Questions
- How much do GICs pay?
5 year GICs are currently paying 1% to 3% depending on the specifics of the product.
- What is the purpose of a GIC?
A GIC is a deposit instrument used to earn interest. In many cases, investors leverage GICs before these funds can be utilized for investments or earmarked expenses. They can provide a safe harbour and allow investors to earn interest without taking any market risk.