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Guaranteed Investment Certificates (GICs) are the safest investment you can make. The reason is that the Federal Deposit Insurance Corporation (FDIC) often insures GIC products. GICs have a structure quite similar to a bond. A typical GIC entails an investor leaving his money for a predetermined time with an institution to receive interest at a specific rate. You can use a GIC calculator to see how much interest you will earn. GICs are called certificates of deposit (CD) in the US.
Canadian financial institutions offer GIC terms anywhere from 1 month to 5 years. As in any other area of finance, GICs have witnessed many innovations. A typical GIC in Canada is not cashable until it matures. But there are stepper GICs which are cashable at specific dates and would increase their interest rate each time a cashable date passes without you cashing out. Cashable GICs allow you to cash out any time in exchange for a lower interest rate.
There are GICs with variable interest rates. But the most exciting innovation in this field is GICs with an interest rate based on market performance. Even the safest investment, if done without forethought, can cause regret. So let us review five points you should consider before investing in GICs.
1- Determine when you might need the money you invest in GICs. To do so, you might need to go through different possible scenarios in your life. For example, you might want to make a big ticket purchase. You need to determine when you would need your money because longer-term GICs often provide higher interest rates.
Thus the ideal situation is to purchase a GIC with a term matching the length of time you would not need your money. It would be regrettable if you need cash and you have money, but you can’t access your money. If you cannot decide when you might need your money, it’s best to accept a slightly lower interest rate and take a redeemable GIC.
2- Shop around. Canada has many financial institutions, each of which independently decides the GIC rate it offers. Some are more generous than others. Furthermore, some might be offering promotional rates. You can often find less famous institutions offering higher rates. For example, at the time of writing, on a three-year GIC, TD offers 3% interest while Peoplestrust offers 4.8% interest.
3- It is beneficial to form an opinion about the direction of interest rates. If you think interest rates will increase, you are better off investing in shorter-term GICs or a variable rate GIC. If you believe interest rates will decrease, you are better off investing in longer-term GICs and avoiding variable GICs.
In general, you can assume interest rates to follow inflation. Interest rates are likely to increase if inflation has a very recent rise or if you have reason to believe that inflation will rise soon. On the other hand, if the inflation rate has recently dropped or you have reason to believe that the inflation rate will decrease, interest rates are likely to fall.
4- Build a GIC ladder. You face an interest rate risk if you plan to reinvest your GIC when it matures. Interest rates often fluctuate; if you are unlucky, they may bottom right when you need to reinvest your GIC proceeds. To mitigate this risk, you can divide your money between GICs with different terms. In this way, they mature at different times. You have diversified the time you have to reinvest and thus mitigated the risk of reinvesting all your GIC portfolio at one rate.
5- Forming an opinion about the stock market’s direction is beneficial. If you think the stock market will rise but cannot take a risk with your savings, market-linked GICs can be an attractive option. Market-linked GICs come in many forms, and their interest rate might be tied to many different indices.
A common form might be to have a minimum and a maximum interest rate. If the linked index performance is worse than your minimum, you will earn the minimum interest rate. Suppose the index performance is better than the maximum interest rate. In that case, you will make the maximum rate. You will earn the index’s performance if the index performs somewhere between those limits. Your bank might construct such a GIC by combining a conventional GIC with buying a call option whose strike price is at your minimum return while selling a call option at your maximum return.
Conclusion: GIC used to be a safe option to invest your money. Today they are not just a safe option but quite flexible.
