Are GICs worth it?
A GIC is a guaranteed investment, but does it always make sense to have one in your portfolio?
When it comes to investing, very few asset classes can guarantee you’ll never lose money. As the name implies, a guaranteed investment certificate (GIC) is one of those rare investment options that offers guaranteed returns at the end of your term. For that reason, more than one-third of Canadians invest in GICs, according to a recent Scotiabank poll. But, really, are GICs worth it?
While GICs and other fixed-income securities are considered necessary for a well-balanced portfolio, your allocation to them can determine how quickly you achieve your investment goals. After all, guaranteed returns don’t mean a whole lot when your investments are barely keeping up with inflation.
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GICs come in a variety of types, terms and interest rates, but they generally share the following characteristics:
- They pay an interest rate upon maturity (whether your returns are “guaranteed” depends on whether you select a fixed or variable rate GIC).
- There are no fees for purchasing GICs.
- Issuers carry an initial investment minimum, usually around $500, that must be paid into the GIC when you open your account.
- Interest payments can be made monthly, semi-annually, annually or compounded until the maturity date.
The Role of GICs
Before you can determine whether GICs make good investments, it’s important to understand why financial institutions issue them in the first place.
Financial institutions use GICs to attract funds from investors that can then be used to finance other business operation such as lending. In other words, the bank lends your money to consumers and businesses. In exchange, you get your full principal back plus interest once the GIC reaches maturity. In this way, GICs operate much like government bonds, raising money from the investing public in exchange for an interest payment.
There are several advantages to owning a GIC:
- Principal investment is safe. GICs are guaranteed investments, so your full investment amount is protected. With a fixed rate GIC, you’re also guaranteed an interest payment once your GIC reaches maturity.
- Portfolio diversification. Because fixed rate GICs offer guaranteed returns, they can reduce portfolio volatility should stock markets decline.
- Several options available. GICs vary by length, term and redemption schedule, which means your funds don’t have to be fully locked in for a long period of time.
- Laddered GICs. By laddering your GIC (i.e. investing in various terms), you will earn higher interest rates every year and boost your annual return. Read our guide to GIC laddering here.
GICs have a few drawbacks you should carefully weigh before investing:
- Interest rates. GICs are valued for being low-risk, stable investments, but their potential to rise in value diminishes when interest rates fall.
- Can’t keep up with inflation. With interest rates so low, even laddered GICs are struggling to keep up with inflation.
- Early redemption. Selling your GICs before maturity can result in a significant penalty.
- Opportunity cost. Investors who select GICs are paying a large premium for stability. A simple mutual fund or ETF that tracks the S&P 500 Index can yield 9.8%, which is the average annualized rate of return over the past 90 years.
Are GICs worth it?
Owning a GIC is considered one of the safest ways to grow your assets over time. As part of the fixed-income pool of securities, GICs are often viewed as a necessary but insufficient component of a well-balanced portfolio. When combined with stocks and precious metals, GICs can help you improve your risk/reward profile over time.
At the same time, there are several drawbacks associated with GICs. Not all pay guaranteed interest (in the case of variable rate GICs), and the asset class has limited upside in an environment of declining interest rates. Unless you are laddering your GICs over several terms, your investment will struggle to keep pace with inflation.