How does a GIC ladder work?

If you’re in the market for a low-risk investment with a guaranteed return, a guaranteed investment certificate (GIC) may be a good place to start. Like bonds, GICs offer long-term stability and guaranteed interest rates, allowing you to build your portfolio over time.

While many Canadians have become familiar with GICs, not everyone is aware of the various portfolio strategies available. One such strategy, called laddering, allows you to maximize the return of your GICs without having to lock away all of your money into one long-term investment.

How does GIC laddering work?

To ladder your GIC investments, simply divide the total amount you want to invest by five. Then take those smaller amounts and allocate them to five individual GIC investments with terms ranging from one year to five years.

For example, if you have $10,000 you want to invest, you would allocate $2,000 to each GIC term. When each term matures, you can reinvest the new amount (original investment plus return) in a five-year term. Repeat this process over and over again to maximize your portfolio’s returns.

Why use a laddered GIC?

The rationale for employing a GIC ladder schedule is simple: Your annual return will be much higher than if you invest your money in consecutive short-term GICs. By investing in various terms (one year through to five years) at the same time, you will earn higher interest rates every year. Combine that with reinvesting at maturity into a new five-year term, and the laddering process yields significant returns over time.

To get a sense of how much interest you can earn in a laddered GIC portfolio, simply add up all of the interest rates in your portfolio and then divide it by five (i.e. the number of investments you made). You’ll find that this average interest rate is higher than what you could earn by investing in short-term GICs.

That’s 11.25% in total interest. If you divide that by five (the number of investments you made), your average interest rate in the first year is 2.25%. Compare that with the interest rate on a one-year GIC and you will quickly see why laddering is more advantageous.

How to compare laddered GICs

You can compare laddered GICs on a number of different features:

• Fixed or variable rate. Most GICs offer fixed interest rates, although market-linked products are based on how well the stock market is performing.
• Interest rate. If you’re investing in fixed GICs, interest rates may differ across issuers. The most familiar issuers in Canada are the Big Five banks: Royal Bank, TD Bank, Scotiabank, Bank of Montreal and CIBC.
• Minimum investment. Most GICs carry an initial investment minimum of $500, but this may vary across issuers.
• Renewal process. A key component of the laddered GIC strategy is reinvesting your money on maturity. Some GICs do this for you automatically, while others need to be cashed out or reinvested into a different product.
• Payment frequency. GICs pay interest at different intervals, the most common being monthly, quarterly, biannually and annually.

Drawbacks of a laddered GIC

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 (as they are now).
• 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.

Frequently asked questions about fixed-rate GICS

• What can I do with my money once a GIC reaches maturity?

  One of the primary benefits of laddered GICs is the ability to reinvest your money after each term expires. However, this doesn’t preclude you from accessing some (or all) of the money you need once your GIC reaches maturity.

• If I ladder my GICs, how much of my money can I access each year?

  A laddered GIC gives you access to 20% of your investments each year – that is, if you made five investments with terms ranging from one to five years. When that year’s GIC reaches maturity, you can either reinvest the amount or take the money out.

• Can I use variable-rate GICs in my laddering strategy?

  A laddered strategy doesn’t preclude you from investing in variable-return GICs, but it is generally intended for fixed-interest GICs. That’s because a laddered GIC is meant to provide you with predictable investment streams without compromising liquidity when you need it.