Learning Centre -
Benefiting from interest earning investments
GICs are not exciting. As a result, they are often overlooked - even disparaged - in the search for investment alternatives. GICs are, however, very straight forward and predictable, and thus easy to understand and manage. With a few simple steps, you can improve the performance of your GICs.
The features and benefits of GICs are best understood in comparison to other fixed-income (interest earning) investments: bonds and bond mutual funds. We'll consider only classic GICs, not those with special features such as links to stock markets.
Perhaps the greatest benefit of GICs is that they are straight forward and predictable. When you make an investment decision, you know exactly what to expect.
Investment size: The minimum investment in a GIC is fairly low (typically $1,000), and any amount in excess of the minimum can usually be invested. Bonds often require a large initial commitment, and additional amounts might be in relatively large increments, so that you are unable to invest exactly the amount that you have available. Bond funds are as flexible as GICs.
Maturity: GICs of one to five years in length, measured to the year, are always available and intermediate and longer maturities can often be arranged. Maturities of less than one year are offered but the minimum investment is higher (typically $5,000). The available maturities on bonds depend on market conditions therefore you may or may not find what you want. Bond funds do not mature per se.
Maturity Value: At maturity, you receive the principal of the GIC, which is equal to your original investment. A bond also repays the principal at maturity, but it is unlikely to equal your original investment because bonds trade at prices above and below the principal. Bond funds do not have a principal, and the value at the time of sale will not equal the initial investment.
Payments: Most GICs pay interest annually, or allow interest to be compounded (calculated but not paid) until maturity. More frequent payments can often be arranged. The interest paid always depends on the quoted rate. Bonds typically pay interest semi-annually. The payment depends on the coupon rate, which is not the same as the yield quoted at the time of purchase. Repackaged bonds, know as strips, are designed to provide compounding. Bond funds distribute payments monthly or quarterly and the amounts are not known in advance. You can also arrange to invest automatically in additional units.
Sources: GICs are issued by banks and other financial institutions, and can be purchased directly from the issuer and from specialists known as deposit brokers. Bonds are issued by governments and corporations, and a bought through stock brokers. Bond funds are set up by financial institutions and mutual fund companies and are available through stock brokers, mutual fund dealers, and some fund companies and institutions directly.
There are several different types of GICs which are offered by various financial institutions. These offerings include:
Traditional - the time horizon on these GICs range from 30 days to 5 years
GIC Cashable / GIC Redeemable - a popular GIC for certificates liquidity option and as a holding vehicle
Market-linked - a certificate used by investors interested in tying their investment into the performance of the stock market. This enables investors the possibility of a higher rate of return without risk to their initial investment
Escalator - a GIC that has been designed as an investment that can not normally be cashed before the specified anniversary date. Interest is paid at a fixed rate but the rate varies from year to year, usually on an upward trend. In most cases, interest can be paid or compounded on a yearly basis. If interest is compounded yearly, investors will receive the blended interest rate at the end of the investment term. Even if interest is compounded, investors will receive a yearly T-5 and must claim the amount of interest earned each year to avoid tax implications at the end of the GIC term.
The straight forward and predictable features of GICs make them easy to understand, and it is not difficult to remain up to date. Bonds are more complex instruments and even if you develop the necessary expertise, you will need to contact a stock broker to learn about the current supply and price. Bond funds eliminate the need to follow bond issues. However, selecting an investment can be extremely difficult: a fund with a good performance record or reputation may not continue to succeed.
GICs are easy to manage. You can track expected payments and maturities with a diary or a good deposit broker can keep the records. To calculate the value of your investments, you add up the principal amounts.
Interest earning investments are exposed to risk from insolvency, interest rates, and inflation. If you invest in GICs, you can virtually eliminate the risk of insolvency by selecting instruments that qualify for CDIC insurance. To obtain the same protection for bonds, you would have to hold Government of Canada instruments or a bond fund that invested in Canada.
Liquidity is the ease with which you can trade your investment for cash, and whether you receive the full value. GICs are not liquid if they are not redeemable: you must hold the instrument until maturity. You can cash a redeemable GIC but you will lose some of the interest.
Timing is the length of time that you should expect to hold an investment, even if it is possible to see the investment earlier. The timing of a GIC is its maturity. If you have a short investment horizon, you can select a short-term GIC. A bond can provide similar timing if you find the maturity that you need.
Bond funds may involve commissions on purchase or sale. As well, the managers must be paid. The management fees are not obvious because they are deducted before you receive your distributions. However, interest payments on the bonds in the fund are fixed, so the manager must deal in high volumes and make smart trading decisions to earn enough to cover the costs.
GICs earn interest, which is taxed
at the highest rate. Bonds and bond funds can earn interest and capital
gains or losses; the rates may be more favorable but the calculations
are more complex and the gains are not assured.
The trade-off for the benefits of GICs is that the return is not high. It is also limited to the promised rate. However, to obtain higher returns on bonds, it is necessary to invest huge sums, buy riskier bonds, or trade actively and successfully. Riskier bonds and trading involve much different strategies than GICs.
There are three things you can do to improve your GIC performance: buy insured GICs, build a ladder, and shop around.
GICs are not appropriate for all investors in all circumstances. You may seek other investments for higher returns, better trading opportunities, lower taxes, or other features. However, GICs are appropriate for the fixed income part of your portfolio. If you are seeking an interest-earning asset, and you prefer an investment that is predictable and manageable, a GIC may be just what you need.
Notice:- Fiscal Agents Financial Services Group are not engaged in rendering tax, accounting or legal professional services or advice. The comments on this page are not intended, nor should they be relied upon, to replace specific professional advice. Before acting on material contained herein, readers should seek advice that is appropriate to their personal circumstances from a professional advisor.