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Back to GICs section Learning Centre - GICs
Benefiting from interest earning investments

- The case for GICs
- The features and benefits of GICs
- GICs: The straight facts
- Different types of GICs
- Understanding your investment
- Managing your portfolio
- Appreciating the risk factors
- The time to reinvest
- Maintaining a degree of liquidity
- Getting your timing right
- Fee structure variations
- Paying the tax man
- High return vs. low risk
- Making the most of your GICs
- Are GICs the ultimate investment?


The case for GICs

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

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.


GICs: The straight facts

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.


Different types of GICs

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.


Understanding your investment

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.


Managing your portfolio

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.
A diary might help track bonds as well. Unfortunately, current prices are only available from stock brokers, although you might obtain an estimate from newspaper listings or on the Internet at www.financials.com.
Bonds funds do not mature, and a diary may not be necessary to track payments. The unit value of the fund should be available from a newspaper however, tacking reinvested distributions and calculating returns can be very challenging.

Appreciating the risk factors

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.
Interest rate changes affect the value of an interest earning investment: as rates fall the value increases and as rates rise, the value falls. This risk is very apparent in the bond market as bond prices change constantly. Although GICs are technically exposed to the same risk, the variations are not obvious because GICs are not usually traded. GICs are thus very useful if fluctuating values make you nervous. As mentioned, both GICs and bonds repay the full principal if the instrument is held to maturity.
Bond funds also react to changes in interest rates however, the impact is hard to forecast because it depends on the specific bonds in a fund's portfolio. Since bonds funds do not have a maturity, you cannot predict the eventual sale price.
Inflation can have a devastating impact on the value of an interest earning investment. However, it affects all fixed income investments, so it cannot be used to distinguish GICs from other assets. The impact can be limited by the strategy used to handle the reinvestment of principal.

The time to reinvest

An important issue for any instrument that earns interest or matures is what you do with the money that you receive. If you are unable to reinvest this money at an attractive rate, this return on your investment suffers.
The solution for GIC interest is to invest in a compounding instrument. A strip provides the equivalent feature for bonds. A bond fund can remove the problem from you view by automatically reinvesting the distributions, but the manager must reinvest the interest on your behalf.
Compounding
2-5 Year term
At maturity you will need to find a new investment for the principal. Although you cannot avoid this issue, you can limit its impact by ensuring that only part of your portfolio matures at any one time. This solution works for GICs and bonds and again, a bond fund effectively transfers the problem to the manager.

Maintaining a degree of liquidity

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.
Bonds and certain GICs are considered to be liquid if they can be readily traded however, the price of a bond sold before maturity will differ from the principal. Bond funds are also liquid because you can receive cash within a day or two however, the value fluctuates daily and is unpredictable.

Getting your timing right

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 do not mature. You should expect to hold any mutual fund for at least five years to overcome the commissions and attempt to reap the benefits.

Fee structure variations

Fees can have an immense impact on the return on your investment. GICs usually do not involve fees, and commissions to a broker are not deducted from your return. Bond commissions are buried in the prices, and thus affect your return through the price. Your stockbroker might also impose other fees on your account.
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.

Paying the tax man

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.
Whatever the investment, tax on interest is payable even if it is not received. Compounding GICs, strip bonds, and bond fund reinvestments are thus best suited for RRSPs or investors who can pay the tax with other funds.

High return vs. low risk

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.
Bond funds may provide much higher returns, particularly if interest rates fall. However, they can also provide much lower returns and even substantial losses. In any event, the return is not assured.

Making the most of your GICs

There are three things you can do to improve your GIC performance: buy insured GICs, build a ladder, and shop around.

Insurance

The CDIC provides insurance of $100,000 per depositor per institution. The insurance covers both deposit accounts and qualifying GICs against the bankruptcy of the issuer. RRSP and other specialized accounts are insured separately. To obtain maximum protection, ensure that the GIC is insured, has less than five years to maturity, and does not cause your total balance (including interest) to exceed $100,000 - even if you are offered a higher rate on a larger GIC.
Interactive Deposit Insurance Calculator


How deposit insurance works


Ladders
To limit your exposure to interest rate and inflation changes, and to provide occasional liquidity, build a ladder. A ladder is a series of investments that mature at regular intervals. For example, one fifth of a portfolio may mature each year for five years; as each GIC matures it is invested for five years to maintain the ladder.
Five year ladders are commonly recommended because they enable you to obtain the usual interest rate premium for longer investments while remaining within the insurance limits.
Interest rates will vary, and each year you will invest the maturing GICs at the new rates. If rates are rising you will get some of the benefit, and if rates are falling, the bulk of your portfolio is still insulated.

Shopping Around
To obtain the best rates on GICs, you should shop around. You can contact the institutions directly or use a deposit broker.
A deposit broker is paid by the institution so there is no direct cost to you. A good broker can offer a very wide selection of GICs, monitor the insurance limits and help you maintain a ladder. Deposit brokers are not regulated but the best are members of the Federation of Canadian Independent Deposit Brokers or FCIDB (www.fcidb.com) . You can protect yourself further by making the cheque payable to the institution that issues the GIC. (What is a deposit broker?)

Are GICs the ultimate investment?

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.





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