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The Money Management Newsletter: GICs and Fixed Income
You can create your own Index-Linked GIC
A how to case study guide

Now that we understand the basics of index linked GICs, we can describe the steps to create your own index linked GIC. The two key traits of the linked GIC are:

  • The opportunity to participate in market returns
  • Not putting your capital at risk.

To illustrate this better, we will follow Brian as he investigates the opportunity of a customized index linked GIC for $50,000.

Step One: Choose a term. In my opinion you should choose a term no less than 3 years. I think that a 5-year term is ideal to ensure that your capital is also CDIC insured. If you are willing to invest for a 10-year term, it is possible to create a guaranteed minimum return using segregated funds with insurance companies. Whatever the case, your personalized linked GIC starts with flexibility because you can choose your own term. Many linked GICs offered by financial institutions have very limited term options - usually 3 or 5 years.

Brian decided that 5 years was a good term. His rationale was that if he could find a decent 5-year GIC rate, he would not hesitate to lock in for 5 years.

Step Two: Shop for the best rate. Once you have picked the term you want, go out and shop for the best rate. This is the easy step, especially if you use the services of a deposit broker. In Brian's case, the best 5-year rate was 5.5%.

Step Three: Calculate the principal. How much do you need to invest in order to guarantee your capital over the term? This is where it can get a little confusing. Using the chart on the next page, Brian finds the column that corresponds to the five year term he selected. Then he goes down and finds the row with 5.5% interest growth. In the box where the column and row meet, he finds the number $38,256.72. This is the amount he needs to invest for 5 years at 5.5% to ensure that after 5 years he will have his original invested capital ($50,000).

% 3 yrs 4 yrs 5 yrs 6 yrs 7 yrs 8 yrs 9 yrs 10 yrs
2.00 47,116 46,192 45,286 44,398 43,528 42,674 41,837 41,017
2.25 46,771 45,742 44,735 43,751 42,788 41,846 40,926 40,025
2.50 46,429 45,297 44,192 43,114 42,063 41,037 40,036 39,059
2.75 46,091 44,858 43,657 42,489 41,352 40,245 39,168 38,119
3.00 45,751 44,424 43,130 41,874 40,654 39,470 38,320 37,204
3.25 45,425 43,995 42,610 41,269 39,970 38,712 37,493 36,313
3.50 45,097 43,572 42,098 40,675 39,299 37,970 36,686 35,445
3.75 44,771 43,153 41,593 40,090 38,641 37,244 35,898 34,601
4.00 44,449 42,740 41,096 39,515 37,995 36,534 35,129 33,778
4.25 44,130 42,331 40,605 38,950 37,362 35,839 34,378 32,976
4.50 43,814 41,928 40,122 38,394 36,741 35,159. 33,645 32,196
4.75 43,501 41,529 39,646 37,848 36,131 34,493 32,929 31,436
5.00 43,191 41,135 39,176 37,310 35,534 33,841 32,230 30,695
5.25 42,884 40,745 38,713 36,782 34,947 33,204 31,547 29,974
5.50 42,580 40,360 38,256 36,262 34,371 32,579 30,881 29,271
5.75 42,279 39,980 37,806 35,750 33,807 31,968 30,230.5 28,586
6.00 41,980 39,604 37,362 35,248 33,252 31,370 29,594 27,919
6.25 41,685 39,233 36,925 34,753 32,709 30,784 28,974 27,269
6.50 41,392 38,866 36,494 34,266 32,175 30,211 28,367 26,636
6.75 41,102 38,503 36,068 33,788 31,651 29,650 27,775 26,019
7.00 40,814 38,144 35,649 33,317 31,137 29,100 27,196 25,417
7.25 40,530 37,790 35,235 32,853 30,632 28,562 26,631 24,831
7.50 40,248 37,440 34,827 32,398 30,137 28,035 26,079 24,259
7.75 39,968 37,093 34,425 31,949 29,651 27,518 25,539 23,702
8.00 39,691 36,751 34,029 31,508 29,174 27,013 26,012 23,159

Step Four: Pick the investment to which you want to link. Brian has $50,000 to invest but the amount needed to invest in the GIC to guarantee the principal is only $38,256,72. Financial institutions typically link the performance to a market index like the TSX or the S&P In the case of the customized linked GIC, you can link to anything you want. Previously, Brian had found some success in the Trimark Fund, a Global Equity mutual fund. He decided to use this product to determine the future performance of the GIC.

Ultimately, in the unlikely event that he loses all his money in the Trimark Fund, he will still have his original $50,000 after 5 years. However, if the Trimark Fund does better than 5.5%, then he will have improved his return accordingly.

If we look at the Trimark Fund, it has never had a 5-year period [at the time of writing, 9/03] where it has lost money In fact, the worst 5-year return it has ever had was 18.6% total growth. The best total return over any 5 year period was 130.5% and the average 5 year total return over all 5 year trailing returns was 75.3%. If Trimark has an average return over the five years that Brian invests for, he will have over $70,000 at the end of 5 years. This will have enhanced his growth by about $5,000 over investing in a conventional 5-year GIC. His return would increase from 5.5% to 7.14%.

  • If Trimark broke even after 5 years, the total return on the original $50,000 would still be 23.5% (4.31% CARR).
  • If Trimark produced 18.6% after 5 years,the total return on the original $50,000 would be 27.9% (5.04% CARR).
  • If Trimark produced 130.5% after 5 years, the total return on the original $50,000 would be 54.1% (9.04% CARR).

Guaranteed Returns over 10 years

As I mentioned earlier, if Brian were to select a 10-year term instead of a 5-year term, he could actually guarantee a minimum return in addition to his guaranteed capital.

As you can see, the customized linked GIC is a conservative way to try and enhance returns without compromising your capital. The benefit over linked GICs offered by financial institutions is that there is greater flexibility to select the term you want, and link to a favorite mutual fund, than being limited to a few market indices.

This concept of creating your own index linked GIC also provides more liquidity than conventional index linked GICs. When you create your own index linked product you will have some liquidity with the mutual fund, stock, index, etc. In a traditional index linked product there is usually no provision for cashability.

Reproduced with the permission from Jim Yih, a financial expert,author, columnist and speaker. He is the founder of Core Financial Advisors, as a full service, financial planning firm in Edmonton, Alberta. Jim is also a member of the FCIDB.

Editors Note: If your considering using this technique and wish the assistance of a Fiscal Agents investment advisor please call 905-844-7700

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