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These GICs track the markets, offering low risk and some upside potential to investors. Here’s how to know if market-tracked GICs are for you.
My bank is suggesting market-tracking GICs as an investment portfolio for part of my retirement nest egg. What is the deal (pros / cons) with this type of investment?
—Bryan
Guaranteed investment certificates (GICs) are safe investments that can be purchased by Canadians. They typically have a term of between one and five years and pay a predetermined rate of interest to investors.
Some financial institutions offer GICs that are tied to the return of a particular stock market or stock market sector over the term, like those your bank is recommending, Bryan. They are most commonly referred to as market-linked or equity-linked GICs, but they may have other names.
These GICs have variable returns that depend on the performance of the underlying index. As an example, a GIC with a return based on the S&P/TSX Capped Financial Index will have its interest rate determined by the bank, insurance and investment company stocks that trade on the Toronto Stock Exchange.
Market-linked GICs are generally guaranteed not to lose money. In other words, your principal is guaranteed. The stock market exposure provides upside potential while the principal protection provides peace of mind. However, the upside potential comes at a cost.
The investor does not get to keep the full return of the index. They may only keep 80% of the return, for example. Or they may be limited to a maximum of 25% for a 5-year GIC—so 5% per year.
GIC issuers will generally offer GICs with exposure to indexes that are unlikely to lose money over the term, like the financial or utilities sectors, or a broad-based index. The issuing financial institution can stack the deck in their favour by selecting terms that are likely to benefit them based on historical data, meaning it is unlikely that the principal guarantee is worth it.
Another point on this recommendation from the bank, Bryan, is that neither banks nor bank employees are required to provide financial advice that is in your best interest. That does not mean you cannot trust them, so I do not want to paint every bank or bank employee with the same brush. But you have to take their advice with a grain of salt.
The person recommending the GIC may only be licensed to sell GICs. They may not hold a mutual fund license or be licensed to sell you stocks, bonds or exchange-traded funds (ETFs). So, even if there is a better alternative investment option, they may be trying to hit their sales quotas by offering a solution that they are licensed to sell you.
Does that make GICs that track the markets bad investments? Not at all. They may be right for the right investor. My mother was a conservative investor who was uncomfortable with stocks and did not understand them well. She sometimes bought market-linked GICs.
The way I look at it, market-linked GICs got my mother to take on stock market risk, even if the price she paid was high. She may have ultimately been better off buying shares of the bank that sold her the GICs. If you would not otherwise take on stock market risk, this type of GIC could be right for you, Bryan. But you would probably be better off investing in a low-cost, diversified portfolio of stocks and bonds.
If you are uncomfortable with stock market risk, the best thing you can do is try to learn about stocks and investing. Stocks go up and down, and individual companies sometimes go bankrupt, meaning their stock value can go to zero. But over the medium term and definitely over the long run, stocks, as a group, go up. And the whole stock market will not go to zero. If you have a diversified portfolio of many stocks from different sectors and geographies—and a long enough time horizon—you will make money.
I would never buy a market-linked GIC. But I am a risk tolerant, experienced investor in my 40s with a long time horizon. Should you buy a market-linked GIC, Bryan? Maybe. If you do, try to spend the balance of the GIC term learning about stock markets so when it comes up for renewal you can at least consider other options.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.
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The article states:
“The investor does not get to keep the full return of the index. They may only keep 80% of the return, for example. Or they may be limited to a maximum of 25% for a 5-year GIC—so 5% per year”.
But, assuming the GIC and all its proceeds are being invested throughout the entire 5 year term, isn’t the actual amount of annual earnings limited to around 4.6%?