Guaranteed Investment Certificates
By Troy Peart The Afro News Vancouver
In the not too distant past, Guaranteed Investment Certificates (GICs) were merely a promise by banks to repay money lent to them by individuals after a period of time or “term”. After this term, GICs were said to have matured and the money would be returned plus a predetermined amount of interest. There was nothing more to know and an individual could base their decisions merely on rates and terms.
Since then, GICs have evolved to become more appealing to a much wider audience of investors. Given the plethora of choices available, it has become progressively more challenging to determine which option is the best for a particular situation or individual.
While there are so many choices available, there are a few fundamental benefits that are present with all GICs. For example, all GICs have a term after which they will mature and no longer be invested. In addition, as the name suggests; GICs are guaranteed. More specifically, this means that one will at least get their principal returned to them at the end of the term. As a result of the aforementioned evolution of GICs, the similarities are overshadowed by the potential differences.
Despite the abundance of options that are available, there are a few categories one can use to classify all GICs. These are: short vs. long-term, cashable vs. non-cashable and fixed vs. variable interest.
The distinction between short and long-term is the length of the term for a particular GIC. Terms generally range between 1 day and 10 years. Longer terms usually pay higher interest rates to compensate individuals for the inconvenience of not being able to access their funds. One should consider how long their investment horizon is prior to committing to a particular term to ensure liquidity is not an issue.
Cashable vs. non-cashable indicates whether or not one can redeem their GIC prior to maturity. The ability to redeem a GIC prior to maturity adds a level of flexibility that usually results in a lower interest rate when compared to an identical GIC that must be held to maturity. As such, one must evaluate whether the added flexibility of a cashable GIC warrants the reduction in interest payments.
The difference between fixed and variable interest is whether or not the interest payments are predetermined prior to one purchasing a GIC. Not surprisingly, fixed interest is predetermined (or fixed) and one can calculate exactly what they will be receiving prior to investing. Conversely, the amount of interest payable for variable rate GICs is determined by some other factor. These factors range from market indexes and individual mutual fund performances to the prime lending rate for an individual bank. As mentioned earlier, the repayment of one’s principal is unaffected by the type of interest payable. Determining which option is most appropriate should be based on one’s risk tolerance, time horizon as well as the other investments and financial obligations that they have.
In addition to selecting the characteristics of individual GICs, one must be cognizant of how these individual investments relate to the remainder of their portfolio. For example, the lack of flexibility inherent with a 10 year GIC may seem undesirable if considered as a stand alone investment. However, if it is combined with GICs of shorter maturities, this may not be an issue and the portfolio could benefit from a higher overall return.
It is important to note that GICs are a small subsector of the larger category of fixed income, which in turn is a subsector within the broader category of investments. As with all financial products, GICs are merely tools that can be used to achieve one’s financial goals and diversification is often strongly recommended. One must evaluate their individual goals and objectives in conjunction with their personal circumstances to assess the suitability and allocation of GICs in addition to other financial products. Professional advice should be consulted as there are other potentially important factors not mentioned in this article like: taxation, inflation, currency and estate planning issues.
Troy Peart B.B.A., CFP, CFA can be emailed at troypeart@shaw.ca. Your questions, comments or suggestions for future articles are encouraged.
