If you’re looking to invest but don’t want to take on much risk, then Guaranteed Investment Certificates (GICs) could be a good fit for you. This type of investment product has been popular with Canadians for decades since it provides guaranteed returns — though the returns you get may not help you reach your goals.
If you’re planning to invest in one, knowing how GICs work is crucial to understanding how they might fit into your overall financial strategy.
GICs are financial products that provide a guaranteed return when you agree to lend money to a financial institution for a fixed period. In most cases, the bank or credit union will pay you a higher interest rate if you’re willing to let them keep your money for a longer time. For example, a three-year GIC would offer a higher interest rate than a one-year GIC.
When you buy a GIC, you’re essentially creating a contract with the borrower (the financial institution). It will pay you a fixed amount of interest once the term is over. That interest rate won’t change, so there’s no need to worry about whether interest rates might be lower by the end of the term.
For example, let’s say a one-year GIC is available with a 2% interest rate. If you were to deposit $1,000 into the GIC, you’d earn $20 at the end of the year. That means you’d have $1,020 when the term is over.
With GICs, you need to tie up your money for the entire length of the contract to get the full benefit. That said, some GICs are cashable or redeemable, but they typically come with a lower interest rate. Also, if you do need to withdraw your funds, you could end up paying a penalty. Unless otherwise stated, GICs are generally non-redeemable.
GICs are often referred to as term deposits since your money is tied up for a certain period, or term. What some people don’t realize is that there are different types of GICs. Understanding how the main types work will help you determine which is the best fit for your portfolio.
Generally speaking, when people talk about GICs, they’re usually referring to fixed-rate products. These types of GICs are easy to understand since they pay a fixed amount of interest is based on the length of the contract and the amount you deposit. For example, if you were to invest $10,000 into a one-year GIC with an interest rate of 3.50%, you’d have $10,350 when the term is up.
Variable-rate GICs have interest rates that can fluctuate during the term. This can benefit you if interest rates go up, but it works against you if rates drop. The interest rate is determined by the financial institution’s prime rate and can change at any time. If the markets perform well, you’ll get paid more. However, if markets drop, you may not get anything at all. On a positive note, your principal is still guaranteed, so you can’t lose money — you’ll still get your original deposit back at the end of the term.
Many people avoid investing in the stock market because they’re afraid of potential losses, but you can protect your capital by purchasing market-linked GICs. Instead of having a fixed interest rate, market-linked GICs give you a return based on the performance of the stock market. If markets go up, so does your rate of return. If markets drop, your principal is protected.
A registered GIC is held in an account registered with the Canadian federal government and allows you to grow your savings tax-free, such as a Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA). You won’t pay taxes on any interest you earn on your GIC while it’s in one of these accounts, but you will have to be mindful of any age or contribution limits.
A non-registered GIC is a GIC that is not held in a registered account. Since they are not regulated by the government, they do not come with any tax breaks or incentives. However, you won’t have to worry about age or contribution limits. You can invest as much as you’d like in a non-registered GIC.
Foreign Exchange GICs, such as U.S. dollar GIC, allow you to earn interest on foreign currency.
Even though GICs are safe and give you a guaranteed return, you should be aware of some drawbacks before you start investing.
Even though GICs are safe financial products, some people still want to ensure that their money is safe in case the financial institution were to fail. If you purchase a GIC through a Canadian Deposit Insurance Corporation (CDIC) member, you’re insured up to $100,000.
If you purchase a term deposit through a credit union or caisse populaire, your insurance coverage is provided by a corporation within your province or territory of residence. For example, residents of Ontario who purchase a GIC via a credit union would be covered up to $250,000 thanks to the Deposit Insurance Corporation of Ontario (DICO).
Purchasing a GIC is easy since just about every financial institution offers them. If you already have an account with a bank or credit union, you can usually purchase a GIC with just a few clicks. You can also purchase GICs from a financial institution you don’t bank with if you call one of its advisors or visit a branch.
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What’s nice about GICs is that they can be held in a variety of accounts, such as:
In an ideal scenario, you’ll only purchase GICs in a tax-friendly account, so you don’t have to give up some of your returns to the Canada Revenue Agency. If you hold your GICs in a non-registered taxable account, all interest earned is fully taxable.
While the rate of return on GICs is minimal when interest rates are low, they’re still an ideal product for those who need to ensure their money is safe. If you have a short investment timeline, don’t want to take on any risks, or need some fixed income in your portfolio, then GICs could be a good fit for you.
Barry Choi is a personal finance and travel expert. His website moneywehave.com is one of Canada's most trusted sites when it comes to all things related to money and travel. You can reach him on Twitter: @barrychoi.