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Market-linked GICs are considered the least predictable type of guaranteed investment certificates (GICs), but they can also be the most lucrative.
Market-linked GICs are kind of a hybrid investment. You get the security of a traditional GIC but the interest rate is based on the performance of an index fund, like the S&P/TSX.
All GICs guarantee your initial investment, but market-linked GICs have the potential to earn interest at a higher-than-typical rate if the stock market rises. Of course, things could also go the other way: if the stock market experiences a net loss during the term, you may not see any gains at all.
Market-linked GICs vs. fixed-rate GICs
The difference between a market-linked GIC and a fixed-rate GIC is all about the potential interest you could earn.
With a GIC, you’re guaranteed to get at least your original investment back, as long as you let the GIC mature. When you buy a fixed-rate GIC, you know the interest rate upfront so you know exactly what you will earn by the end of the term.
With a market-linked GIC, you have no idea what you will walk away with because the interest rate depends on the performance of an unpredictable stock market. You could earn more than if you’d chosen a fixed-rate GIC, but you could also walk away with nothing but your original investment. You won’t know how much you’ve made in interest until the GIC has matured.
Because market-linked GIC returns are tied to the stock market, they are especially unpredictable during times of economic turmoil. Fixed-rate GICs, on the other hand, often become more attractive in such environments, particularly when interest rates are rising.
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How to compare market-linked GICs
A market-linked GIC could be a great option for people who are willing to take a little more risk with their GIC investment. But before you jump on board, make sure to compare GIC rates and ask the following questions:
- Is there a maximum performance guarantee? Some products specify maximum returns that might be lower than the return of the market they’re linked to. For example, if a GIC has a maximum return of 30%, that’s all you’ll get, even if the market goes up 40%.
- Are you comfortable with no minimum performance guarantee? While maximum performance guarantees are common, minimum performance guarantees are not. When the stock market’s trending downward, as it has been for most of 2022, you might walk away with low or no gains at the end of your term.
- What are the tax consequences? When you invest in the stock market, the money you earn is considered capital gains. But when you invest in a market-linked GIC, the money you earn is interest. Interest is taxed at a higher rate than capital gains, so choosing this investment option means you could pay higher taxes. Along the same lines, your market-linked GIC will not earn you any dividends, which you could be entitled to if you invested directly in the stock market.
- Could a lack of liquidity be a problem? Market-linked GICs are locked in, so you cannot access your money before the term is up. If you might need to use this money in that time frame, a market-linked GIC is not a good option for you. A cashable GIC would be a better choice.
- What is the participation rate? A participation rate is a predetermined percentage that represents the correlation between your GIC and the performance of the stock market. Essentially, it means that your performance will not be based on 100% of the underlying stock market return — it might be 60% or 80%. Again, this means you will not earn as much as if you had invested directly in the same stock market index.
It’s also important to know what index your market-linked GIC is tied to. Some indexes or mutual funds may be more volatile than others, so do your research before investing.
» MORE: Should you keep a GIC in a registered account?
Pros and cons of market-linked GICs
A market-linked GIC might seem exciting because it’s a “safe risk,” which sounds like the best of both worlds. But it’s important to consider the pros and cons before you invest in one.
Pros
- Higher earning potential.
- Still a safe investment, so your principal is not at risk.
Cons
- Usually have maximum return limits.
- Not tax-efficient.
- Not as liquid as other types of GICs.
Frequently asked questions about market-linked GICs
Typically, no. Unlike cashable or redeemable GICs, you must wait until the market-linked GIC matures to access your money.
There’s no chance of losing the money you originally invested in a market-linked GIC, which is called your principal. However, you may not walk away with any gains.
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