When it comes to investing, it doesn't get any simpler than a guaranteed investment certificate (GIC). Or does it?
The simple part is what's common to all GICs. You invest a principal amount for a specified period. You get security of capital and regular interest payments at a predetermined rate.
What's not so straightforward is getting the best GIC deal. Your rate of return can vary significantly, depending on your choice of issuer, the term to maturity, the frequency of interest payouts, or whether you want to be able to cash in at any time. Choosing the right GIC for you is a matter of considering these and other factors to ensure that you meet your needs for safety, liquidity and income.
Size of the GIC issuer
You can buy GICs from banks, trust companies, credit unions and life insurance companies. They're also known as term deposits (although that name is most often used for investments with maturities of 365 days or less). If issued by life insurance companies, guaranteed deposits are known as guaranteed investment annuities.
Financial institutions of all sizes set and administer GIC rates. In many cases, smaller is better. That is, smaller deposit-takers such as credit unions and online banks tend to offer higher rates than the banking giants.
The tradition of bigger companies offering lower rates can be linked to the thinking that smaller operations must compensate for an investor's additional risk of forgoing the security of a more established company. That's virtually a non-issue today, since government and industry safeguards are applied across the board. However, the practice of small firms paying higher rates persists, and GIC rates offered by say, a local credit union, will often beat rates from the Big Six banks.
Term to maturity
Although you can get shorter or longer terms to maturity, the most popular terms range between one and five years. GICs with terms of five years or less have an additional layer of built-in safety in the form of a government guarantee against failure of your financial institution. Canada Deposit Insurance Corp. automatically covers up to $100,000 in GICs, per investor at each member firm. Equivalent coverage for insurance company GICs comes from the Canadian Life and Health Insurance Compensation Corp., known as Assuris, which imposes the same limits and conditions as CDIC does.
Interest payouts
The stated yield on a GIC depends largely on how long you want to invest -- the longer you lock in, the higher the rate -- and how often you choose to receive interest payments. While most GICs pay interest annually or at maturity, some GICs can provide a regular income stream from these interest payments. However, the decision to take income payments regularly is likely to result in a lower interest rate on your GIC. That's because issuers who set the rates take into account the administrative costs of making these ongoing payouts.
In a recent survey of GICs for non-registered accounts, for example, one bank offered annual rates of 1.2%, 1.45% and 1.75% respectively for three-, four- and five-year GICs with semi-annual interest payments. Opt for less frequent interest payouts and you can expect slightly higher rates -- in this case, 1.45%, 1.7% and 2% when interest payments are made annually. Conversely, somewhat lower rates apply when payments are more frequent: 1.08%, 1.33% and 1.63% with a quarterly payment schedule.
Another feature to consider if you don't need a regular income stream from your GICs is compounding. Some, not all, GICs accrue compound interest (as opposed to simple interest). Choosing this feature lets you earn interest on your interest and can boost overall return.
Liquidity
Depending on your needs, it may also be important to consider the liquidity of your GIC investment. Most so-called "cashable GICs" have one-year terms and allow the option of cashing in, without penalty, any time after 30 days, 60 days or 90 days. Although not as liquid as savings accounts, cashable GICs often work as substitutes for cash and some institutions pay short-term GIC rates that are comparable to the rates on high-interest savings accounts available from some banks.
If there's a chance you'll need access to the funds before maturity, choose a redeemable GIC or you could end up paying to access your cash. The redeemable feature typically allows investors to cash in their investment before maturity, normally at each anniversary date, without interest penalty.
Be aware that this flexibility usually comes at a cost. In the earlier example of the GIC that makes semi-annual interest payouts, rates fall to 0.95%, 1.2% and 1.5% for three-, four- and five-year terms when you add the option to redeem. In other words, you would have to give up a quarter of a point in annual interest for the option to redeem.
Beware of automatic renewals
Whether you use GICs as part of your long-term fixed-income strategy or a short-term parking spot for cash, an important but under-publicized aspect of GIC investing is the tendency of financial institutions to automatically renew your investment on maturity. Unless you advise your financial institution before that time, you could end up locked-in for another term -- and it could be at a rate quite different from the rate on your original investment.
