Looking for a risk-free investment to add to your portfolio? Look no further than GICs (Guaranteed Investment Certificates). According to a recent Scotiabank poll, two in five Canadians (38 per cent) invest in GICs. What attracts us to these riskless investments? A whopping 68 per cent list competitive interest rates as most important, followed by a low risk profile in a close second at 62 per cent.
Whether you’re saving for a short-term goal like a summer vacation in Europe or a long-term goal like a down payment for a new mortgage, GICs are an excellent choice. GICs are a great form of fixed income for investors young and old. Let’s take a look at some investment strategies to make the most from your GICs.
What are GICs?
As the name suggests, GICs are guaranteed investments. You loan a lender, such as a bank or credit union, a sum of money for a specified period of time, and in exchange, the lender agrees to pay you an agreed upon interest rate for the duration of the investment. GICs can last as few as 90 days or last up to 10 years. You usually receive the highest interest by locking up your money the longest period of time. GICs come in all shapes and sizes – redeemable, non-redeemable and market-linked to name a few.
GICs are as simple as investments get; they’re the plain vanilla of the investment world. Unfortunately, as the saying goes, there’s no such thing as a free lunch – every guarantee has its price. If interest rates fall while you’re holding a GIC, you’ll come out ahead over a high interest savings account. However, if interest rates rise, you won’t be as lucky.
Are GICs Truly Risk-Free Investments?
Although GICs are often touted as a risk-free investment, there are several aspects you need to be aware of. Unfortunately GICs rates aren’t what they once were. In our current low interest rate environment, inflation risk is a major concern. If the inflation rate is two per cent and you’re only receiving 1.5 per cent, your real return after inflation is minus 0.5 per cent. Another consideration is your tax liability. Interest earned on GICs is fully taxable at your marginal tax rate. You can lessen your tax burden by holding GICs inside your TFSA or RRSP, although it’s hardly worth it when rates are so low.
Build Your Own GIC Ladder
Are you hesitant to tie up a large sum of money in GICs when rates are so paltry? GIC ladders offer an excellent solution. This method spreads your risk of rates creeping higher once you’ve locked up your hard-earned cash. Building a GIC ladder is easy – simply divide your investment into five equal sums and invest in one-to-five-year GICs. For example, if you have $5,000 to invest, you’d invest $1,000 in one-through-five-year GICs. Each year when one of your GICs matures, simply purchase a new five-year GIC. Before you know it you’ll be climbing your way to financial freedom!
What is the benefit of laddering your GICs? Each year at least one of your GICs will mature. If interest rates are higher you can lock-in at a higher rate. What if interest rates fall? Instead of locking your full investment at a lower rate, you’ll only lock-in a fifth of your investment at the lower rate, thus reducing your interest rate risk.
Although I wouldn’t suggest putting all your money in GICs, they’re are a solid cornerstone to a balanced portfolio. Start the New Year off right by starting your GIC ladder today!