Products such as the BMO Growth GIC are seductive because they appeal to our desire for gains while assuaging our fear of losses.Getty Images/iStockphoto
My bank is offering a "BMO Growth GIC" that pays up to 16 per cent at the end of four years depending on the performance of a group of stocks, with no chance of losing money. Is this a good deal or am I missing something?
Products such as the BMO Growth GIC are seductive because they appeal to our desire for gains while assuaging our fear of losses.
What's not to like about potentially making a double-digit return and never having to worry about losing a penny?
Let's dig into the details of this product and you'll see why it might not be such a good deal after all.
First, consider the potential payout of 16 per cent. This is the maximum you can make over a four-year period, and there is no guarantee you'll achieve it.
But let's assume you do. What would your return be on an annual basis? If you answered 4 per cent, you're too high. Your annual compound return would actually be 3.78 per cent (because 1.0378 to the power of four is about 1.16).
It's worth repeating: Even if everything goes right, you'll only make 3.78 per cent a year.
There are plenty of great stocks that will pay you 3.78 per cent annually in dividends alone – and many that yield more than that.
If you buy a dividend stock you'll have to accept the possibility of a capital loss, of course, but you'll also have the potential for capital gains.
Speaking of dividends, if you read the fine print of the BMO Growth GIC you'll notice another drawback.
As the "terms and conditions" state: "The value of the securities in the reference portfolio used to calculate the return … will not include any distributions or dividends declared on the securities."
I always stress the importance of dividends – particularly dividends that grow over time. The contribution of dividends to a stock's total return varies widely depending on the company and time frame in question, but it often accounts for a big chunk of an investor's gains.
Calculating the "reference portfolio" return based on price changes alone – with no contribution from dividends – is a big disadvantage.
What is the "reference portfolio," you ask?
For the BMO Growth GIC that I looked at (Series 115, which has an issue date of Dec. 14, 2016, and maturity date of Dec. 14, 2020), the portfolio consists of 15 stocks – Toronto-Dominion Bank, Canadian Imperial Bank of Commerce, Bank of Nova Scotia, BCE Inc., Saputo Inc., National Bank of Canada, Power Corp. of Canada, Royal Bank of Canada, George Weston Ltd., Potash Corp. of Saskatchewan, Canadian Tire Corp. Ltd., Suncor Energy Inc., Enbridge Inc., TransCanada Corp. and TransAlta Corp.
These are fine companies for the most part. But it's important to understand that if you buy the BMO Growth GIC you don't actually own them.
They are merely used as a "reference" to determine the GIC's return, which is calculated as the average of the simple price returns of the stocks in the portfolio over the four-year term – with the stipulation that the GIC's return cannot be less than zero or greater than 16 per cent.
For example, if the price return of the stocks over the entire four years averages 10 per cent, the GIC would return 10 per cent (equivalent to about 2.41 per cent on a compound annual basis).
If the stocks do terribly and post an average return that is negative (which seems very unlikely), the GIC's return would be zero and you would get your original investment back (although you would have lost purchasing power after inflation).
But – and this brings up another drawback – if the stocks shoot the lights out and rise by an average of, say, 30 or 40 per cent over the four years, your gain will be capped at 16 per cent.
People don't like to lose money. I get it. That's why guaranteed investment certificates are popular.
If you're investing money that you'll need in the next few years – to buy a car or a house or pay for college – then a plain-vanilla GIC with a fixed interest rate can make sense.
But if you want your money to grow over the long run, there is no substitute for investing it in stocks or equity funds.
Products such as the BMO Growth GIC may make you feel like you're getting the best of both worlds, but the safety comes at a hefty price.
John Heinzl