This is the fourth of a six-part course on investing basics that we publish every Tuesday. The advanced investor version appears every Thursday.
Guaranteed investment certificates (GICs) get a bad rap as being too conservative and generating meagre returns. But when used properly, these straightforward investments can be an effective wealth-building tool for most investors, particularly those who don't mind trading off the potentially higher returns of stocks for the ability to sleep well at night.
And after last year's market collapse, sleeping well is not such a bad thing.
There's still a lot of interest out there in GICs, judging by a recent online discussion that generated tremendous reader response. You can read the discussion, with accountant and author David Trahair here:
You can also read five-part primer on GICs here:
Even for investors who can stomach more risk, GICs provide ballast for a portfolio.
A GIC provides a guarantee in two ways. The first is that, unlike stocks, GICs guarantee to return your principal, plus interest, after a certain period. The second guarantee is that the Canada Deposit Insurance Corp. will protect your savings, up to $100,000 per account, in the unlikely event that the financial institution should go bust.
It's important to remember a couple of things here. First, to be protected you must deal with a CDIC member institution, so always check before depositing your cash. Second, CDIC insurance covers only GICs of up to 5 years. For more on how deposit insurance works, and how to make sure you're covered, look here.
More about GICs:
Rock-solid guarantees aren't the only thing GICs have going for them. Another great feature is that, if you choose compounding GICs, all of your interest payments will be reinvested. In other words, you'll earn interest on your interest. Compounding is one of the your best friends as an investor, and GICs make the process automatic.
To take full advantage of the magic of compounding, consider setting up a GIC ladder. The idea here is simple but powerful: Take the money you want to invest, says $25,000, and divide it into five (or four or three) equal piles. The first $5,000 goes into a one-year GIC, the second into a two-year-GIC, and so on. The final $5,000 goes into a five-year GIC, which will usually have the best interest rate because your money is locked up for the longest time.
When your one-year GIC matures, take the money (including the interest) and reinvest it in a new five-year GIC. Do the same with the two-year GIC when it matures a year later. This way, you'll always be rolling your money into new five-year GICs that offer the highest rates.
Learn more about investing from John Heinzl The 2010 Investor Education series for beginner investors:
The 2010 Investor Education series for advanced investors:
Gail Bebee's weekly mentoring for our investor education contest winner:
Laddering has other advantages. It gives you access to a portion of your cash every year if you need it. It also prevents a situation where all of your investments come due during a period of low interest rates. With a ladder, you'll be reinvesting regularly, minimizing this "reinvestment risk."
For more on the benefits of GICs and setting up a ladder, check out this column: