|
< Back
Plain-Jane GICs have attractive side
How to squeeze higher returns from low-interest vehicle
THERESA EBDEN
If a GIC could talk its way into your portfolio, its best sales pitch would be "better safe than sorry."
It's true, you won't get rich buying guaranteed investment certificates from your bank. But on the flip side, when stock markets decline, this portion of your portfolio will be blissfully unaffected by the grief and destruction among equities.
In other words, the rate you'll get on a GIC is low compared with the return seen in the stock market lately, but unlike with equities, the danger of losing money on a GIC is slim to zero.
That's why GICs are particularly popular with pensioners and people approaching retirement. Their life savings are safe in a GIC unless the bank that sold it goes into default - and even if this did happen, the Canada Deposit Insurance Corp. insures each GIC holder against a loss, up to $100,000 per issuer. (Generally the larger Canadian banks sell GICs under three or four different legal corporate issuers, meaning an investor can hold $100,000 of insured GICs in each of a single bank's units.)
The Canadian banks and trust companies that sell GICs do promise a fixed rate of return. However, this rate varies according to which bank you buy from, the amount you invest, the period of time you lock it in for, and how effectively you haggle with the branch.
GICs are known as "deposit investment securities," which means you, the investor, make a deposit at the financial institution for a fixed term at a fixed rate. The term could be anywhere from a few days to 10 years, although one- to five-year GICs are the most popular. GICs of more than five years are not protected by the CDIC.
Once the bank has your money, you get paid interest for as long as the bank hangs onto it. During this time, the bank doesn't just hide your money in a vault, however. It loans it out to other customers, and the bank makes a profit on the difference between the lending rates and the GIC rate.
"GICs do make sense for a lot of investors," said David Birkbeck, senior manager of term deposits at RBC Royal Bank, the Canadian unit of RBC Financial, Canada's largest bank by assets. GICs "guarantee the preservation of the initial investment, and that's key for a lot of clients who are risk adverse. A guaranteed rate of return is important to them."
Generally, GICs are more popular among seniors than younger adults because of the difference in risk tolerance, Mr. Birkbeck added.
"Typically with somebody who's many years away from retirement, they'll want to grow that investment, and if you want to grow, you'll want to have less invested in GICs," he said.
Investors can choose from among several types of GICs, including:
Non-redeemable: For those who won't need to access their money during the term of the investment, a non-redeemable GIC provides a higher rate of return. The money is locked in, and the longer it's locked in for, the higher the interest rate.
Cashable: If you're not sure when you might need your money, a cashable GIC allows you to redeem your investment before the term date and still collect interest. The liquidity comes with a price, however - rates are generally lower than those of non-redeemable GICs.
Index-linked: With this type of GIC, your initial investment is protected but your rate of return is based on performance of the equity markets. If stocks do well, you make more money. But if they don't, you won't lose it.
Customers should negotiate GIC rates with their bank, Mr. Birkbeck said, adding that it's not uncommon for Royal Bank to offer 30 to 50 extra basis points in interest to loyal customers. (A basis point is 1/100th of a percentage point.)
A popular investing strategy with GICs is to build a "ladder," which means splitting your money into equal amounts and purchasing GICs that mature at different times.
For example, you could divide your money into five portions this year and buy GICs maturing in one through five years, which would be 2007 through 2011. During each of those years, a GIC would come up for renewal, and you would buy a new five-year GIC.
By 2011, you would have five GICs, each with a five-year term, with one maturing every year until 2016. Because five-year GICs generally have higher rates, you would get a better rate of return as well as keep up with interest rates, which are expected to rise from today's relatively low levels.
"We've been hearing for the last three years that rates will move up, and finally they have started to do so," Mr. Birkbeck said. "Clients had parked money in cashable GICs and interest-bearing accounts. They may have been better off starting a laddering strategy back then."
As with any type of investment, banks have developed their own GIC products.
For those who don't want to commit to a lengthy ladder strategy, Scotiabank has an Ultimate Laddered GIC available in three- to five-year terms, for investors with at least $5,000. The five-year version gives investors the option of redeeming up to 20 per cent of their money each year, as well as being able to extend the GIC an additional year at a blended interest rate.
Investors can use this product to switch from short-term GICs to longer-term deposits that yield more, said Ahmad Dajani, director of retail deposits at Scotiabank.
"One of the hardest decisions people make is whether to invest for the long term or the short term. On the longer end, the disadvantage is your money is locked up, and if rates do rise you lose the opportunity of gaining on those higher rates," Mr. Dajani said. "The best way to get around that is the laddering strategy."
More knowledgeable investors with larger sums of money are better off with other investments such as bonds, said Glen Daniel, senior investment adviser with the Abbott Daniel Advisory Group, a part of TD Waterhouse.
Canadian government bonds are rated at AAA by major credit rating services, whereas banks have slightly lower ratings, Mr. Daniel points out.
They also pay more than today's GICs, he adds. For example, a no-frills, five-year, non-redeemable GIC from a Canadian bank will yield about 2.9 per cent annually.
By comparison, Canada's benchmark 5-year bond, the 4 per-cent coupon security maturing in 2010, yielded 3.89 per-cent last week. Once transaction fees are factored in for purchasing the bonds, the investor still comes out ahead.
"You're getting a full percentage point more with a safer product, even with trading fees included," Mr. Daniel said.
Still, not everyone has a huge portfolio, and that's why GICs remain a good option, he said.
"A GIC fulfills more of a comfort role. There's a perception that they're safe, and they are."
Theresa Ebden is an associate producer for Report on Business TV.
< Back
| 
