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investor clinic

Why are yields on five-year guaranteed investment certificates (GICs) so much higher than yields on five-year government bonds, when both have the same term and would appear to have the same level of risk?

GICs do indeed yield more than bonds – a lot more. When I compared GIC rates on Globeinvestor.com this week (scroll down the page at tgam.ca/personal-finance), the top five-year yield was 2.95 per cent, offered by Hubert Financial, the online division of Manitoba-based Sunova Credit Union.

The benchmark five-year Government of Canada bond, meanwhile, was yielding a minuscule 0.73 per cent as of Friday at noon – a difference of more than two full percentage points.

Credit unions tend to have the highest GIC rates out there, but bank and trust company GICs also crush the yields of government bonds. For example, Community Trust, based in Mississauga, offers a five-year GIC at 2.2 per cent, and smaller banks, including Canadian Tire Bank and Canadian Western Bank, pay more than 2 per cent on a five-year term, according to my discount broker. To get these rates, you often have to invest a minimum of $5,000.

Government bonds and GICs are both relatively safe. Bonds are backed by the credit of the Government of Canada, and GICs are covered by deposit insurance. In the case of credit unions, that insurance – which in some cases is unlimited – is provided by provincial deposit guarantee corporations, while bank and trust company GICs of five years or less are covered by Canada Deposit Insurance Corp., up to $100,000 an account type .

If the risks are essentially the same for government bonds and GICs, why are the yields so different – and not just for five-year terms, but for one-, two-, three- and four-year terms as well?

The most obvious reason is liquidity. If you buy a bond and you suddenly need the cash, you can easily sell it in the secondary market. Unless you hold a cashable GIC (which typically pays lower interest than a non-cashable GIC), you're basically stuck with it until maturity because there is no active secondary market. In return for locking up your money, you get a higher yield. One exception is if the registered GIC holder dies, in which case early redemption is permitted.

Another reason GICs pay higher interest than government bonds is that bonds can be pledged as collateral on a loan. GICs can be used as collateral in some cases, but usually only with the financial institution that issued them.

Finally, government bond yields have plunged recently amid a "flight-to-safety" by investors, who are worried about low oil prices and slowing economic growth. When investors plow money into government bonds, bond prices rise and their yields – which move in the opposite direction – drop. GIC yields have also slipped recently, but not by as much as bond yields, so the spread between them has widened.

As I've discussed before , GICs are often overlooked in an environment of low interest rates. But they still serve a useful purpose in a balanced portfolio; they help to control volatility, provide peace of mind, generate predictable returns and can be a great way to save for expenses that you know you'll be facing in a few years, such as a new home or a child's education.

Because GIC rates vary widely between financial institutions and can change frequently, it's important to shop around. Generally, you'll do better by bypassing the big banks and going with a smaller organization. It pays to be on the lookout for a company that is especially eager to get funds in the door.

"There may be, from time to time, a financial services company that offers a special promotion," says Collin Gordon, portfolio manager and partner with Vantage Point Investment Management in Calgary. "These institutions will offer higher-than-average GIC rates to address liquidity concerns or [lending] opportunities they have as a business."

Websites such as Globeinvestor.com and Ratesupermarket.ca make it easy to compare GIC rates. A deposit broker can also help you find the best GIC deal; you'll find more information about deposit brokers on the Registered Deposit Brokers Association website.