Guaranteed investment certificates, once considered stodgy, are enjoying a renaissance. With yields now well north of 5 per cent, no price volatility, and no meaningful risk of default, the humble GIC is more attractive than it has been in a generation.
But not to everyone, apparently.
In recent months, several commentators have taken aim at GICs. One robo-adviser went so far as to ask whether GICs are “the worst investment ever,” dismissing them as “a poor investment choice for the short, mid, and long term.”
Even Vanguard Canada, with its reputation as one of the good guys in the investment industry, published a flawed comparison of GICs and bond funds, declaring the latter to be superior in just about every way.
Unfortunately, comparisons between bonds and GICs are rife with problems. Exhibit A: As its proxy for bond returns, Vanguard Canada used the FTSE Canada Universe Bond Index, which includes government and high-quality corporate bonds with an average maturity of about 10 years, with many bonds carrying terms over 20 years. Vanguard then celebrated the outperformance of this index over one-year GICs.
This is anything but an apples-to-apples comparison, as bonds with longer terms typically pay higher yields because they carry significantly more risk. It would be more sportsmanlike to compare an index of short-term bonds (with maturities of fewer than five years) to a similar index of GICs, which can also be bought with terms of one to five years. But to be fair to Vanguard, no such GIC index exists – at least not yet. More on this in a moment.
For its part, the Bank of Canada publishes a weekly table of GIC rates it describes as “the most typical of those offered by the six major chartered banks.” However, anyone who has shopped around for GICs knows that smaller banks and mortgage lenders tend to offer much more attractive yields than the Big Six.
For example, the Bank of Canada’s “typical” rate on a five-year GIC on Aug. 30 was 4.35 per cent, while anyone using an online brokerage could easily have obtained rates well over 5 per cent from smaller banks, mortgage lenders and trust companies. To be clear: GICs from smaller issuers carry no additional risk if they are covered by Canada Deposit Insurance Corp., or CDIC.
Index providers such as Morningstar use the Bank of Canada’s data to build GIC benchmarks that have been used to make comparisons with bonds. The problem is they don’t reflect how real people invest in GICs. Morningstar’s indexes effectively assume the investor buys and sells new GICs every month, which of course is impossible. Even Morningstar admits this flaw, stating that its Average 5-Year GIC Index “should be treated as an approximation only and with due considerations that five-year GICs are naturally held for five-year terms, not monthly ones.”
Indeed, the traditional way to use GICs is to build a “ladder.” If you’re investing $100,000 you would put $20,000 each in GICs with maturities of one to five years. Ideally you would have access to GICs from multiple issuers and could choose the best available rate for each maturity. (This option is available to DIY investors through almost any online brokerage.) A year from now, when the first GIC matures, you reinvest the principal and all the annual interest in a new five-year GIC to renew the ladder.
To make a truly useful comparison of bonds and GICs, then, we needed a GIC index that included the best available rates (not just those offered by the big banks) and better reflected the experience of an investor maintaining a GIC ladder. Since nothing like this existed, we created our own.
We started by obtaining some 18 years of data from Luanne Jamieson at MBI Financial, a GIC brokerage in Southwestern Ontario. Instead of being limited to the “typical rates” offered by the Big Six, this rich data set included higher-yielding GICs from smaller banks and mortgage lenders. (We were careful to exclude those not covered by CDIC.)
To construct the index, we identified the best available GIC rates for each maturity at the beginning of each year, starting in 2005. We then assumed an investor builds a ladder with equal amounts in each maturity. The following year, when the one-year GIC matured, the proceeds (including all annual interest payments) were reinvested in a new five-year GIC at the best available rate.
When we compare the performance of our Laddered GIC Index to popular bond exchange traded funds that track traditional indexes, the results are compelling.
First we compared it to the iShares Core Canadian Universe Bond Index ETF (XBB), which tracks the same FTSE index that Vanguard Canada used as a proxy for the bond market. From 2005 through August, 2023, the Laddered GIC Index slightly outperformed XBB, and with no drama along the way. Granted, investors in the bond ETF would have enjoyed higher returns until late in 2022, but at the cost of significant volatility.
Then we compared our Laddered GIC Index to the iShares Core Canadian Short Term Bond Index ETF (XSB). This ETF includes only bonds with maturities less than five years, which makes it a more appropriate benchmark for a five-year GIC ladder. Here the GICs outperformed significantly over our measurement period.
The lesson here is not that GICs are superior to bonds: On the contrary, it’s misleading to suggest that investors need to choose one or the other. With our own clients, we usually use a mix of GICs and bond index ETFs in balanced portfolios, for the simple reason that each has its pros and cons.
A broad-market ETF includes bonds of all maturities, and longer bonds have historically delivered higher returns than those with terms of less than five years, albeit with more risk. Bond funds also tend to go up in value when interest rates decline (as they did dramatically in 2019 and 2020), something GICs cannot do. Finally, bonds are essential for their liquidity: When we need to rebalance portfolios by selling fixed income and buying more stocks, we can’t do that with GICs.
But as we have shown, a properly maintained GIC ladder can deliver similar long-term returns to a broad market bond ETF, with no volatility. And compared with short-term bonds, a GIC ladder should have higher expected returns without additional risk, as investors are rewarded for accepting the lack of liquidity.
Perhaps most important, the sharp rise in interest rates that began in 2021 has driven home the reality that bond funds can be very volatile, and when bond prices plunge, investors are prone to panic selling. GICs, on the other hand, offer the predictability and stability most people crave from fixed income.
Investors should be wary of any source that proclaims either bonds or GICs to be inherently superior. The more subtle truth is that both can have a place in a balanced portfolio.