What should you look for when choosing a GIC?
THE STACK #43Investing in the stock market is one of the best ways to build wealth, but due to the risks and volatility of the stock market, it is always advisable to have a long-term strategy of at least five to ten years.
But what if you need to grow your money in the short term? You can do so by purchasing GICs.
In today’s issue of The Stack, I give an in-depth breakdown of GICs.
So, let’s jump right in!
THE STACK
What is a GIC?
A Guaranteed Investment Certificate (GIC) is a low-risk investment that guarantees the initial investment amount and provides a fixed or variable interest rate for a specified period of time.
Essentially, it involves lending money to a financial institution with the expectation of receiving the initial amount along with a guaranteed interest upon the contract's termination.
What are the benefits of a GIC?
The main benefit of a GIC is the safety and security it offers as it guarantees the return of the initial investment amount.
Additionally, GICs typically provide higher interest rates compared to regular savings accounts, making them a popular choice for individuals looking for low-risk investment options.
Where can you purchase a GIC?
GICs can be purchased from banks, credit unions, and other financial institutions.
Many financial institutions offer GICs with various terms and interest rates, allowing investors to choose the option that best suits their needs.
Which account should you hold a GIC?
GICs can be held in various types of accounts, including registered accounts like RRSPs (Registered Retirement Savings Plans) and TFSAs (Tax-Free Savings Accounts) and non-registered accounts like High-interest Savings Accounts (HISA).
Despite the tax savings on interest earned with a GIC in a TFSA, I still prefer to hold my GICs in a HISA instead of a TFSA because it allows me to have more room in my TFSA for investing in higher return options like ETFs and stocks.
What should you look for when choosing a GIC?
When choosing a GIC, it's important to consider the following factors:
1. Interest Rate:
Look for a GIC with a competitive interest rate that meets your financial goals.
GICs in Canada can have different types of interest rates, including fixed interest rates, variable interest rates, and market-linked interest rates.
Fixed interest rates remain constant for the term of the GIC.
Variable interest rates can fluctuate based on the prime rate set by the Bank of Canada.
Market-linked GICs offer returns linked to the performance of an underlying market index.
3. Term Length:
Consider the length of time you're comfortable locking in your funds. Shorter terms may offer more flexibility, while longer terms may offer higher interest rates.
The ideal term length should be between 1-5 years. Any goal longer than five years should be invested in other high-return assets like ETFs or stocks
4. Redeemability:
Redeemable GICs allow you to withdraw your funds before the GIC's maturity date, although there may be penalties or restrictions for early redemption.
On the other hand, non-redeemable GICs do not allow you to access your funds until the GIC reaches its maturity date, except in certain circumstances such as the death of the account holder.
Non-redeemable GICs typically offer higher interest rates compared to redeemable GICs due to the commitment to keep the funds invested for a specific term.
5. Financial Institution:
Choose a reputable financial institution that offers GICs and has a strong history of financial stability.
6. Insurance Coverage:
Ensure that your GIC is eligible for deposit insurance with the Canadian Deposit Insurance Corporation (CDIC) to protect your investment in case the financial institution fails. (I’ll explain more about CDIC in an upcoming newsletter)
7. Special Features:
Some GICs offer unique features, such as the ability to earn a higher interest rate if certain conditions are met. Consider whether these features align with your investment strategy.
In our next newsletter, I will be sharing a list of the best GICs in 2024!
THE TOOL
GIC Calculator
Curious to find out how much interest you will earn from your GIC? You can use this GIC Calculator to find out.
THE ACCOUNTABILITY
Do you have a short-term goal you’re saving for? Consider purchasing a GIC with it.
Remember, for long-term goals, it is better to invest in ETFs and Stocks.
THE COURAGE
THE KNOWLEDGE
Annual vs Effective Interest Rate
The annual interest rate is the simple interest rate that the GIC offers over a year, expressed as a percentage.
For example, a GIC with an annual interest rate of 3% will earn 3% interest on the principal amount each year.
On the other hand, the effective interest rate is the actual interest rate that takes into account the effects of compounding on the GIC.
GICs can compound interest at different frequencies, such as annually, semi-annually, quarterly, or monthly. The effective interest rate reflects the true return on the GIC, considering the impact of compounding.
For example, if you have a GIC with a 3% annual interest rate that compounds interest semi-annually, the effective interest rate will be slightly higher than 3% due to the compounding effect.
The more frequent the compounding, the higher the effective interest rate will be compared to the annual interest rate.
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