What is a GIC? Learn how to use it and when it is useful

The financial market offers various options for those who wish to invest their money securely and profitably. 

Among these options, Guaranteed Investment Certificates, or GICs, are a popular choice among Canadians seeking stability and predictability in their investments. 

GICs are ideal for those who prefer to avoid the risks associated with stocks and other more volatile investments, offering a guaranteed way to grow capital over time. 

Below, we will explore more details about what GICs are, how they work, the different types available, and also the pros and cons of this investment method. Come with us!

What is a GIC (Guaranteed Investment Certificate)?

A Guaranteed Investment Certificate (GIC) is a financial product offered by banks and other financial institutions in Canada. 

When you invest in a GIC, you are essentially lending money to that institution for a fixed period, in exchange for a guaranteed return in the form of interest. 

GICs are known for the security they offer, as the principal amount invested is guaranteed, regardless of how the financial market performs.

How do GICs work?

GICs operate in a very simple and straightforward manner. You deposit a fixed amount of money in the financial institution for a predetermined period, which can range from 30 days to 10 years. 

During this period, your investment accumulates interest at a rate that can be fixed or variable. At the end of the term, known as maturity, you receive back the original amount invested, plus the accumulated interest. 

The main advantage of GICs is security, reinforcing that the invested capital is guaranteed, making them a low-risk option for investors.

Types of GICs and their differences

There are several types of GICs available in the Canadian market, each with specific characteristics that meet different needs and financial goals. Let’s look at some of the most common types:

Redeemable

Redeemable GICs offer the flexibility to withdraw your money before the end of the established term, usually after a minimum holding period. 

This option is ideal for investors who may need access to their funds in case of emergency or financial plan changes. 

The additional flexibility comes with a downside: redeemable GICs generally offer lower interest rates compared to non-redeemable ones.

Non-redeemable

Non-redeemable GICs require you to keep your money invested until maturity. In exchange for this lack of liquidity, they generally offer higher interest rates. 

These GICs are ideal for investors who are sure they won’t need to access the funds before the final term, allowing them to maximize their interest earnings.

Foreign Currency GICs

Foreign currency GICs are denominated in currencies other than the Canadian dollar, such as US dollars or euros. 

They are a good option for investors looking to diversify their currencies or who plan to spend or invest money abroad. 

However, these GICs come with the additional risk of currency fluctuations, which can affect returns.

Market-linked GICs

Market-linked GICs offer the possibility of higher returns as they are tied to the performance of a specific market index, such as the TSX or the S&P 500. 

While the principal amount is still guaranteed, the interest can vary depending on market performance. 

These GICs combine the security of guaranteed capital with the opportunity for higher returns, although the returns are not as predictable as fixed-rate GICs.

How to choose a GIC?

Choosing the right GIC can seem challenging, especially with the variety of options available. Here are the important factors to consider when making your decision.

Financial goals

Determine whether you need immediate access to your money or if you can leave it invested for a longer period. If liquidity is a priority, redeemable GICs might be the best option. 

Otherwise, consider non-redeemable GICs to maximize interest.

Interest rates

Compare the interest rates offered by different types of GICs and financial institutions. Remember that non-redeemable GICs generally offer higher rates.

Liquidity

Decide if the flexibility to withdraw your money early is important to you. If there is a chance you might need the funds before maturity, a redeemable GIC might be more suitable.

Diversification

If investing in foreign currency GICs, evaluate the impact of currency fluctuations on your portfolio. Diversifying your currencies can help protect against currency risks.

Risks

Assess your comfort with the risks associated with market-linked GICs. While they offer potential for higher returns, the interest can be less predictable.

Pros and cons of GICs

Now that you know what a GIC is, it’s even more important to understand the positives and negatives when deciding to invest. This way, you can make a more informed decision.

Advantages

• Security: The invested capital is guaranteed, offering safety to investors. This guarantee is especially attractive in times of economic uncertainty.
• Predictability: Returns are predictable and known at the time of investment, facilitating financial planning.
• Flexibility: Redeemable options provide flexibility to access funds before maturity if needed.
• Diversification: Availability of foreign currency and market-linked GICs allows portfolio diversification, helping to mitigate risks.

Disadvantages

• Low interest rates: GICs generally offer lower returns compared to higher-risk investments, such as stocks and mutual funds.
• Limited liquidity: Non-redeemable GICs lock your money until maturity, which can be inconvenient if you need access to the funds.
• Currency risk: Foreign currency GICs are subject to currency fluctuations, which can affect returns and investment security.

How do GICs compare to other investments?

GICs are often compared to other investment products in terms of risk, return, and liquidity. Check out an analysis of how they compare to other common alternatives:

GICs vs. Savings Accounts

Savings accounts offer immediate liquidity and easy access to funds but generally pay lower interest rates compared to GICs. 

If the priority is safety with slightly higher returns than a savings account, GICs may be a recommended choice. For those who need instant access to money, a savings account is more suitable.

GICs vs. Investment Funds

Investment funds, such as mutual funds, offer the potential for higher returns but come with greater risk due to market volatility. 

GICs are a safer option, with guaranteed returns, making them ideal for risk-averse investors. However, investors willing to tolerate more risk in exchange for higher returns may prefer investment funds.

GICs vs. Stocks

Investing in stocks offers the possibility of significant gains but also comes with considerable risk, as stock prices can fluctuate widely. 

GICs, on the other hand, offer security and guaranteed returns, although generally lower. For conservative investors or those looking to protect their capital, GICs are a safer choice.

Strategies for investing in GICs

Did you know there are strategies for those who wish to invest in GICs? Check them out below:

GIC Laddering

A common strategy to maximize returns and maintain some liquidity is GIC laddering. This approach involves dividing your total investment into several portions and investing each portion in GICs with different maturity terms. 

For example, if you have $10,000 to invest, you can place $2,000 in a one-year GIC, $2,000 in a two-year GIC, and so on. 

This allows you to have access to part of your money at regular intervals while still benefiting from higher interest rates offered by longer-term GICs.

Reinvesting interest

Another strategy is to reinvest the interest earned into new GICs. Instead of withdrawing the paid interest, you can reinvest it to increase your capital and consequently your future earnings. 

This is particularly effective in a compound interest environment, where earnings on earnings can significantly grow your investment over time.

Guaranteed Investment Certificates (GICs) are a very useful tool for investors seeking security and predictability in their investments. 

With a variety of types and options available, GICs can be tailored to meet different financial needs and economic goals. 

Although they offer lower returns compared to higher-risk investments, the capital guarantee and predictable interest make GICs an attractive choice.

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