Before playing it “safe”
Author: Sound Choices
June 19, 2019
Consider both inflation and tax implications.
The content in the article below is meant for Canadian investors only.
Many investors like the safety and predictability that a Guaranteed Investment Certificate (GIC) offers. Your principal and interest payments are guaranteed by the GIC issuer (with “guaranteed” actually embedded in their name), so you know you’re going to receive your original investment back at maturity, and you also know exactly what you’re going to receive in the form of interest.
However, while GICs can fill a specific need in an investor’s portfolio, it is important to consider both the inflation and tax implications.
The break-even point
Do you know how much you have to earn with a GIC to break even with inflation and tax rates?
Canada’s annual inflation rate in April 2019 was 2.0% according to Statistics Canada, up from 1.9% in March and 1.5% in February.
So looking at the 2.0% inflation rate numbers in the table below and assuming your tax rate is 30%, for example, you’d need a GIC paying 2.86% annually to break even.
|1.0% Inflation||2.0% Inflation||3.0% Inflation||4.0% Inflation|
|20% tax rate||1.25%||2.50%||3.75%||5.00%|
|30% tax rate||1.43%||2.86%||4.29%||5.71%|
|40% tax rate||1.67%||3.33%||5.00%||6.67%|
So how can you stay ahead?
Given that the after-tax, inflation-adjusted returns of GICs can be relatively unattractive, especially when compared to many other investments, how can you stay ahead of inflation?
Balanced funds, for example, are a portfolio invested in a mixture of equities, fixed income and cash. Their diversified nature help to reduce volatility and increase long-term capital growth potential. Although the returns of balanced mutual funds aren’t guaranteed, the table below shows that the returns have been stronger than those of GICs over the last 20 years.
Growth of $10,000 investment on December 31, 1998 until December 31, 2018
|Year||Balanced Portfolio**||GIC rates*|
*Five-year average GIC Rate Index.
**The hypothetical portfolio weights and rates of return are for illustrative purposes only and should not be interpreted as a guarantee of future rates of return. The hypothetical portfolio is based on pre-determined investments in the above indexes with the portfolio weights rebalanced monthly. The hypothetical portfolio is comprised of 30% Barclays Global Aggregate Bond Index, 10% FTSE Canada Universe Bond Index, 45% MSCI World Index and 15% S&P/TSX Composite Index.
A financial advisor can help you sort out how your investment portfolio can best meet your long-term needs.
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