The GIC dilemma – will you have enough?
Author: Sound Choices
March 13, 2018
The content in the below article is meant for Canadian investors only.
What you need to know before playing it “safe”.
Most people like to play it safe. That’s why so many Canadians invest in guaranteed investment certificates (GICs). 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.
Sounds good? It is … to a point.
That’s because when working to meet your longer-term financial needs, GICs may not actually be the ideal solution for a number of reasons. Maybe the most important reason is that interest rates are at (or near) their historic lows. This means the income return you receive from your GIC is likely not going to help your investments grow at a rate that will meet your financial needs over the longer term.
The table below illustrates the GIC rate that must be obtained in order to break-even with various inflation and tax rates. For example, if the inflation rate is 2.0% and the investor’s tax rate is 30%, he or she will require a GIC paying 2.86% annually in order to break even.
|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%|
Source: AGF Investments Inc. For illustrative purpose only.
What other options do you have?
Although the safety of GICs may appear attractive, their after-tax, inflation-adjusted returns have proven to be relatively unattractive, especially when compared to many other investments.
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. While not guaranteed, the returns of balanced funds have been considerably stronger than those of GICs over longer periods of time.
|GIC rates*||Year||Balanced |
Source: Morningstar Direct, December 31, 2017. For illustrative purposes only, you cannot invest directly in an index.
* Five-Year Average GIC Rate Index
** Balanced Portfolio based on 50% S&P/TSX Composite TR Index / 50% FTSE TMX Universe Bond TR Index
Talk to your financial advisor to determine which investments can help you stay ahead of inflation, while at the same time grow your portfolio to meet your long-term needs.