When considering Index Funds vs. GICs, one is not necessarily better than the other, they just serve different purposes.
Index funds are great for building long-term wealth, but you’re also subject to fluctuating market conditions. GICs on the other hand are very safe, but won’t give near the same returns as index funds over the long run. Both can serve a purpose in your overall portfolio, and each have situations where they may be better.
So when exploring index funds vs. GICs, it’s not as easy as one being better than the other. But rather it’s recognizing what you’re looking for, and matching the asset to your needs.
When to Purchase Index Funds?
Index funds are best when you are looking at a longer time horizon (greater than 3 years).
Index funds follow the performance of the stock market, and as such will fluctuate as the market moves. This means that index funds have the potential to go down in value.
Over the long run, the stock market has produced great returns, but it has had some drops along the way. If you’re looking at a longer time horizon, you have time to recover from these dips. But if you are going to use the money you invested in the next year, you don’t want to risk the stock market dropping 20%. You would hate to have a home purchase delayed since the market went down, or needing to delay your retirement to wait for your savings to recover. As such, index funds are best when you have time for your investment to recover.
Some of the best market days actually happen right after a crash, in fact, 7 of the 10 best market days in the last 20 years were within two weeks of the 10 worst days. And if you had missed those ten days, your return would drop from 9.8% to 5.6%. So staying invested for the long run and riding out the dips is best for your long-term wealth.
Index funds allow you to grow your wealth in the long-term, so long as you can stay invested through the dips.
When to Purchase GICs?
GICs are best when you need the money in the short run (6 months-2 years), and you want to protect your capital.
GICs rates are typically only a few percent, but the value of a GIC only ever goes up. This means that you eliminate the downside risk, in exchange for lesser returns on your money.
This is perfect for when you know you need the money at a certain date, and you don’t want to risk losing it. For example, imagine you want to purchase a home in a year’s time. Putting the downpayment in a GIC would be a great way to make sure you don’t lose the money for the downpayment, while also getting some returns. In a situation like this, protecting the downside is more important than getting a large return. GICs can provide this safe, but sure return.
GICs are great in the short-term to protect your capital, but aren’t good for long-term wealth. If you were to only purchase GICs over the long-run, you would greatly reduce the amount of growth on your money compared to index funds. But GICs don’t have the downside risk that index funds have.
GICs aren’t going to make you rich, but they allow for a small amount of safe growth in the short term.
Index Funds vs. GICs Depends on Your Situation
The most important question when considering index funds vs. GICs is “when do I need this money?”
If you need the money in the next year or two and don’t want to risk losing value, GICs may be right for you. If you are investing for the long-term, index funds are going to propel the growth of your money. But to get this growth, you need to be able to stomach and ride out any short-term dips.
So think about your goals for your wealth, and recognize it’s not an either or – both tools can have a place in your financial life.