Guaranteed Investment Certificates (GICs) are an investment tool that allows you to lend your money to a bank or other financial institution in exchange for an interest rate.
The interest rate you receive will depend on the terms and duration of the GIC, with longer durations typically having higher returns. But often, this money is locked up for the entirety of the term, and if you are even allowed to remove it early, you will pay a penalty.
GICs can be seen as a safe investment opportunity, as you’re guaranteed to get the return specified. But don’t be misled by the rates that are provided, there are a number of downsides to GICs that you should be aware of before parking your hard-earned money there.
Here are 6 downsides of GICs to be aware of:
Lower Returns
Though GICs may present good returns during high-interest periods, over the long-term they will never exceed returns from the stock market.
Over the history of the S&P 500, the returns have been on average around 10% per year. This by no means has been a smooth ascent, but if you leave your money invested for the long-term, you would have gotten this rate of return.
In a low interest environment, GIC rates may sit at a couple percent (2-3%). When central bank interest rates rise, GICs typically rise with them. In fact, at the time of this writing (November 2023), you can see GIC rates at >5.5%.
These rates seem attractive in times of market downturns, but keep in mind that the best market days often happen shortly after the worst days. And if you were invested for the last 15 years, had you missed the 10 best market days, your returns would be cut from 8.8% to 3.3%. So, by pulling your money out of the market to take advantage of high GIC rates, you may be costing yourself in your investment returns.
Locked Up Money
In terms of investment vehicles, GICs are typically low liquidity. What this means is that once you put money into a GIC, you can’t just pull it back out without consequence. To get the rate of return you are expecting, it’s necessary to leave the money in the GIC for the entire term.
With this, a key consideration for your GIC is whether it is redeemable or not.
A redeemable GIC will allow you withdraw funds before your term is completed, but often will come with a penalty. This will typically be an interest rate surrender, where the return on your money is less than you agreed to, or only at a certain date. For example, if you withdraw early, you may lose some or all of your interest earned, or you may only get returns if you leave it in for a defined period (e.g., 90 days).
Non-redeemable GICs do not allow you to withdraw until the term is over. In exchange for locking in your funds, your rate of return will typically be higher compared to a redeemable GIC. But of course this means you completely lose access to this money.
Losing access to these funds is an important consideration for if GICs are right for you. Read here to find out when a GIC may make sense.
Fully Taxable
Another downside of GICs is that are taxes just like employment income.
Unlike investments, which can fall under capital gains tax rates, any interest earned on GICs are taxed at your marginal income tax rate. So, if you earned $75,000 from your employer, and earned $1,000 from GIC returns, the additional $1,000 would be taxed as if you made $76,000 from your employer.
This means that the taxes you pay on these returns can be much higher compared to other forms of income, like capital gains or dividends.
Holding GICs in a registered account may eliminate/reduce this taxation, but registered accounts are better suited for investments.
Opportunity Cost
Because the returns from GICs are less than from other forms of investments, by purchasing them you are creating opportunity cost.
GICs create opportunity cost because they involve parking your money in a GIC rather than another investment, and thus mean giving up the potential benefits of the forgone option. For example, if you invest your money in a GIC for one year, you will receive a guaranteed interest rate, but you will also lose the opportunity to invest your money in another asset that might have a higher return or more liquidity.
For example, let’s compare putting money into a GIC vs. investing in the S&P 500. Imagine you had $10,000. If you put your money into a GIC at 3% with a 1-year term, at the end of the year, you’d have a guaranteed $300 gain. However, if you invested in the S&P 500, using the historical average returns of ~10%, you’d have gains of $1,000. This means your opportunity cost is $700.
Now it’s important to note that the stock market returns are by no means guaranteed, and you may actually lose money in the short term. However, in the long run, the stock market will always outperform GICs, and so by putting your money there, the opportunity costs are the differences in returns. These differences will just compound with time, so in the long-term the stock market will always win.
That said, there are times where GICs make sense, read here to find out more.
May Not Outperform Inflation
Comparing GIC returns to inflation is a way of measuring the real value of your investment over time. Inflation is the general increase in the prices of goods and services in an economy, which reduces the purchasing power of money. GIC returns are the interest payments you receive from lending your money to a financial institution for a fixed term.
Now depending on the GIC rates offered and the inflation rate at a given time, the GIC rates may not be as good as they sound. For example, if you are getting a 1.5% rate on a 1-year term GIC, but inflation is a 2%, your real interest rate is -0.5% (1.5%-2%). So, the value of your money may actually be decreasing, even though the total amount is increasing.
It’s important to consider the inflationary environment you’re in and consider the real interest rate you’re making on your money.
Minimum Deposit
Another downside of GICs is that they may come with a minimum deposit.
This deposit can range anywhere from $100 to $5,000 depending on the institution and term. Depending on your financial situation, this may mean that you are excluded from more favourable rates due to lack of capital.
The minimum deposit depends on a number of factors, including:
- The Plan Type – Registered accounts my have higher minimum deposits.
- GIC Type – The type of GIC can affect minimum deposit.
- Redeemable vs. Non-Redeemable GICs – See more above
- The Term – How long you’re committing your capital for
The most typical minimum deposit is $500, but it’s important to review the terms of your specific GIC when you’re considering using this tool.
Though GICs have a number of downsides as outlined in this article, there are also circumstance where they make sense:
- When you have a known expense a while out (e.g., tuition payment, downpayment, etc.)
- When you can’t afford to lose any money in preparation for a big purchase
- When you are risk-averse, and can’t weather the volatility of the market
- When you can afford to sacrifice the use of that money for the length of the term
Read on here to find out if and when GICs make sense for you. You can also learn more about investing here.