Guaranteed Investment Certificates (GICs) provide a safe, reliable return on your money. They come with a defined duration and interest rate, and at the end of the term your money is guaranteed to have grown by the interest rate advertised.
Now in exchange for this safe, guaranteed return, GICs have some downsides. Firstly, the returns are going to be lower compared to investing in the stock market. Second, your money is locked up for the duration of the term, meaning you cannot withdraw without a penalty, or sometimes not at all. Finally, the growth on GICs is fully taxable, meaning it’s taxed at your marginal tax rate (similar to employment income).
Though GICs have downsides, there are circumstances where a GIC makes sense. Namely, when you have an expense coming up in the next 6 months to 2 years, and you can’t lose the money allocated to it. In that case, you want the downside protection, while also getting some growth.
Now there are a number of alternatives to GICs available to Canadians, each with its own advantages and disadvantages. Read on to find out about the best places to put your money.
Index Funds
Index funds are my personal favourite way to invest. Index funds are passive, simple, and give strong returns relative to their risk.
Index funds are essentially a pool of stocks that follow a given index, most commonly the S&P 500. When you purchase a share of the index fund, you essentially own a small portion of all the stocks on the index. As such, it allows you to very quickly diversify across a large number of stocks.
Index fund investing has numerous advantages, including strong growth (10% average returns), easy diversification (own large number of stocks in one fund), lower risk relative to individual stocks, very low fees (<0.5%), and being almost completely passive. All you need to do is purchase the fund, and leave it to grow.
Index funds do also have some disadvantages. Namely, they expose you to market risk, they’ll only ever give average returns, they’re boring, and they offer limited control. Due to the possibility of losing money, index funds are not recommended for short-term investing (<2-3 years).
That said, if you’re looking for a simple, low maintenance way to grow your money over the long run, index funds are a great investing strategy.
Mutual Funds
Mutual funds are similar to index funds in that they are a collection of stocks and or bonds, but unlike index funds they are actively managed.
What this means is that there is a fund manager, and typically a team surrounding them, actively making decisions about what stocks to buy and sell. Because there’s a team to manage the portfolio, the fees for a mutual fund are typically much higher than index funds (1-2%).
Now because there’s a team actively managing the fund, mutual funds have the potential to outperform the market, but in practice this rarely occurs. The reality is that not a single mutual fund has beaten the market regularly over the last 5 years. When you consider fees, you’re much better to invest in index funds.
Mutual funds have the advantages of quick diversification, lower risk compared to individual stocks, and low maintenance.
The disadvantages of mutual funds is that they have higher fees and lower returns compared to index funds, they are boring, and they offer limited control.
If you’re looking for a simple, low maintenance investing strategy, index funds are the clear winner over mutual funds.
Stocks
Another alternative to GICs is investing in individual stocks.
Stock picking is certainly a skill that can be developed, and if you’re good at it, you can build immense wealth. Think of someone like Warren Buffet, who is one of the richest people on the planet due to his stock-picking skills. But it’s important to note that stock picking isn’t easy. As mentioned above, even mutual fund managers, who are professional investors and have a team around them, often underperform the market.
Because you’ll usually hold a smaller number of stocks relative to an index fund, you tend to be less diversified. This means that a single stock’s performance can have a large impact on your portfolio. As well, depending on the time frame of your investing strategy, you may not know if you’re underperforming the market for a long time.
Stock investing can have the advantage of allowing control, being able to outperform the market indexes, and being an engaging way to invest.
For disadvantages, stocks are higher risk, take more work to invest in successfully, and can have an impact on your emotions and stress levels.
Stocks can be a great part of your portfolio, but due to the risk it’s wise to pair with a lower risk asset such as bonds.
Bonds
Bonds are essentially loans made to governments or companies. When you purchase a bond, they typically have a specified term and interest rate. Typically, higher risk companies (smaller, less established companies) pay higher interest rates than blue-chip companies, and governments pay even less due to the low risk.
In general, you wouldn’t purchase individual bonds, but rather buy a bond fund such as ZAG.TO. The fund will contain a collection of bonds and pay a regular dividend (often monthly). Bonds are much lower return compared to stocks but are also less risky.
Bonds have the advantages of being lower risk compared to stocks, paying regular dividends, and being simple to invest in, as you can just purchase a fund.
For disadvantages, bonds provide lower returns compared to stocks.
Bonds and stocks pair very well together to manage risk while also allowing growth. Often you should allocate a portion of your portfolio to each.
High Interest Savings Account
Another alternative to GICs is high interest savings accounts. High interest savings accounts are similar to traditional savings accounts, but typically provide a much higher interest rate.
They are a great option for emergency funds, or for funds that you may need in the short-term, and can’t give up access to (whereas GICs require you to give up access). The interest rate will typically be lower than GICs, but they offer more flexibility.
High-interest savings accounts have the advantages of being very safe, providing more return than a traditional savings account, and providing complete access to your funds.
The disadvantage is that the growth is going to be lower than other options.
Summary
In summary, though GICs may serve a purpose, there are certainly other options available to Canadians.
If you’re looking at a longer time frame (>2 years), investing in stocks, bonds, and/or index funds is recommended (or even a combination of all three). When you have a longer timeframe, you have the ability to weather the volatility, and these options will provide greater growth than a GIC. Mutual funds are not recommended. Again, if you’re looking for passive investing, you’re better off with index funds.
If you have a short timeframe (less than 6 months), or you’re not willing to give up access to your funds, High-Interest Savings Accounts may be a great option. They offer some growth, but also provide ultimate flexibility.
There are infinite potential options for where to put your money, what’s important is finding an allocation that works with your lifestyle and goals.