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Guaranteed Investment Certificates (GICs)

The concept behind GICs is very much the same as that of savings accounts. The only difference is that your money is locked in for a set period of time at a fixed interest rate. The length of time for which your money is inaccessible is called the "term", after which the certificate "matures" (i.e. becomes accessible) and can be "redeemed" (i.e. the money can be deposited into your chequing account). GICs are generally available for terms of 1, 2, 3, 4 or 5 years and can be "purchased" from most financial institutions.

If you buy a one-year GIC on March 1st 2006 in the amount of 1000 dollars at a rate of 5%, then you may redeem it at maturity on March 1st 2007 and receive 1050 dollars.

Generally, GICs can only be redeemed at maturity or at the death of the registered holder (this would be you… You probably don't want to count on this scenario). In return for guaranteeing to the bank that you will not be withdrawing your money for a fixed period of time, you will usually receive slightly higher interest rates than those available for savings accounts. The banks enjoy the security of knowing you cannot pull out the money they have loaned to someone else, and reward you with a higher interest rate to encourage the purchasing of GICs. As well, GICs having longer terms offer higher interest rates since you are offering the bank an assurance that the money will be theirs for a longer while to come.

There also exist many variations to the standard GIC. The following are a few:

· The redeemable GIC
This GIC may be redeemed prior to maturity. A penalty, in the form of a reduced interest payment, is generally incurred. These GICs are recommended.

· The cashable GIC
This GIC claims to allow you to redeem at any time with no penalty. Were this the case, they would be the equivalent of a savings account. These certificates can only be redeemed however, after a wait time of up to three months and offer interest rates that are no better than high interest savings accounts. One would therefore be better off getting the same interest rate in a savings account, and being allowed to withdraw easily at any time.

· The escalating rate GIC
This GIC, recently promoted by the CIBC bank, pays a rate of interest that increases for every year that it is held. This is a gimmick that holds no merit. This GIC provides the illusion of higher interest rates when it may very well pay less than a traditional GIC. To compare the actual interest rate provided by such a GIC to a traditional one, average out the interest rates claimed for each year. For example, an escalating GIC that pays 1% the first year, 2% the second year, and 3% the third, is actually paying you 2% ((1+2+3)/3). Therefore, a traditional GIC paying 2.5% would actually be superior, even though this may not be obvious at first sight.

· The index linked GIC
The interest rate on this GIC is linked to the performance of the stock market while ensuring you cannot lose any money (as we would expect from a GIC). Although this may seem appealing at first, keep in mind that you will receive less than the performance of the stock market to make up for the bank's assurance that no money will be lost. Therefore, if the stock market increases in value by 10% next year, such a GIC might only increase by 5%. As well, you could very well make 0% interest on your GIC should the stock market decrease in value next year. One would be better off either investing in the stock market (and receiving the full benefits of any increases in the value of the market) or purchasing a traditional GIC (and being assured a set interest rate).

As with savings accounts, the best GIC rates can usually be found at virtual banks and credit unions. The following is a list of some financial institutions that provide good rates on GICs. For a current comparison of the best GIC rates at a vast array of Canadian financial institutions, visit the GIC rate comparison calculator provided by Fiscal Agents.

The main criterion to use when comparing GICs is the interest rate for the term you desire. Based on the above table, if we wanted to use our savings in one year's time, the Home Trust Company, with a rate of 4.10% would be the best bet. If however, you won't need the money for five years, Achieva Financial with a rate of 4.95% is the way to go. Keep in mind that some GICs have minimum deposit amounts that should be taken into consideration when selecting an appropriate certificate. Also, you will have to consult the websites of the various financial institutions to determine how to go about purchasing a GIC. Some financial institutions require you to open an account while others will simply request a cheque for the deposit amount and will mail a cheque back to you when the GIC matures. Moreover, whether you actually receive an official paper certificate in the mail will depend on the financial institution's practices.

Because GICs lock your money in for a period of time, they are best used for long-term savings. When deciding to purchase a GIC, you should be certain you will not need that cash until it matures. This is ideal for high school students saving up for their university education because it provides a way of earning interest at higher rates than those found in savings accounts while guaranteeing they will not be tempted to spend that money.

The advantage of GICs is that you can earn slightly higher interest than with savings accounts while having no chance of losing your money. As well, because the money cannot be accessed until maturity, you are certain you will not be tempted to use the money in the mean time. They are easy to use and can often be purchased with no minimum deposit. On the other hand, the money cannot be accessed until maturity and it may be possible to earn more money by investing in stocks or mutual funds. Next we investigate stocks.

Continue to Part 5

Article Table of Contents:
1 - Introduction
2 - Investment Vehicles
3 - Savings Accounts
4 - GICs
5 - Stocks
6 - Mutual Funds
7 - The UniversityAdvice Bottom Line

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