Episode #59: Is It Time To Invest In a GIC? (GIC’s for beginners)
Everyone is excited about GIC’s right now because the interest rates they’re offering are high, and they seem like a shiny spark of guaranteed investment income in a sea of otherwise rocky stock market volatility. GIC’s are not for everyone though and there are only a few specific circumstances where it’s right to use a GIC. We’re going to walk through:
What exactly is a GIC
Why everyone is loving GIC’s at the moment
When it’s the right time to use a GIC
Why a GIC is not the right investment product for investing and growing wealth for your future and your retirement. (I know, I’m sorry to burst your risk-averse bubble, but it’s true.
What is a GIC?
GIC stands for Guaranteed Investment Certificate. When you purchase a GIC you’re loaning your money to the bank. Buying a GIC is essentially saying to the bank ‘yes I will lend you $20,000.00’, and in return the bank says ‘great thank you, we will keep your $20,000.00 for exactly one year, and at the end of that year we guarantee that we’ll give your full 20k back along with 5% interest that we’ll pay you for letting us borrow your money’.
When you buy a GIC from your bank, before you sign on the dotted line, it’s agreed in advance how long the bank will keep your money for, and what interest rate you’ll earn while you’re lending that money out. You’re guaranteed to get your full principal back, as well as the predetermined amount of interest, as long as you don’t try to take your money out earlier than agreed on. This makes it an extremely predictable investment product, which people go crazy for, because you know exactly when you’ll get your money back, and exactly how much you’ll earn from it.
Now if you’ve been learning with me for a while you might be wondering how is this different than a high interest savings account? First, the interest rates offered by GIC’s are generally much higher, and you’re usually offered a higher interest rate the longer the term of the GIC, so a 1 year GIC will offer a higher interest rate than a 3 month GIC. Unlike a high interest savings account, when you buy a GIC you need to leave your money there if you want to earn the interest. Most GIC’s have heavy penalties for withdrawing your money early, which can often cancel out any interest earned. So if you think you might need to access your money before the term is up, a high interest account is a better bet for you than a GIC.
Why Everyone Loves GIC’s Right Now
GIC’s are such a hot topic right now because they’re an extremely safe investment product that’s currently offering an eye catching interest rate. GIC’s purchased from reputable canadian banks are CDIC insured up to a certain amount, which means you can’t lose your money even if the bank goes bankrupt, and you’re guaranteed your interest rate payout. For the last few years GIC’s have been largely ignored because they offered so little interest, but recently people are noticing them because we’re seeing offers like 1 year GIC’s with a 5% interest rate of return. So if you put $1,000.00 into a GIC, you’ll earn $50.00 over the course of that year.
And that sounds pretty good right? It’s guaranteed, it’s extremely low risk, sounds like a good deal. BUT we all know the saying ‘high risk = high reward’ right? Well when it comes to GIC’s the more appropriate way to say it would be ‘no risk = low reward’. Yes they’re safe, and yes 5% sounds like a good return, but only to other young people like myself because we’ve largely spent most if not all of our adult working lives in an extremely low interest rate environment. So, even though 5% sounds high, it’s not, it doesn’t even keep up with the rate of inflation we’ve experienced this past year, so don’t be fooled by that shiny rate of return.
What is a GIC Good For?
A GIC is not a good long term investment vehicle, but what it is good for is for people who are saving a chunk of money for a large purchase in the near future. This means if you’re saving money that you would otherwise be keeping in cash because you’re going to need it very soon, you would look at investing it into a GIC so you can earn at least a little bit of interest and you’re still guaranteed to get it all back in the end. Examples of what GIC’s might be useful for are saving money for a downpayment, a tuition payment, a new car, or to start your own business.
These are all examples of expenses that you need to save a relatively big chunk of cash for, and you absolutely don’t want to risk losing that cash. A GIC is a good buy in these cases because you know when you’ll get your money back, your principal investment is guaranteed, and you know how much you’ll earn from the GIC.
When Should You Not Use a GIC?
This brings us to what a GIC is NOT supposed to be used for, which unfortunately conflicts with why a lot of people are feeling excited about GIC’s right now. You should NOT be viewing GIC’s as a good investment for long term retirement investing. People love the idea of the safety of a GIC, and many people who have been too afraid to invest in the market are turning to GIC’s as alternative investments, but this is definitely not what a GIC is intended to be used for!
Why do you not want to use a GIC for long term investing? The single biggest reason comes down to the opportunity cost. Yes, for a year you’re guaranteeing that you’re going to earn 5%, but based on historical average rates of return in the stock market you’re going to cost yourself at least that same amount of money and likely much more in potential returns in the long run. Yes it feels safe, but do the math for how much of your own money you’re going to have to invest to be able to retire eventually using a 5% rate of return. You’re going to have to come up with a tonne of cash yourself to fund your retirement at this rate compared to how much you’d have to contribute over 30-40 years of being invested in the stock market. And that’s even making the assumption that GIC rates are going to stay as high as they are right now! If you’re still in the active years of your working life and you’re using a GIC as an investment option for your future retirement strategy, you’re essentially shooting yourself in the foot at the start of the marathon. You’re crippling your ability to grow wealth, and you’re going to have to hope you come up with some windfall of money at some point in your life to make up for the lost opportunity cost of using GIC’s instead of the standard low cost index fund recommendations for beginner investors.
So, remember, a GIC can be a great tool to use for increasing the value of money you would otherwise have sitting around in cash, like money you’re saving for a downpayment for a home. A GIC is absolutely not part of a long term investing strategy for your future though, as it’s simply not a powerful enough wealth building tool to get you to where you need to be if you want to afford to retire one day. So, don’t get caught up in the hype about GIC’s, and don’t get caught up in the fear about the volatility of the stock market!
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