Guaranteed investment certificates are a common recommendation for those starting to build their portfolio. GICs work like a special deposit where you lend the bank money for a period of time. When the GIC matures, you can cash out or reinvest the funds.
As the name implies, you’re always guaranteed at least your initial investment when the GIC matures. This blog post helps you understand what GICs are, how they work and the risks associated with this type of investment.
1. What Are Guaranteed Investment Certificates?
GICs are guaranteed investments obtained by loaning money to a bank or credit union. You agree to lend them money for a certain period of time, and in return, you’ll be paid an agreed upon interest rate. GICs can last three months, six months or even up to 10 years. Usually, you get the highest interest return the longer you hold the GIC. The period you decide to loan the bank money will depend on how you think the interest rates will perform compared to inflation.
Guaranteed investment certificates are excellent for people looking to make a low-risk investment. Unless the bank defaults, you’re guaranteed to receive the principal amount you put up. Generally, higher interest rates are considered a bad thing, however, if you’re holding GICs then you’ll be hoping for the best GIC rates to rise quickly.
2. Where Can You Buy GICs?
You can purchase guaranteed investment certificates through your bank or credit union. You can also use trust companies and certain brokerages to facilitate the buying process. Depending on the company you choose, there may be a fee for purchasing or a commission taken out on your GICs. The majority of banks and credit unions allow you to purchase GICs for free.
3. Are There Any Risks Associated With GICs?
GICs are usually recommended for their stability, but they still carry some risk. Depending on the type of GIC you invest in, these risks may not apply. Generally, there are two risks associated with GICs:
- Buying Index/Market Linked GICs – This type of GIC pays you based on the performance of a guideline like a stock exchange or index. The risk with this type of GIC is you lose money on the principal investment if the benchmark ends up failing. Fortunately, this risk is limited to GICs connected to an index or a market.
- GICs Are Susceptible To Inflation – Most low-interest GICs don’t return enough each year to beat rising inflation rates. If you decide to hold GICs long term, you need to make sure the interest rate is enough to offset inflation.
4. What Options Do You Have When Buying GICs?
Guaranteed investment certificates come in a few different variations. Each variety is different in how and when you can access your investment. Here are four options you have when investment in GICs:
- Laddered GIC: This type of GIC is non-redeemable. With Laddered GICs you can access a portion of your principal investment on the anniversary. If you purchase a GIC with a six-year maturity date, you’ll be able to access a certain percentage of your investment on each of the six yearly anniversaries. This is a good option that allows you to get the benefits of higher interest rates without having all of your funds tied up.
- Redeemable GIC: Redeemable GICs give you the flexibility to access your investment before the maturity date. However, this often comes with harsh penalties. Redeemable GICs have a fixed interest rate.
- Cashable/Flexible Gic: This type of GIC gives you more access to the cash you put up. With cashable GICs you have the option to cash in a portion or all of the GIC before the maturity date. In exchange for the flexibility with your money, cashable GICs usually have a lower interest rate.