After years of painfully low rates, Guaranteed Investment Certificates (GICs) are now paying in the area of 5% annually. And after a year of lousy stock and bond returns, this is causing some people to ask “why not just put it all in GICs?” Here is my take on that.
First of all, yes, you could do that. There are concepts that advisors use to determine what to recommend to investors. But I always put that aside and say “comfort trumps everything.” We could tell you that you have lots of time and that the volatility of stock markets shouldn’t matter to you and will offer better long-term returns. But if you can’t bear to deal with the ups and downs that come with it, then you must choose the path that gives you peace of mind.
But most people are used to seeing their returns vary and they’re looking for a way to deal with the bad times and to optimize the balance of risk and reward. Here are the pros and cons of GICs.
Liquidity. You’ll need to lock up your money for anywhere from one to five years. There are GICs that can be cashed in early, but they generally pay much lower rates. So you’ll have to think about the scenarios that could cause you to need money in the meantime and the likelihood that they will occur so that you can leave yourself with enough accessible money in case the need arises.
Reinvestment Risk. GIC rates are fairly good now. But we don’t know what they’ll be when the certificate you might buy now matures and you have to reinvest. And we don’t know what the other options will look like then. If rates are poor and you consider going back into stocks, will stock prices be elevated or depressed at that time?
Inflation. While GIC rates are paying 5%, inflation has been running higher than that. It’s expected to come down. If it does, likely so will interest rates. Right now, you’re actually losing money – or buying power at least – by locking in a return that is lower than inflation. Now, just about everyone reading this will say “Matt, my stocks and bonds went down last year. That’s losing money too. More!” True, but those assets can and have always rebounded quite quickly and offer a better opportunity to outpace inflation. A company that is growing and generating more each year in profits; that has the ability to adjust their prices to inflation and to pay out more and more each year in dividends, will offer the best means of maintaining the buying power of your money. If you invest $10,000 in a GIC, you’ll get back your $10,000 plus interest. There is no opportunity for wealth creation the way an enterprise provides.
Taxes. This applies only to non-registered accounts and not to RRSPs, RRIFs or TFSAs. Every dollar of interest you earn must be reported on your tax return. Dividends and capital gains get preferential treatment. You’ll have more after-tax income if you earn dividends from a stock than you will by earning the same amount of interest. Currently, a lot of blue-chip companies are paying dividends greater than 5%. These are companies that have never missed a dividend payment, nor reduced their dividends, and in fact, have a long history of increasing them every year or two. The share prices of these same companies have come down and can be purchased at a relatively low level meaning less downside risk and more upside opportunity.
So what should you do? I’m not saying that GICs are a bad idea. I’m just pointing out the limitations. There are pros and cons to everything, including stocks and bonds. You should examine your overall situation (or let me do it with/for you). You should prepare a financial plan to understand what your needs are and use GICs in whatever way serves you well and helps deliver on your plan. The plan will also reveal where and how stocks and bonds are a better fit, if at all. The solution is likely to be a combination of all of them.