The (Renewed) Case For GICs

**This is a sponsored post written by me on behalf of EQ Bank. However, as always, all opinions are my own.

A guaranteed investment certificate (GIC) is unlikely to spark an exciting dinner party conversation but when stock markets are reeling, like they were earlier this year, investors often seek safe havens to wait out the storm. Cash is king for those who don’t have the stomach to watch their portfolio plunge in value, and GICs at least offer the promise of a modest return.

Back in February 2009, when the global financial crisis had just about reached rock-bottom, 30-year-old me was scrambling to meet the RRSP deadline and bought a five-year GIC. It was a costly mistake in hindsight. The Toronto Stock Exchange surged ahead for the next five years, earning annual returns of 9.52 percent, while my five-year GIC earned an average annual return of 2.75 percent.

Instead of turning my $7,000 contribution into nearly $10,000, I only had $7,800 to show for my decision. At the time, though, I thought the GIC was a smart move because I had to make a quick decision on what to do with my contribution, and the stock market still looked downright nasty.

The Renewed Case For GICs

Why invest in GICs?

The truth is there’s nothing wrong with stashing your savings inside the comfort of a GIC. Here are four times when it makes good sense to put your money in GICs:

  1. When your entire portfolio is sitting in cash, waiting for “the right time” to get into the market.

If you’re the type of investor who can’t ignore the doom-and-gloom economic headlines, and who’s convinced that a market meltdown is always imminent, maybe the stock market isn’t right for you.

Having your retirement savings constantly sitting in cash and earning nothing is like sitting on the fence and being paralyzed to move for fear of making the wrong decision at the wrong time.

A GIC ladder, which might involve purchasing equal amounts of one, two, three, four, and five-year terms, will maximize your risk-free returns and still give you the option of dipping your toes in the market each year when one of the terms comes due.

  1. When your investing strategy boils down to chasing last year’s winning stocks or mutual funds.

If you’re the type of investor who’s constantly looking for the latest fad, you might be falling victim to the behaviour gap – the difference between investment returns and investor returns.

Consider that, according to DALBAR, from 1986 to 2016 the S&P 500 Index averaged 10.16 percent a year, but the average equity fund investor earned just 3.98 percent a year.

When you think about our poor investor behaviour, coupled with sky-high mutual fund fees (at least, here in Canada), those investors who just can’t help themselves might be better off parking their savings in the best five-year GIC and earning a guaranteed return.

  1. When you just can’t stand the thought of losing money in the stock market.

Some investors simply can’t stomach the fact that a stock portfolio may drop by up to 50 percent during a market crash. They can’t handle the volatility, and can’t stop listening to pundits and economists who constantly push the fear button.

There’s no sense trying to convince this type of investor about the merits of investing in stocks for the long run. A nervous investor is just the type to bail when the going gets tough – which is a disaster waiting to happen.

A GIC might just be better for peace of mind. One caveat is that you’ll need to save a lot more to make up for the lower returns of an all-GIC portfolio.

  1. When you’re retired (or close to retirement) and need to keep a portion of your portfolio in cash or guaranteed products.

Having all of your retirement savings in the stock market might make sense for a 30-or-40-something, but once you’re retired, or you’re close to calling it a career, you’ll want to keep three-to-five years of expenses in cash or GICs.

An investor who hopes to retire in a year could structure his or her portfolio in a way that places equal amounts (i.e. one-year of expenses) into a GIC ladder. The first rung of the ladder matures the year the investor retires, which then gets cashed out and put into a chequing or savings account to cover living expenses. Rinse and repeat each year, pulling one-year of expenses out of your stock portfolio to replace the five-year tranche of your GIC ladder.

Here’s an example to illustrate:

EQ Bank currently offers GICs with competitive interest rates and flexible terms. A retiree could take a slice of his or her portfolio, say $100,000, and implement a GIC ladder strategy that looks something like this:

2018 2019 2020 2021 2022 2023
1-year GIC 2.76% $20,000 $20,552
2-year GIC 3.01% $20,000 $21,222
3-year GIC 3.25% $20,000 $22,014
4-year GIC 3.30% $20,000 $22,774
5-year GIC 3.50% $20,000 $23,754

To see how much you could be earning in interest, check out EQ Bank’s online calculator.

Final thoughts

I was quite happy to cash in my $7,800 GIC when it matured and put that money to work in the stock market. In fact, I’m an all-equities investor at this time. But many people are perfectly content having all, or a portion of their money in an ultra-safe GIC.

It might seem like investing in a GIC is akin to treading water after inflation and taxes rear their ugly heads, but interest rates have started to tick up and savers are beginning to take notice. They see that GICs can play an important role in their investment portfolio, no matter what age and stage you’re at in life.

There’s a renewed case for GICs, but ultimately you need to do what’s best for your portfolio and invest in a way that helps you sleep better at night.

Rates shown are in effect as of May 28, 2018 and are subject to change. For GIC terms equal to one year, simple interest is calculated on a per annum basis and paid at maturity. For GIC terms of over one year, interest is calculated on a per annum basis and paid either annually (simple interest) or at maturity (compounded annually). Interest is accrued for the entire GIC term. Non-Redeemable. For more GIC rates and information, visit EQ Bank is a trade name of Equitable Bank.

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  1. Brian Vroomen on June 7, 2018 at 7:19 am

    Regarding your comment:

    “At the time, though, I thought the GIC was a smart move because I had to make a quick decision on what to do with my contribution, and the stock market still looked downright nasty”

    what is obvious to me is that yes you seemed to have delayed your RRSP contribution to the point where you needed to just get the money into an RRSP to get the deduction in time to claim on your tax return; however, you never have to make an immediate decision as to how it is going to be invested. You could have just made the contribution to your RRSP and had it go to a cash account for the time being while you considered your options. I haven’t touched a GIC in over 40 years. I have shares of Atrium Mortgage Investment Corp and Firm Capital Mortgage Investment Corp in my RRSP and TFSA, currently paying out around 7% and some first mortgages at 8.49% with 20% loan to value, so I am very secure in those. Give yourself time to do better research and know that you never have to rush to any specific investment.

    • Robb Engen on June 10, 2018 at 8:36 pm

      Hi Brian, fair point but I was just a kid at the time and didn’t know any better. The flip side to your argument is how many people leave their RRSP contribution in cash because they don’t know what to do with it.

      • Brian Vroomen on June 10, 2018 at 9:16 pm

        Hi Rob,
        I am not sure what the statistics are on what percentage of RRSP holdings are just sitting in cash but it would be interesting to know. I would hope people would have had some advice or read something at some point to tell them that cash is not the place to be.

  2. K Hall on June 7, 2018 at 7:31 am

    There is also a case for using GICs “when you just can’t stand the thought of losing money in the bond market”. I use GICs instead of bonds in the fixed income portion of my portfolio.

    • Robb Engen on June 10, 2018 at 8:34 pm

      @K Hall – good example and that’s becoming more and more common especially as investors and retirees are worried about how bonds will react as interest rates rise.

      • Brian Vroomen on June 10, 2018 at 9:51 pm

        Hi Robb,
        Regarding the comment about “how bonds will react as interest rates rise”, see my reply to Jen’s comment on my comment below. I too was worried about having bond funds in my asset allocation even though it was appropriate, but knowing they have no where to go but down in net asset value as interest rates eventually ticked up. I have completely eliminated that concern with the mortgage investment corporation shares (Atrium and Magenta) and the first mortgages. The mortgages held in the MICS have terms of 1-2 years so I know that within 2 years max, I will be at the new interest rates. Since I am getting 6.5-7.5% on those now (a lot more than your GICs), I can live with that. Regarding my first mortgages, the company I go through does one year terms on the first mortgages, trying to help the mortgagees to move over to main stream financial institution financing at better rates. So my money is only tied up for one year, it is very secure in that I have 60-80% equity as a cushion in the value of the home, and once it renews, I get the new current rate. Try getting that with a bond fund. Doesn’t happen. You can’t control the term to maturity. Yes you could just ladder actual bonds or GICs, but you are getting very very low rates. As I mentioned in my reply to Jen, when you deposit your money in a GIC, your financial institution then lends that money back out as a 1st or 2nd mortgage for a similar term except that now they typically have lent out your money to fund up to 80% of the value of the person’s house. I’m eliminating the middle man so I can get the higher return and my money is lent out, at my choice, to fund only 20-40% of the value of the recipient’s house. Without trying to repeat everything in Jen’s reply, just see my comments there.

  3. Jen on June 7, 2018 at 9:15 am

    Brian clearly has a fairly high risk tolerance and his strategy is good for him, but not necessarily for everyone who reads this post. Interestingly for a long time after the GF Crisis, you would have made more money in many of the high interest savings (ISAs) accounts than in any GIC between 1 and 5 year terms. It was a strange period that lasted close to 8 years (if my memory is correct), where if absolute safety was the goal, staying liquid in high interest savings account would have served most people better and given them complete flexibility to jump back into the markets at any time. Now that rates are starting to creep up, using an ISA and Short Term GICs are really decent options for implementing a cash wedge strategy for those in retirement that want to avoid taking money out of the markets during periods of volatility or a correction (sequence of returns). It allows them to keep the majority of their portfolio fully invested and still pull out the desired (or required) income.

    • Robb Engen on June 10, 2018 at 8:38 pm

      Hi Jen, I really like that approach in retirement and it’s nice to see rates ticking up at or above 3 percent.

    • Brian Vroomen on June 10, 2018 at 9:42 pm

      Hi Jen,
      I actually don’t have a very high risk tolerance for the majority of my investments. I am 8 years from turning 65 and I restructured all my investments out of mutual funds in December just before the crash and moved them to the investments I mentioned. I did not want another 2008 episode, where I would potentially wake up later and find out I had exactly the same amount I started with 8 years ago.
      The investments I have mentioned are not as risky as I think you think they are, especially the mortgage investment corporations and the first mortgages. I hated having bond funds in my portfolio even though it was proper in asset allocation terms. What bothered me was that I knew interest rates had no where to go but up and this would negatively impact the net asset values of my bond fund units. I had not control over the term to maturity other than having to pick either a short term bond fund or a long term bond fund, but the first had too low a return given my other options, and the second gave me little comfort knowing what would happen when rates did go up, and again, the returns were not that great either.
      In terms of risk, if you have ever done any research on mortgage investment corporations, especially Atrium or private placement investments with Magenta Mortgage Investment corporation, you would see that they are not very risky. Your GICs and high interest savings accounts are risky to me. Remember that there are a number of risks to consider when investing. There is interest rate risk, that the rate will move in a way that affects the share value of your investment. With mortgage investment corporations, the average term to maturity is usually between 1 and 2 years, not 5 or 15 as is the case with the bond funds. While interest rate risk does not affect the GICs and high interest savings accounts only benefit from increases in interest rates, my mortgage investment corp shares holdings will all be at current rates within the 1 – 2 year time frame as the mortgages held mature and are reinvested at current rates. In terms of risk, the management of the company does their due diligence and Atrium and Magenta are very good at what they do. So I am making 6.5% to 7.5% and I have no concern of risk. I have been investing for over 40 years and have tried almost every type of investment you can make so I have knowledge to say what I am saying. The first mortgages I am doing, where is my risk if I am getting 8.49%, sometimes paid up front for the whole year in some of the deal structures, and the 1st mortgage is for 20-40 % of the value of the house (my choice)? The house would have to drop in value by 60-80% before I have any concerns. Do I think that is reasonable? No! Do I think the person will just leave their house if the value goes down? No! Why would they. Most likely every other property would have the same issue. The only concern I would have is if the mortgagee lost their job. Again, I don’t care because there is a lot of equity in the house protecting my mortgage lending.
      Getting back to the risk you face with GICS or high interest savings accounts, you have to consider inflation and the fact that the rates on these may not keep pace. If they are held in a taxable account, you are probably losing money after taxes and inflation. So who has the higher risk tolerance here? I don’t think you can judge and say I have a higher risk tolerance. I don’t. I have a lot of knowledge regarding a lot of financial options. I pity people who don’t understand the options available to them and who won’t consider them because they THINK that they are safe having their money in GICs and high interest savings account. Their money ISN”T SAFE in those investments. If it is held in registered accounts, you still lose to inflation and you certainly would need to have a huge amount of money in order to live off the interest in retirement. If I wanted $40,000 in income from my investments in GICs, I would need $2 million earning 2%. Yes rates will probably go up, but I am okay with not investing $2 million at 2% and investing money at 8.49% in first mortgages, safe and secure, and in mortgage investment corporations.
      Do you also realize that when you go down to your financial institution to put money into a GIC or high interest savings account that they turn around and match the GIC with a like term mortgage? In my case, I am the one lending the money out as a mortgage. So your money is essentially lent out as 1st or even 2nd mortgage money by your financial institution. And they don’t mind doing it and they lend up to over 80% of the value of the property!!! I am only going up to 20-40%. So again, how is what I am doing riskier? You could argue that regardless, your money is insured by the government up to a certain amount. If we ever got into a situation where we would need to invoke that government guarantee, there would be a lot more to be worried about and it is likely that there would not be enough government money to make good on the claims that would be coming in. I would suggest you do some research on what I am doing before you limit your returns to 1/4 of what I am making.

  4. Steve on June 7, 2018 at 10:00 am

    I agree with K. Hall. Rising interest rates punish bond funds. Instead of loosing 2% (or more), why not make 3.5%, guaranteed? That’s like earning 5.5% (with no risk).

    • Brian Vroomen on June 10, 2018 at 9:43 pm

      Steve, see my comment just made to Jen.

  5. Murray Holland on July 24, 2018 at 5:15 am

    Which is better, GIC’S, the stock market or mutual funds, when you need the interest every month/ year to lives off of without risking your principal? CPP-Diability not able to work and use the interest for monthly income to live, does this make stock more risky to save for retirement?

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