Is now the right time to be buying a GIC?
Lets start with, what exactly is a GIC?
A GIC is a term investment that pays you a guaranteed interest rate on the anniversary of your purchase. Generally speaking, the longer the term of your GIC, the higher the interest rate you will receive, and terms tend to vary between 30 days and seven years.
Additionally, a GIC can be redeemable or non-redeemable. A redeemable GIC gives you access to your funds at any time, whereas a non-redeemable GIC has to remain locked in until it matures. Because a redeemable GIC gives you easier access to your funds, they will generally pay you slightly less than a non-redeemable GIC.
Was there a wrong time?
So is now the right time to buy a GIC? Firstly this implies that there was a wrong time to be buying GICs.
For the last few years, GIC rates have been extremely low as rates will follow what is happening in the interest rate market. If you are getting a low rate on your mortgage, GIC rates will also be low. This intuitively makes sense as banks take in deposits and then lend the money back to others at a higher rate. The rate they pay you on a GIC has to be lower than the rate they charge on a mortgage, or they won’t be making any money. As we know, financial institutions are in business to make money.
The issue with low GIC rates is after factoring in taxes and inflation; returns tend to be negative. For the last number of years, GICs paid anywhere from 1-2.5%.
Let’s say you have $100,000 invested in a 2% GIC. After one year, your GIC is now worth $102,000. However, if the GIC isn’t held in an RRSP or TFSA, you will have to pay tax on the $2,000 made during the year.
If you’re in a 30% tax bracket, you will need to pay $600. This lowers your net return to $1,400 or, in percentage terms, 1.4%. We also need to factor inflation into the net return. Prices of goods go up over time; when you were a child, you could buy a jug of milk for less than a dollar. Today if a jug of milk costs less than a dollar, I wouldn’t exactly trust what was inside it.
If inflation was 3% at the same time the GIC was purchased, you need your $100,000 to grow to $103,000 to keep up with rising prices. After factoring in inflation of $3,000, your purchasing power has dropped to $98,400, or a loss of 1.6% on the year.
GIC rates are going up
Today GIC rates are much higher as interest rates have increased substantially. I looked at 30 financial institutions and the best available rates for terms ranging from 1-5 years were as follows.
1 Year: 4%
2 Year: 4.44%
3 Year: 4.49%
4 Year: 4.54%
5 Year: 4.67%
As we can see, rates are much higher than they were previously but so is inflation coming in at 7.7% for May of 2022 (https://www150.statcan.gc.ca/n1/daily-quotidien/220622/dq220622a-eng.htm)
So if you purchase a one-year GIC for $100,000 at 4%, you will have $104,000 next year. Taxes will need to be paid on the $4,000 of interest if the GIC is in a non-registered account. Assuming a 30% tax rate, the net return on this GIC would be 2.8%. If inflation comes in at 7.7% for the year, your purchasing power after one year is down to $95,100 or a net loss of 4.9%.
Even though GIC rates are higher than in the past, your net return is actually worse because inflation is so high.
Another reason people want to purchase GICs is for the stability it provides to their portfolio. If you’ve invested in the stock market this year, you’ll know it’s been extremely volatile.
The US stock market, as an example, was off its high by as much as 22.50% in June.
Should you be selling out of the stock market to buy a GIC?
Historically, the stock market has always risen over time.
If you believe in the stock market, you should also believe it will recover in time.
Let’s run through a quick example.
Bob had $100,000 invested in the US stock market; after a rough year, he was down 20% and had $80,000 remaining. He decided to sell his portfolio at a 20% loss and buy a GIC that paid him 4% per year over five years.
With this strategy, it would take 6 years for Bob’s portfolio to return to $100,000
Alternatively, Bob could remain invested in the market, and chances are that the recovery would happen much quicker.
Based on past market declines, the stock market has recovered quickly.
To summarize, Bob can sell his portfolio and buy a 4% GIC; at that rate, it will take him just over six years to return to $100,000. Alternatively, if he is still comfortable with the volatility, he can remain invested, and chances are the recovery will happen much sooner.
What if Bob came into money, say a $500,000 inheritance? Would it be a better time to buy a GIC as he wouldn’t need to sell anything at a loss?
If Bob doesn’t need this money, he has a real opportunity to add to his portfolio as he would be buying into the market during a downturn. As we just saw, the recovery can happen swiftly, and Bob would be buying into the stock market while it’s on sale.
If Bob plans on using these funds over the next five years, he should consider buying a GIC as you want to give yourself a more extended timeframe to invest in the stock market.
If inflation remains high, Bob’s rate of return would still likely be negative, but it’s still better than leaving that cash in a chequing or savings account.
So is now a good time to buy a GIC?
If you have a long time frame (5+ Years) before requiring access to the funds, I would say you have better options available. If your timeframe is less than five years, then I would say a GIC is a good option as the returns are better than a savings account.
