Understanding index linked GIC products
Conventional GIC products provide guarantees of your invested capital as well as a guaranteed return on your capital. There is a new breed of GIC products that continue to guarantee your capital from losing money but provide some variability in terms of your investment return. These products are commonly known as index linked GICs.
Index linked GICs are similar to conventional GICs from the standpoint that you select a length of time you want to invest. Usually these products are offered for only a 3 or 5 year terms. Let’s use Tamara as an example. She decides to invest $100,000 into an index linked GIC for 3 years. At the end of the term, Tamara has the comfort of knowing that she cannot lose any money and at the bare minimum, she will get her $100,000 back. The return on her GIC is unknown until the end of the 3-year period. In Tamara’s case her GIC was linked to the performance of the S&P500 stock index. If the stock market makes money, then the return on her GIC will reflect the gains. If the stock market loses money, then she will simply get her capital back with no gains.
Index linked GICs are perfect for conservative investors who would like to have the potential for stock market types of returns. In fact, this may be an ideal time for index linked GICs with nervous investors and cheap stock markets.
Not all index linked products are the same
If you are considering buying an index linked GIC, make sure you shop around before you buy. Not all financial institutions offer Index Linked GICs and the ones that do can differ dramatically in what they offer. Here is a list of questions to ask:
- Is there a minimum performance guarantee?Most institutions simply have a guaranteed of capital with no minimum guarantees. However, I have seen some institutions go so far as offering a minimum guarantee like one or two percent.
- Is there a maximum guarantee?Many institutions have maximum performance guarantees. For example, one product might offer the returns of the stock market up to a maximum of 30% (total return). This means that if the stock market is up 40%, you will only get a maximum of 30%.
- What index does the performance link to?There are many different stock market indexes that you can link your product to. The most common are the S&P500, the TSX, and a global index. Some products are being innovative by linking to well-known mutual funds or even baskets of specific stocks. Knowing which index you are linking to is key.
- What is the participation level?Some Index Linked GIC products will stipulate a participation rate. For example, an 80% participation rate means that your performance will be equal to 80% of the underlying stock market return instead of 100%.
- How is the return calculated?Some companies simply base your return on the percentage gain of the index between the issue date and the maturity date of the GIC. Others will use the monthly average of the index over the term of the GIC or some other average in their return calculations. The average return calculation is less risky in the event that the market collapses around your maturity date.While conceptually, these products are quite appealing to the conservative investors, the fine print will ultimately tell the tale. While the details can get pretty complicated, don’t lose sight of the simple benefits of Index Linked GICs – guaranteed capital and higher potential returns.
A few more considerations
Taxation. No matter what the return is for the Index Linked GIC, it is classified as interest income. If you buy an Index Linked GIC with non-RRSP money, your gains will be added to income and taxed at your marginal tax rate. Index Linked GICs are not tax efficient and may be better suited for RRSPs than non-RRSPs.
Liquidity. Typically, Index Linked GICs are not cashable. This means that once you buy, you cannot access the money. Be sure to make liquidity provisions when buying an index linked product.
Security. Not only are Index Linked GICs guaranteed, they also fall under the coverage of CDIC insurance. This means that they are insured up to the $60,000 limit per institution.
As you can see, every product has pros and cons. Without question, the key benefits of the Index Linked GIC is the ability to protect capital while still providing higher returns. However, be aware that they are not liquid or tax efficient investments and the variability of returns can actually work against you. Be sure to shop around or call a deposit broker (www.fcidb.com) to help you buy the best GIC product.