Index linked GICs have often been described as the best of all worlds. You get a guarantee of capital just like a GIC and you get the potential for higher returns like non-guaranteed products.
What is an index linked GIC?
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 a 3 or 5-year term. The return on the GIC is unknown until the end of the 3-year period. The returns are linked to the performance of an underlying investment like a mutual fund or stock market indices. If the underlying investment makes money, then the GIC will reflect the gains. If the stock market loses money, then the capital will be returned with no gains.
One of the problems with the index-linked products is that your options are quite limited. Not all companies offer these products. Many of the ones that do, will only offer them in high demand periods such as RRSP season. Also, you can only go 3 or 5 years. The odd life insurance company have some offering over 10 years.
One of the solutions to the limited supply is to simply create your own linked product. That way you can choose any term you want and pick your favorite mutual fund to link to. Best yet, you can buy it anytime you want. Here are the steps to set up your own linked GIC.
- Step One. Choose a term. I suggest that you should go with a minimum of three years. The longer you go, the better the chance of making money because markets are more predictable over a longer term. Ideally, 5 to 7 years works well.
- Step Two. Shop for the best GIC rate for the term you choose. For example, a 5-year GIC pays 4.35%.
- Step Three. Calculate how much money you need to invest to regrow the original capital. For example, let's say you have $50,000 to invest. At 4.35% you need to invest $40,410 to grow to $50,000 after 5 years. With this step you have created the guarantee of capital.
- Step Four. You take the remaining $9,590 and invest that into a mutual fund, a hedge product, a stock or whatever you want to create the performance link. If you are investing non-RRSP dollars, you can use a corporate class mutual fund for maximum tax efficiency. As long as the investment beats the GIC rate, you will be ahead of the game.
Have your cake and eat it too
So there you have the customized linked GIC with many great features:
- Guarantee of capital
- Higher potential returns than GIC interest rates
- Flexibility of choosing the timeline that is right for you
- Cashability of the linked investment
- Choose any investment to link to
- Tax preferred over GICs and even index linked GICs outside of RRSPs
- RRSP eligible
And now you can invest with the benefits of both guarantees and higher potential returns.