Terry Tang, Investment Advisor
February 3, 2020
For years, Canadian banks offer market-return GICs to their customers, and it is becoming somewhat popular. As the name suggests, market-return GICs are an investment product that integrates traditional GIC with stocks investing. In essence, you invest a lump-sum for 3 to 5 years, each year you receive a small amount of interest income, the investment is referenced to a basket of stocks or linked to an index, meaning if these stocks or the index go up in 3 to 5 years, you get the upside plus your principal back. Sounds perfect right?
If it sounds too good to be true, it probably is. Sure, this type of investment product is appealing to some investors because it offers a blend of principal guarantee, income, and growth. However, the design of the product is unnecessarily complicated and lacks flexibility. Look deeper and you may change your opinion about it.
Let’s say you invest $10,000 into a market-return GIC for 5 years. Each year you get approximately 0.40 percent interest payment, as well as the potential growth of a set of stocks that are referenced to the product. In most cases, these stocks are primarily large Canadian corporations that pay an attractive amount of dividends each year. But here comes the twist - you don’t get those dividends. Instead, you are paid a fraction of the gain if the stock prices went up in 5 years, known as the participation rate that ranges between 50 to 60 percent of the gain, plus the 0.40 percent interest income each year. In other words, you’re missing out on a big chunk of investment returns.
What’s worse? The stock market stalled and there is no growth in your market-return GIC, leaving you just 0.40 percent interest each year - not even enough to offset inflation. You would have been better off putting your money in traditional GIC, which is currently paying roughly 2.0 percent a year.
"These stocks are primarily large Canadian corporations that pay an attractive amoutn of dividends each year. But here comes the twist - you don't get those dividends."
Here are some of the most common stocks held as reference for market-return GICs:
To be fair, the prices of dividend stocks fluctuate over time but historically they tend to be stable and likely go up moderately in value over the course of 3 to 5 years. For example, Bank of Montreal had a total return of 71.36 percent including dividends in a 5-year period from 2015 to 2020. These companies tend to have diversified business, proven management, stable revenue growth, and a stable dividend policy. Simply put, you would be better off directly investing in these stocks because they offer attractive dividend yield, potential gain in stock prices, as well as preferential tax treatment on Canadian dividends. If you lack the time or knowledge to invest yourself, hire an investment professional.
To sum it up, market-linked GICs are complicated and inflexible. Investors get only price-return and miniscule interests income. The basket of stocks above has an average dividend yield of 4.18 percent, but the investor does not receive them. You’re simply not making the money work for you.
The views and opinions expressed are those of the author and may not necessarily be those of Aligned Capital Partners Inc. The content is for informational purposes only and not meant to be personalized investment advice.
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