Picture a Canadian who has $10,000 invested in a fixed-income product such as the guaranteed income certificate (GIC). Over the last three years, falling interest rates meant that the GIC payout consistently declined.
But last week, the Bank of Canada (BoC) raised its policy rate by 25 basis points, to 2.5%, the first hike in more than three years. So what does that mean for our GIC investor?
Source: Getty Images
The GIC rate gap between big banks and online lenders
Where you shop matters as much as when.
Finanque’s October comparison, compiled before the hike, showed a wide gap on one-year GICs. Royal Bank of Canada (TSX: RY), Scotiabank and CIBC paid 2.45%, while TD and BMO paid 3.00%, and National Bank paid 3.30%.
On a $10,000 investment, a 2.45% GIC will yield $245 annually before tax. At 3.30%, you earn $330, which is $85 more for the same year, as long as the issuer is a CDIC (Canada Deposit Insurance Corp.) member and you stay under the limit.
Do GIC rates beat inflation after tax?
Here the story gets uncomfortable. Statistics Canada says inflation rose to 3.1% in September from 3.0% in August, and BoC expects it to average about 3% in 2027.
A 3.30% GIC beats inflation marginally, and a 2.45% GIC trails it by about 0.65 points and reduces purchasing power.
Interest in a taxable account is fully taxed at your marginal rate. So, take a hypothetical investor in a 30% bracket. A 3.30% GIC leaves about 2.3% after tax, which is below inflation. However, if the GIC is held in the Tax-Free Savings Account (TFSA), it is exempt from Canada Revenue Agency taxes.
Nobody knows where rates go next, and expected hikes may already be priced into today’s GICs.
One way to hedge is to use a strategy called the GIC ladder. Instead of locking everything into one term, divide your money into three parts. Allocate a portion of your savings in a one-year GIC, some in a two-year GIC, and the rest in a three-year GIC.
When the first one matures, move that money into a new three-year GIC. From then on, a part of your savings comes due every year, and you can reinvest it at the going rate, which helps if rates keep climbing.
Match each term to when you will need the money, and keep each deposit under the CDIC cap of $100,000 per category at each member institution, interest included.
What Royal Bank’s CFO says about savers leaving term deposits
A GIC is a promise, and a stock is a bet on a business. Owning both can provide some portfolio diversification.
At Barclays’ financial services conference on Sept. 16, Royal Bank of Canada CFO Katherine Gibson described where customer money is heading.
“Clients are moving their flows from term deposits into investments,” she said.
Gibson added that rising rates could pause or even reverse that shift, because term deposits look attractive again.
For the quarter ended July 31, RBC reported record net income of $6 billion, up 11%, and a CET1 capital ratio of 13.5%, according to its filings.
RBC pays a dividend of $7.04 a year, which translates to a yield of 2.5%, well below the 3.30% GIC rate. However, the dividend payouts have more than tripled over the last 15 years. Moreover, RBC stock has returned close to 400% in the last decade, after accounting for dividend reinvestments.
Although stock prices are volatile and dividends are not guaranteed, an insured GIC held to maturity offers a fixed payout and principal protection. GICs are ideal for investors with a low risk appetite or a short-term investment horizon.
