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a GIC primer

Sure, we all enjoy a little adventure in our lives, but there's much to be said for some simple relaxation. The same goes for investing. While more volatile investments may spice up your portfolio, conservative investments — like Guaranteed Investment Certificates (GICs) — can help reduce your investment risk, and will help you earn interest income. That's why it helps to understand how GICs can fit into your overall investment strategy.

A GIC is an investment that is normally taken out for a fixed period of time at a set interest rate, and that offers the security of guaranteed interest and full protection of your principal. The financial institution agrees to pay the full amount of your initial investment plus interest — which is payable on a regular basis. The amount of interest you earn depends on how much you invest, the features of the GIC, and how long you plan to hold the GIC before getting back your money. That period of time is called the GIC's "term", and it can range from 30 days to several years.

What makes GICs appealing to investors?

They're affordable. You can buy a GIC with as little as a $100 initial investment, and sometimes even less.
You get to choose the term of your GIC. For instance, you can invest in a one-year GIC if you're saving towards a short-term goal, like a big vacation next year. Conversely, if you don't need the money in the near future, you may want to consider investing in a longer-term GIC, which typically offers a higher rate of interest than shorter-term GICs.
You decide what to do with the interest you earn. Depending on your income requirements, you can decide to receive the interest earned in cash or to simply re-invest it in your GIC — where it will continue to grow over time.
You can enjoy a good return without risk. Once you buy a GIC, the interest rate on that investment is fixed, which means it won't change (except on an index-linked GIC, as discussed below). Plus, the value of the amount you invest doesn't fluctuate and you'll get that money back at the end of the term. The result? You can benefit from a reasonably good return, with minimal risk of losing your investment.

So, how do you decide which GICs are right for you?

Consider your investment goals. Are you saving up for a short-term purchase, like a car? If so, you may prefer to invest in a short-term GIC. On the other hand, if you're investing for a longer-term goal like a house, a long-term GIC might work better for you.
How much of a return do you hope to earn? If your goal is a higher guaranteed return, a longer-term GIC makes sense.
Review your options. Some GICs offer special features that may be relevant to your financial situation, depending on your objectives. For instance, some are RRSP-eligible, which means they can be held within your Registered Retirement Savings Plan (RRSP). There, the taxes you would otherwise pay on any interest income are deferred until the money is withdrawn from the RRSP. Other GICs are "redeemable": if you need your money before the end of your GIC's term, you can withdraw your funds at any time, subject to certain conditions. Some institutions pay a lower rate on their redeemable GICs than on their non-redeemable GICs. And, in return for the flexibility of early redemption, many will pay you a lower rate than the GIC rate if you do choose to redeem early. In addition, "index-linked" GICs (sometimes called "equity-linked" or "market-linked" GICs) are available. With these, your principal is guaranteed, but instead of paying a fixed rate of interest, the rate of return you may earn is tied to changes in a stock, bond, or other index (like the S&P/TSX Composite Index). While there is potential for higher income than with a regular GIC, there is no income guarantee: if the index stays at the same level or falls, you may earn nothing.
Think about what other types of investments you already own, if any. If a lot of your investment funds are held in more volatile holdings — such as stocks or growth mutual funds — GICs can help balance and potentially reduce the overall level of risk in your investment portfolio.

For more information, take a look at the must-have GIC.