Index-linked Guaranteed Investment Certificates
This type of GIC is issued with a guarantee for the repayment of your invested capital, but the interest earned is dependant on the performance of an underlying index or benchmark over the term to maturity. Not only is the interest income unknown, it's also not guaranteed. This type of GIC is similar to Principal Protected Notes (PPNs) issued by Canadian Chartered Banks.
- Term to Maturity: A stock market based GIC typically has a term to maturity of 3 or 5 years.
- Minimum investments: Most GIC issuers require a minimum initial investment of $500.00 to $1,000.00. Check with your financial institutions.
- Flexibility: Due to the complicated structure of Stock Market Linked GICs, investors do not have much flexibility.
- Non-Redeemable: These types of GICs are non-redeemable. The investor must hold them to the date of maturity.
- Flexible or Cashable: Stock Market Linked GICs are not cashable.
- Participation Rate: Each GIC issue has a complicated structure that will detail the specific underlying index or benchmark to be used in calculating the investment’s rate of return. In addition, the GIC may or may not earn a return equivalent to a percentage of the performance of the underling benchmark (for example, if the GIC has a maximum participation rate in the performance of the underlying benchmark). If the benchmark increased in value by 10%, then the rate of return for this GIC would be 3.5% or 35%. Participation rates can also be restricted to maximums. For example, if the same benchmark increases in value by 15% in a single quarter, the GIC participation rate may be restricted to 10% in any quarter. In this case, the GIC owner does not participate at a 35% rate but rather a 23.33% rate (3.5% divided by 15%). Investors should fully understand the description of the GICs participation rate.
- Maximum and Minimum Rates: Many market-linked GICs have set maximum and minimum rates of return that the investor can earn. For example, if the Maximum Return for a 3-year market-linked GIC is set at 12.0%, the investor can earn no more than 12.0% in the 3-year period, or 4.0% per year. Even if the underlying index increased in value by 25% during the 3-year period, the investor’s maximum return is capped at 12.0%. Investors should ensure that they understand market-linked GIC terms and features before investing.
- Income Payment Options: Market-linked GICs do not provide any return or income stream prior to maturity. A return, if any, is tied to the performance of the underlying benchmark. There is no assurance that the underlying benchmark will appreciate over the term to maturity, and therefore, no assurance that investors will receive any amount at maturity other than repayment of principal. The return on the market-linked GIC will be determined in accordance with the calculation method as described on the GICs Information Statement. Some market-linked GIC calculations of final investment returns exclude dividends earned and paid by the underlying benchmark indices. Some of the market-linked GICs have a prescribed minimum interest rate that would be calculated annually.
- Currency: These GICs are Canadian Dollar denominated. The underlying growth benchmark can be an international index.
- Transferable: Non-Transferable.
- CDIC Insurance Coverage: According to the CDIC, market-linked or index-linked GICs are term deposits whose returns are linked to a variation in a stock exchange index. They are neither an insurance contract nor security. They are deposits redeemable at maturity. An index-linked deposit would be insurable if it meets the CDIC’s eligibility criteria.
- Taxation: Returns from a market-linked GIC held inside a tax-free or tax-deferred account are not subject to income tax. If the market-linked GIC is held in a taxable account and has a guaranteed minimum interest rate the interest income from the minimum rate will be calculated and reported annually in a T5 Income Tax information slip. The market-linked calculated return in excess of the guaranteed minimum interest rate, if any, will be reported as interest income on a T5 Income Tax slip for the year of maturity. This income will be taxed as interest income, not capital gains, and all of it will be taxed in the year the GIC matures.
- Additional Thoughts: In the investment industry, an accepted Rule of Thumb is that a risk-free investment rate of return should be equal to the rate of return on a government guaranteed bond. So if an investor purchases a market-linked GIC that has no risk of principal loss then, in theory, the investment’s annual rate of return should be equal to that from a government bond with the same term to maturity, before fees. After fees, the investor’s return would be less. Market-linked GICs have fees and costs that an investor does not see. It is difficult to know if market-linked GICs actually earn investors a return that is higher than a regular GIC with the same term to maturity. Because of the individual nature of market-linked GICs, no actual performance details are ever published. The marketing literature for market-linked GICs relies heavily on “Back-Testing” historical data that can be misleading and potentially meaningless.