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GICs aren't just one-stop shopping any more

Financial institutions have introduced a variety of cashable products that offer greater flexibility - a plus in a low-interest-rate environment, ANGELA BARNES writes

A word of warning: If you are shopping for a guaranteed investment certificate, be prepared to spend some time sorting through the wide variety available to find the one that best suits you.

GICs don't all fall into the plain vanilla category any more: There are cashable GICs of varying maturities, traditional non-cashable GICs, index-linked GICs, GICs with escalating rate structures and GICs whose maturities can be laddered to provide cash at each anniversary and many variations thereupon.

No longer is it a case of simply deciding how long you want to invest the money. But then, GICs are facing heavier competition from other investment products than they were in the early to mid-1990s. Stocks and mutual funds became the way to go for many investors, especially as the equity markets soared in the late '90s. The GIC business shrank.

The slide in the stock markets in 2000, the terrorist attacks of 9-11 and stock scandals such as Bre-X and Enron helped revive interest in GICs. But by then, interest rates had fallen to 40-year-plus lows.

Still, the overall GIC market is again growing.

Indeed, 2003 was "quite a successful year for GICs," says Julie Sheen, vice-president of term investments at Bank of Montreal. Despite low interest rates, many investors, nervous about the prospects for the equity markets, opted for the safety of GICs. The GIC market also expanded in 2004, but "mutual funds did far better and, in particular, the conservative equities," she said.

It remains to be seen how this RRSP season will play out. Ms. Sheen expects growth in the GIC market "will be okay, but not overwhelming."

Financial institutions have come to market with a wide range of new products in recent years. Equity market-linked GICs became commonplace in the late 1990s. More recently, financial institutions have introduced a variety of cashable products that give the holder greater flexibility, a plus in a low-interest-rate environment. Investors, worried that rates are headed higher or unsure where rates are going, can take out, for example, a GIC with a two-year term that allows the holder to cash out after 90 days or a GIC with a one-year term cashable after 30 days. Sometimes, the cashable GIC actually pays a higher rate than the traditional GIC. For example, at the Canadian Imperial Bank of Commerce, the one-year traditional GIC, which is non-redeemable, pays 1.55 per cent on a $500 investment while the one-year flexible - read cashable - GIC pays 1.65 per cent.

But there is an even higher rate one-year product for RRSP season. CIBC's RRSP one-year bonus rate GIC carries a rate of 2.25 per cent.The differing rates underscores the need to explore the range of options available. It also underlines the advisability of shopping around."The GIC business over the last couple of years has become much more competitive, especially amongst the big banks," says Todd Lawrence, vice-president of fixed term investments at CIBC. "So there definitely is more innovation to bring product features that are attractive to clients as well as offer some premium returns."

Cashable

The cashable GICs are one of those innovations. They now play a major role in the GIC market.

The more competitive environment also sparked the introduction in the past several years of what are called escalating rate GICs. The rate paid rises each year. CIBC has a five-year non-redeemable GIC, that pays 2 per cent at one year, 2.3 per cent at two years, 2.75 per cent at three years, 3.05 per cent at four years and then 7 per cent at five years on a $1,000 deposit, for a blended rate of 3.4 per cent over the five years. That compares with the 3 per cent rate available on a traditional five-year GIC.

Escalating rate

Like the cashable GICs, the escalating rate product is a response to investors' reluctance to opt for the traditional five-year term GIC, which for many years was the benchmark for the industry.

The reluctance is understandable, given low interest rates. Indeed, those whose five-year GICs are now maturing are going to suffer some "sticker shock," says Joan Dal Bianco, associate vice-president of term deposits at TD Canada Trust. Rates have fallen significantly over that time period. Laddering The escalating rate encourages investors to opt for longer terms. So, too, does the idea of laddering. Laddering can be done a number of ways. For example, investors can purchase, say, a five-year GIC every year for five years. That way, they have a GIC maturing each year for a number of years. Alternatively, there are products where the investors buy simultaneously a one-year, two-year, three-year, four-year and five-year GIC. When each matures, the proceeds are rolled over into a five-year GIC. And there are five-year GICs where 20 per cent of the principal matures each year.

Market linked

Then, there are the GICs linked to various market indexes, such as the S&P/TSX composite index, the Standard & Poor's 500-stock index or a basket of global indices.

The one linked to the TSX composite index is, not surprisingly, particularly popular. Such GICs can also be linked to sectors such as the TSX financial services group. Toronto-Dominion Bank's financial services linked GIC, for example, had an average annual return of 14 per cent between September, 1999, and September, 2004. Several new variations on the basic theme of market-linked GICs have been introduced recently. For example, Bank of Montreal has just introduced a GIC whose return is linked to the BMO Dividend Fund.

The market-linked GICs offer a guarantee of principal. They are gaining some ground, but Mr. Lawrence says he expects products such as the escalating-rate GICs will still be a much stronger seller than the market-linked GICs, the improvement in the stock markets notwithstanding.

Investors buy GICs for a variety of reasons, most notably for safe, reliable income. That feature makes them more attractive at some stages of life than others. People in their 20s, for example, tend to gravitate toward them as they start building their portfolios. They may also consider using that portfolio as a down payment on a house or to supplement the family income if one spouse leaves the labour market to care for children.

Later on, the need for portfolio growth becomes more important and investors put more emphasis on stocks and mutual funds. However, GICs and other fixed-income products rise again in appeal as the investor gets close to retirement as well as after, when capital preservation becomes a bigger issue.

Individuals with a low tolerance for risk may opt solely for GICs, no matter what their age.

And some individuals have more money to invest than others. They may prefer a heavier weighting in GICs because they have more income coming in. As a result, a financial adviser will take a client's age, risk tolerance, financial status and time horizon into account when determining how much money to place in GICs.

abarnes@globeandmail.ca

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