I have a bit of a love-hate relationship with GICs. They have plenty of drawbacks that limit their use cases, but at the same time I can see the role that they can play in someone’s personal financial plan. So what do you need to know about GICs and when to use them?

What is a GIC?

GIC stands for Guaranteed Investment Certificate, and like the name suggests, they are very safe investments that guarantee a certain return over a certain period of time (typically up to 5 years). You put some money into a GIC, and at the end of the timeframe, you get that money back, plus interest. Easy as pie.

Terms for GICs can range from months to years, typically up to five years (though 10-year GICs exist). There are two types of GICs: redeemable, and non-redeemable. Redeemable GICs mean that you can cash in your investments and take the money back earlier than the term. Non-redeemable GICs, on the other hand, mean your money is locked in for the specified timeframe.

While Redeemable GICs offer more flexibility, non-redeemable GICs usually offer better interest rates.

How are GIC interest rates determined?

The interest that GICs pay is influenced by the Back of Canada prime lending rate, but it’s not a perfect one-to-one correlation. Financial institutions make their own decisions about what interest rates they’ll offer on GICs, which means that rates are also based on the level of competition in the market. In Canada, that means you probably won’t see GIC rates go up 1% just because the Bank of Canada increased its prime rate by that amount. There’s just not enough competition for that to be the case!

When might it make sense to invest in GICs?

GICs can make sense as an investment if you have something specific you’re saving for in the short to medium term. Say you’re saving to buy a car two years from now; in that scenario, investing those savings into stocks is really risky. Sure, you could make a bunch of money… but as we’ve seen this year, you can also lose it pretty quickly too. And unlike investing for retirement, you don’t have the luxury of riding out the low period; you need to make your purchase now.

So rather than roll the dice while you save for your car (or whatever), you can put your money into a GIC, which will make a bit of interest while being guaranteed to be there when you need it at the end of two years.

Said another way, GICs can be a good tool if you have a short-term thing you’re saving for, and you know you won’t need the money sooner.

What aren’t GICs good for?

Where do I start?

Emergency Fund

GICs aren’t a good bet for your emergency fund, because GICs tend to be illiquid – that is, you can’t just take your money out whenever you need it. The whole point of an emergency fund is that the money is there when shit hits the fan, and GICs often don’t offer that flexibility (or it comes at a huge cost).

Retirement Savings

Secondly, and probably more importantly, GICs are not a vehicle for saving for retirement, unless you’re very close to retirement. I’m no financial advisor, but I can do some basic math… so let’s look at a scenario.

Say you’re in a 40% tax bracket, and you’re holding GICs in a non-registered account. Current 5-year GIC rates pay around 4.5% interest per year. Great! Except you pay tax at your full marginal tax rate on that interest, which leaves you with 2.7% growth after tax.

But we’re not done yet!

Inflation is currently around 7.5% in Canada, which eats away at your money’s purchasing power over time. So wow, all of a sudden, your money is no longer growing, but shrinking, at a rate of -4.8% per year. Shrinking money doesn’t seem like a great way to hit retirement to me.

“But Jason,” you say. “I would never put my GICs in a non-registered account, I’ll put it into an RRSP!”

Cool. You’re still down -3.5% per year on your money after inflation, which doesn’t care what account you’ve got your money in. And by the way, if you’re thinking to yourself, “Oh this math only works this way because inflation is so high right now, it will come down and then GICs will be positive again,” remember what I said about how GIC rates are set.

If inflation is coming down, the Bank of Canada has probably reduced its rates, which means that the GIC rates on offer also go down alongside inflation. Before the pandemic, you couldn’t find a GIC paying more than 1.5% interest a year. That was when inflation was 2%, meaning you were always going to lose money in real terms.

So bottom line: GICs aren’t good for retirement. Don’t use them for that. Index funds are a much better option!

Wrapping it Up

Believe it or not, this is an improvement in my objectivity toward GICs; I used to respond by swearing like a trucker any time someone asked me about them. But they do have their uses, even if it is a short list. Just know that they’re not meant to be a long-term play, and they’re usually not flexible enough to work for an emergency fund. Using them for short-term savings is a lot better than putting money under your mattress (or the digital equivalent, which is putting your money in a savings account) though!