Financial Cliché VI: GIC’s preserve my capital

Before I start with my post of the day, I would like to thank you Blogging Away Debt for hosting the 107th carnival of personal finance. My post about “The Way Banks Look at You Part3 : It’s A Baseball Game” is featured. Be sure to check it out!

Individuals with an aversion to risk, senior citizens or simply those who listen to most bankers have GIC’s in their portfolio. They hold on to this product the same way my son is holding to his mom’s leg when he is scared. Is it good to keep this product in your investment portfolio thinking that you are preserving your capital? I don’t think so.

Then why bankers are selling GIC’s as on of the best product on earth? It is because all financial institutions are regulated by compliant rules and investment rules. This is also why you have to fill in one of those questionnaires to create your investment profile. In order to avoid any law suits or any other problem with their clients, banks will offer GIC’s and other similar products to averse to risk individuals. After all, you can’t technically lose with a GIC’s. Therefore, in most cases, banks are protected as they act diligently and clients are happy as they think can not lose money.

This is where the catch is. You can lose with a GIC. Actually, you are almost sure to lose money with this investment product. How can you lose when your capital is 100% guaranteed? Unfortunately for those who think so, other calculations must apply.

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First of all, GIC’s revenues are categorized as being interest revenues. Therefore, they are taxed at your marginal tax rate. Let’s take 40% as an example. After all, if you have savings, you must be making at least 45K. On average, a conventional GIC will give you around 4% yield. Taxed at 40%, you 4% become 2,4%. This is how much you are making after taxes.

Then, you are still making money at this point. Really? How about inflation? Inflation rate in Canada is between 2 to 3% every year. You can count on that as the Bank of Canada aim 1 to 3% with at 2% median goal year after year. Therefore, you 2,4% will become 0,4% in the best case scenario and can show a negative return of -0,6% if inflation rate goes up to 3.

This is how banks are selling products that are comforting for your mind, but they are also gradually taking your money away. Don’t blame banks; after all, they are only selling what you have been asking for. I must admit that they are also trying to create products that are very similar to GIC’s with a guaranteed capital so you can hope to make more than 4% and make a few pennies!

Funny note: For those of you who understand French, a GIC is a CPG (stands for Certificat de Placement Garantie). However, there is another meaning for CPG: Certificat de Pauvreté Garantie. Cheers,

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