Insight into GICs and Online Brokers

GICs have a place in any portfolio, especially RRSP and derivative accounts and TFSAs. If they fit in your portfolio it is essential that you get the highest interest rate. This can be certain through an online brokerage account. First, let’s talk about the interest rate you receive when you lend your money to a financial institution.

Interest rates are a factor of many things. Two important factors are the prevailing interest rate and the credit quality of the company or institution you lend your money to. Prevailing interest rates dictate much. They are low these days. A 5-year Government of Canada bond pays around 2.4% in mid November 2018. A 5-year corporate bond will price off this. Depending on the credit quality of the company, the corporate bond will yield slightly more to substantially more. But, no matter the situation of the company, all will yield less than if prevailing interest rates, or the Government of Canada 5-year bond, payed much higher interest rates.

Prevailing interest rates affect GICs. With a 5-year GoC bond paying 2.4%, you won’t find a 5-year GIC offering 8%. Prevailing rates are low for both the lender and borrower. To borrow to buy a house will cost around 3.5% these days. If an institution is charging 3.5% on a 5-year mortgage term, they can’t offer 4% on a 5-year GIC. Banks make money by charging clients more to borrow than they pay when borrowing from clients. When you invest in a GIC, you are lending your money to the bank. They turn around and lend it to someone else at higher rates. This is a basic business model of the financial service sector.

The credit quality of the institution offering the GIC is substantially less important than the credit quality of other borrowers. GICs are guaranteed by the government through the Canadian Deposit Insurance Corporation. If GICs are guaranteed by the government, the credit quality of the issuer is substantially less important. If the issuer goes bankrupt, you still get your money. There maybe some headaches, and you may not get all the interest promised but the worst-case scenario isn’t too bad.

GIC rates are also determined by the demand for money from the financial institution offering the GIC. If people are lining up for car loans at financial institution 1 and not at financial institution 2, financial institution 1 needs to attract more funds to lend to car buyers than financial institution 2. Financial institution 1 will offer higher rates than financial institution 2 to attract funds. This is potentially bad for the GIC investor.

The GIC investor who deals with one or two financial institutions is likely investing when their financial institutions do not have the highest demand for money. If they aren’t among the top money demanders, the GIC investor sacrifices return.

The online broker provides a massive advantage for the GIC investor. They are brokers. They don’t issue their own GICs. They offer GICs from other institutions. The investor has choice. For example, RBC Direct Investing, Royal Bank’s online brokerage service, currently (mid November 2018) offer one-year term GICs from 34 different providers and five-year GICs terms from 32 different providers. They offer other terms as well. It is likely that at least one provider has a high demand for money at any given time. All online brokers offer GICs from multiple issuers.

Peoples’ Trust and Home Trust offer a one-year GICs at 2.75%. This is higher than all others and significantly higher than many. Homequity Bank offers a five-year at 3.5% which is higher than all others. There are a couple issuers offering 1.1%. They currently have a low demand for money.

CDIC coverage can’t be ignored. It is prudent to remain under the $100,000 protection limit. You can be covered for up to $700,000.

This topic is important to your financial health. Imagine you always have a portion of your portfolio in GICs. A 50 to 100 basis point boost to return annually over the course of a lifetime produces astounding results. For example, $10,000 growing at 4% grows to $48,010 in 40 years. At 4.5%, it grows to $58,164. Imagine a portfolio of GICs growing 50 to 100 basis points faster over the course of a lifetime. Or, take a look at this on the importance of higher growth rates (And please ignore the spelling mistake).