Saving & Managing Money

Market-linked GICs: The pros and cons for investors – MoneySense

What is a market-linked GIC?

Some financial institutions offer GICs that are tied to the return of a particular stock market or stock market sector over the term, like those your bank is recommending, Bryan. They are most commonly referred to as market-linked or equity-linked GICs, but they may have other names.

These GICs have variable returns that depend on the performance of the underlying index. As an example, a GIC with a return based on the S&P/TSX Capped Financial Index will have its interest rate determined by the bank, insurance and investment company stocks that trade on the Toronto Stock Exchange.

The pros and cons of market-linked GICs

Market-linked GICs are generally guaranteed not to lose money. In other words, your principal is guaranteed. The stock market exposure provides upside potential while the principal protection provides peace of mind. However, the upside potential comes at a cost.

The investor does not get to keep the full return of the index. They may only keep 80% of the return, for example. Or they may be limited to a maximum of 25% for a 5-year GIC—so 5% per year.

GIC issuers will generally offer GICs with exposure to indexes that are unlikely to lose money over the term, like the financial or utilities sectors, or a broad-based index. The issuing financial institution can stack the deck in their favour by selecting terms that are likely to benefit them based on historical data, meaning it is unlikely that the principal guarantee is worth it.

Should you trust financial advice from a bank?

Another point on this recommendation from the bank, Bryan, is that neither banks nor bank employees are required to provide financial advice that is in your best interest. That does not mean you cannot trust them, so I do not want to paint every bank or bank employee with the same brush. But you have to take their advice with a grain of salt.

The person recommending the GIC may only be licensed to sell GICs. They may not hold a mutual fund license or be licensed to sell you stocks, bonds or exchange-traded funds (ETFs). So, even if there is a better alternative investment option, they may be trying to hit their sales quotas by offering a solution that they are licensed to sell you.

Does that make GICs that track the markets bad investments? Not at all. They may be right for the right investor. My mother was a conservative investor who was uncomfortable with stocks and did not understand them well. She sometimes bought market-linked GICs.

Source link