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Home Financial Health Blog Bank, borrow, manage debt and improve cash flow Conservative Investors: Index-linked GICs rarely deliver what they promise

Conservative Investors: Index-linked GICs rarely deliver what they promise

by Tim Weichel

Financial institutions continue to create and market products like index-linked GICs that harvest many fees and commissions, but defy investment logic.

Index-linked guaranteed income certificates (GICs) promise to safeguard a portion of investors’ portfolios. In volatile markets like the ones we’ve been experiencing, these products may seem like an appealing place to put some of your money.

Index-linked GICs provide the buyer with a return that is “linked” to the direction of the stock market in a given period. The link depends on a formula or set of rules that is buried in the fine print. A quick look at the rules on these deals may give you the impression that the investor can profit substantially with little risk.

These investments are marketed as offering all of the advantages of stock-market investing with none of the risk. But banks and insurance companies aren’t in the business of giving customers something for nothing. The capital gain that holders get depends on an ingenious formula which is cleverly designed to sound generous while minimizing the potential payout.

For instance, the payout may depend on the average level of the index over the course of a year, rather than the year-end value. This will tend to diminish the performance that determines investor returns.

Look closer and there’s a tax disadvantage

Another drawback is that returns on index-linked GICs (or bonds linked to an index) are taxed as interest. That’s because you’re not actually investing in the stock indexes themselves; you’re just getting paid interest based on the change in the indexes. That’s a drawback because interest is the highest taxed of all investment returns.

Usually, stock-market investing produces capital gains and dividend income, both of which are taxed at a lower rate than interest. (Of course, if you hold the GICs in an RRSP, all income is tax deferred.)

These GICs do protect your principal. But few investors if any make a good return on index-linked GICs. Most make less (at times substantially less) in index-linked GICs than they would have made in old-fashioned GICs.

If safety is your primary concern, you’d be better off with “plain vanilla” stocks and bonds. If you already own index-linked GICs, you may wish to cash them in at the earliest opportunity. If you don’t own them, you might want to stay out.

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