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Beth Buczynski
Market-linked guaranteed investment certificates (GICs) are considered the least predictable type of GICs, but they can also be the most lucrative.
Market-linked GICs are kind of a hybrid investment. You get the security of a traditional GIC but the interest rate is based on the performance of an index fund, like the S&P/TSX 60 Index.
All GICs guarantee your initial investment, but market-linked GICs have the potential to earn interest at a higher-than-typical rate if the stock market rises. Of course, things could also go the other way: if the stock market experiences a net loss during the term, you may not see any gains at all.
Market-linked GICs vs. fixed-rate GICs
With both types of GICs, you’re guaranteed to get at least your original investment back, as long as you let the GIC mature. The difference between a market-linked GIC and a fixed-rate GIC is all about the potential interest you could earn.
When you buy a fixed-rate GIC, you know the interest rate upfront, so you know exactly what you will earn by the end of the term.
With a market-linked GIC, you have no idea what you will walk away with at maturity because the interest rate depends on the performance of an unpredictable stock market. You could earn more than if you’d chosen a fixed-rate GIC, but you could also walk away with nothing but your original investment. You won’t know how much you’ve made in interest until the GIC has matured.
Because market-linked GIC returns are tied to the stock market, they are especially unpredictable during times of economic turmoil. Fixed-rate GICs, on the other hand, often become more attractive in such environments, particularly when interest rates are rising.
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How to compare market-linked GICs
A market-linked GIC could be a great option for people who are willing to take a little more risk than a traditional GIC, but not as much risk as investing directly in the market. But before you jump on board, make sure to compare GIC rates from different financial institutions and ask the following questions to make sure you understand the differences between market-linked GICs, other types of GICs, and other kinds of investments:
- Is there a maximum performance guarantee? Some products specify maximum returns that might be lower than the return of the market they’re linked to. For example, if a GIC has a maximum full-term return of 35%, that’s all you’ll get, even if the market goes up 40%. If you’d invested in stocks or index funds directly, you’d benefit from the full increase.
- Is there a minimum performance guarantee? While maximum performance guarantees are common, minimum guaranteed returns are not. If your GIC has no minimum performance guarantee and the stock market trends downward during your term, you might walk away with low or no gains. That’s not as good as the guaranteed interest you’d earn with a traditional GIC — but it’s better than the potential loss of your principal if you’d invested directly in the market.
- What are the tax consequences? When you invest in the stock market, the money you earn is considered capital gains, and only 50% of those capital gains are taxable. But when you invest in a market-linked GIC, the money you earn is interest, which is taxed at the same rate as the rest of your income. That means you’ll pay more in tax on earnings from your market-linked GIC than if you earned the same amount in capital gains from a different investment.
- Could a lack of liquidity be a problem? Market-linked GICs are locked in, so you cannot access your money before the term is up. If you might need to use this money in that time frame, a market-linked GIC is not a good option for you. A cashable GIC would be a better choice.
- What is the participation rate? A participation rate is a predetermined percentage that represents the correlation between your GIC and the performance of the stock market. Essentially, it means that your performance will not be based on 100% of the underlying stock market return — it might be 60% or 80%. Again, this means you will not earn as much as if you had invested directly in the same stock market index.
Nerdy Tip: It’s also important to know what index your market-linked GIC is tied to. Some indexes or mutual funds may be more volatile than others, so do your research before investing.
Pros and cons of market-linked GICs
A market-linked GIC might seem exciting because it’s a “safe risk,” which sounds like the best of both worlds. But it’s important to consider the pros and cons before you invest in one.
Pros
- Capitalizing on market shifts could lead to higher earning potential.
- Your principal is not at risk.
Cons
- Market-lined GICs usually have maximum return limits.
- Not as tax-efficient as investments that earn capital gains.
- Not as liquid as other types of GICs.
Frequently asked questions about market-linked GICs
Typically, no. Unlike cashable or redeemable GICs, you must wait until the market-linked GIC matures to access your money.
There’s no chance of losing the money you originally invested in a market-linked GIC, which is called your principal. However, you may not walk away with any gains.
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