Module 7 · GICs, Ladders and Individual Bonds Advanced

For many Canadians, the best bond is not a bond at all. It is a GIC: a fixed rate, a fixed date, deposit insurance and a value that never moves. This module covers GICs and deposit insurance properly, shows you how to build a ladder that pays out every year, and explains when buying individual bonds makes sense.

GICs

A guaranteed investment certificate (GIC) is a deposit with a bank, trust company or credit union for a fixed term, at an interest rate set on the day you buy. Terms usually run from 30 days to five years, sometimes longer. The US equivalent is the certificate of deposit (CD).

A GIC has no market price. It is worth what you put in plus the interest earned so far, so it does not fall when interest rates rise. In exchange, your money is usually locked in.

Market-linked GICs are sold as “stock market upside with no downside”. Read the terms closely. With a cap on gains, no dividends and the real chance of earning zero, many have done worse over time than a plain GIC. Most investors are better off keeping the safe money in a plain GIC and the growth money in a stock fund.

Where to buy. You can buy GICs from your own bank, or as brokered GICs through a discount brokerage account, which offers GICs from many different issuers in one place, often at better rates. Brokered GICs can be held in a TFSA, RRSP or FHSA, and they are usually non-redeemable.

Interest. Interest is paid out each year, monthly, or compounded and paid at maturity. In a taxable account, compound GIC interest is still taxed each year as it is earned, even though you do not receive it until the end. Module 9 covers this.

Deposit insurance

GICs and other deposits at member institutions are protected by the Canada Deposit Insurance Corporation (CDIC), a federal Crown corporation. If a member bank fails, CDIC pays back eligible deposits up to the limit.

The key word is category. Deposits in your own name are one category. Joint deposits, deposits held in trust, and deposits inside each kind of registered account (such as TFSAs, RRSPs, RRIFs, FHSAs and RESPs) are separate categories, each with its own $100,000 of coverage.

Example. At one member bank you hold $80,000 of GICs in your own name, $60,000 of GICs in your TFSA and $90,000 in your RRSP. Each amount is under $100,000 in its own category, so all $230,000 is covered. But $150,000 of GICs in your own name at one bank would leave $50,000 uninsured. You could keep $100,000 there and move the rest to a different member institution.

• Eligible deposits include savings and chequing accounts, GICs and other term deposits, including foreign-currency deposits. Stocks, bonds, mutual funds and ETFs are not covered, even when bought through a bank.
• Some banking groups run more than one member institution, each with its own coverage. Check the CDIC member list.
• Credit unions are covered by provincial deposit insurers instead, with limits that vary by province and are unlimited in some.
• In the US, the FDIC covers up to $250,000 per depositor, per bank, per ownership category.

Building a ladder

If you put all your safe money into one five-year GIC, you face two problems: you are stuck if you need cash in year two, and you are betting everything on today’s rate. A ladder solves both.

Example. You have $50,000. Instead of one GIC, you split it into five equal “rungs” of $10,000, maturing in 1, 2, 3, 4 and 5 years.

Each year, one rung matures. If you don’t need the money, you reinvest it in a new five-year GIC at the top of the ladder. After five years, every rung is a five-year GIC, usually the best-paying term, yet one still matures every single year.

What you get on day one. Suppose one- to five-year GICs pay 3.6%, 3.7%, 3.8%, 3.9% and 4.0%. With equal rungs, the ladder’s average rate is (3.6 + 3.7 + 3.8 + 3.9 + 4.0) ÷ 5 = 3.8%.

A ladder does three things for you:

• Cash every year without breaking a GIC early.
• No forecasting. If rates rise, the next rung is reinvested at the higher rate. If they fall, most of your money is still locked in at the old ones. You end up with an average of rates over time.
• Mostly long-term rates once it is fully built, with short-term access.

The same method works with individual bonds, using one bond per maturity year. The article How to build a bond ladder walks through it step by step.

Buying individual bonds

Most discount brokers let you buy individual government and corporate bonds. You get a known coupon, a known maturity date and, if you hold to maturity, a known result. But there are costs that are easy to miss.

• The markup is hidden in the price. There is often no separate commission. Instead, the dealer sells you the bond at a slightly higher price, which means a slightly lower yield. Compare the yield to maturity, not the price, across brokers and against a similar government bond.
• Selling early can be expensive. Many bonds trade rarely. If you need to sell before maturity, the price you are offered may be well below fair value.
• Minimum sizes. Some bonds can only be bought in large amounts, which makes it harder to spread money across many issuers.
• Call features. Some corporate bonds are callable: the issuer can repay them early, usually when rates have fallen, which is exactly when you would least like to reinvest.
• Concentration. One corporate bond is one company’s credit risk (Module 4). Government bonds avoid this; a single corporate bond does not.

For most people, individual bonds make sense for one job: a government bond (federal or provincial) that matures on a date you need money, held to maturity, usually in a registered account. For everything else, a GIC or a bond ETF is simpler.

Ladder or bond ETF?

Module 8 covers bond ETFs in detail. The choice between them and a ladder comes down to what the money is for.

Put it into practice