If you pick investments based on a popularity contest, chances are you would be on the hunt for something with a guarantee. In times like this where equity markets have disappointed investors for the last three years, investors are searching for the things that they miss like guarantees, income and conservative.
I am a believer that psychology plays a huge role in investing, and while I fundamentally believe that investors should not give up on the markets and mutual funds, there is no question that clients, readers and investors in general are asking and seeking information on guaranteed investments.
What does guaranteed investing mean?
Typically when the word guarantee is used, investors are referring to the guarantee of capital and that they will not lose capital under any circumstances. If they invest $100,000, then they will continue to have $100,000 at a minimum no matter what happens to the markets, economies, or interest rates.
Let me share with you some of the most popular strategies to guarantee your investment capital.
- High Interest Bank Account. Those who are familiar with my articles and philosophies will know that I am a huge proponent of high interest bank accounts. Currently, Manulife Bank is paying 3.05% from dollar one with no fees and full liquidity. ING bank is paying a close 3.00%. President’s Choice rounds out the three most popular choices with an account paying 2.75%. In all cases, the interest rate is a floating rate but the capital cannot be lost.
- Conventional GIC. Most investors will be familiar with the conventional GIC. You pick a term 1 to 5 years and you will be guaranteed a specific interest rate for that term. Today 1-year rates are 3.5% and 5-year rates are 4.5%. The most important tip I can give investors looking to invest in GICs is to shop for the best rates. In many cases, shopping for rates can add over 1% everytime. Don’t settle for posted bank rates because they are usually the lowest rates on the market.
According to Dave Newman, president of the Federation of Independent Deposit Brokers (FCIDB), “GIC investors should really use deposit brokers to do the shopping. Investors will get the best rates without paying any fees. The deposit broker business is the fastest growing channel.
- Index linked GIC. The index linked GIC is an interesting product in that the capital is guaranteed. However, the return on the capital is dependent on the performance of an underlying index. Typically, you must choose between a 3 and 5-year term. The index is usually one of the major indexes like the TSE or the S&P500. When it comes to index linked GICs, it is important to read the fine print on how your return is actually calculated. The linked GIC appeals to investors who want to preserve the capital but are willing to risk the growth a little. At worst case you will get your capital back with no growth. There are many unique linked products on the market linking to the performance of some of the most popular mutual funds.
- Step Rate GICs. Step rate GICs are becoming increasingly popular. Often the advertisements for these products lure you in with a high interest rate in the last year. An example of a step rate GIC is a GIC that pays 2% in the first year, 2.5% in the second year, etc. If you calculate the average annualized yield, you will find that you probably could have found a better conventional GIC over the 5-year term. Step rate GICs are not bad, you just have to understand the true return behind the marketing.
- Segregated Funds. Segregated funds are interesting because the guarantee of capital only occurs in certain circumstances. Most often, you are guaranteed your capital if you die or if you invest for a full ten-year period. Many investors have found that when they buy segregated funds their statements will show the day to day fluctuations just like any other mutual funds or non-guaranteed investment. You must be careful about getting too secure with segregated funds. While the guarantees do exist, you must also read the fine print and understand when the guarantees apply and how they are calculated. You also need to understand that the guarantees are not free and often they do not come cheap. Higher fees are standard when it comes to segregated funds. You must simply rationalize whether you perceive benefits in having mutual fund type investments with guarantees of capital.
For the next couple of weeks, we will continue our discussion of guaranteed investing delving into some specific strategies and concepts.
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