In addition to the payout schedule, you’ll want to understand how interest is compounded for the GIC you’re considering.
- With simple interest, the bank pays interest on the initial principal only. This means that if you invested $100,000 into a two-year GIC with a 1.25% return, you’d receive $1,250 in interest every year. So at the end of year two, the interest payout will total $2,500.
- With compound interest, the bank pays interest on the initial principal and the interest earned at every interval. For the same investment as above, with compound interest, you’d earn $1,279.19 in interest after one year, and $2,515.52 at the end of the two-year period. That’s an extra $15.52.
Clearly, compound interest is the higher-paying option, but also pay attention to the payout schedule. In the above scenario, there’s an annual payout, but if it had compounded monthly interest, you would earn even more—at the end of your two-year term, the CIC would have $2,530.18 in monthly compounded interest.
Remember that you are agreeing to the terms (the principal and how interest will be paid) when you sign the GIC contract. Once that’s done, you cannot change the terms and conditions. The payout terms will affect the amount of interest you will ultimately earn, so it’s important that you review them carefully.
How does the Bank of Canada’s overnight rate affect GIC rates?
The Bank of Canada (BoC) sets a policy interest rate, also known as the overnight rate. This is the interest rate at which financial institutions borrow or lend funds to each other, and it is almost always the lowest available rate at a given time. Financial institutions also have a prime rate, which moves in conjunction with the BoC’s overnight rate.
Changes in the prime rate affect the interest earned on GICs, high-interest savings accounts (HISAs) and other investment vehicles. When the overnight rate increases, individuals can earn higher interest on the aforementioned types of savings, because financial institutions have more flexibility to compete on the interest rates they offer. On the other hand, people who are retired or living on a fixed income from a savings fund can be negatively affected when the overnight rate drops.
Does inflation impact GIC rates?
GICs are term deposits, meaning that you essentially “lock” them in for a set amount of time. If, during that time, the inflation rate outpaces your interest rate, you’ll actually be losing money in real terms. In the example above, your $100,000 deposit would earn $1,250 in simple interest at the end of the term. But if the inflation rate is 2%, you’re actually losing 0.75%, or $750, annually. Deflation, on the other hand, can help your investments and increase the buying power of the money you earn. All of this is to say that inflation and deflation are important variables when you’re evaluating the GIC interest rates available to you.
The best time to buy GICs
The best time to buy a GIC is when you’re saving up for a goal, like school tuition, a down payment or a trip. But it can also be good to invest in GICs when you’re feeling risk-averse. You might be considering a GIC as a way to balance your portfolio or to generate some passive income in retirement or if you’re taking time off work to raise your family, for example. While GICs don’t tend to have the highest interest rates of all the investment vehicles available to Canadians, they do offer a low-risk way to store money while earning some interest.
If you’re considering adding a GIC to your portfolio, you’ll want to pay attention to a few key numbers. The interest rate of the GIC itself is a good starting point. Generally, the higher the interest rate, the more attractive the product. It also pays to look at the likely rate of inflation or deflation you can expect during the term, to determine whether that factor is likely to eat into your profits or enhance them. If you find that the numbers work out, a GIC can be an excellent no-risk investment for a set period of time.
