If you have long-term money in GICs, this post is for you. I know, rates are abysmal, and I’m not here to talk you into investing in mutual funds, or ETFs, or to buy bonds directly. If you’re comfortable with GICs, and you can meet your income or capital-preservation goals with them, then keep on keeping on.
With that little slice of affirmation out of the way, I want you to something for me: think back to the last time that one of your GICs matured. Did you have a conversation – either with your bank representative or with yourself – that went something like this?
The difference between the one or two year rate and the five year rate isn’t that great. Interest rates are going to go up soon. (They certainly can’t get any lower.) I’ll just pick a shorter-term GIC and by the time it matures rates will be higher.
Maybe you’ve even had that conversation more than once. I’m here to ask you not to have it again. Please, for the love of all that’s holy, keep your GICs in a five-year ladder, renew into another five-year at each maturity, and stop trying to outguess interest rates.
You aren’t doing yourself any favours. Let me demonstrate.
Related: How to create a bond or GIC ladder
Let’s assume that you had $100,000 to invest in GICs ten year ago. You could either set up a five-year ladder (by breaking it up into $20,000 sections and investing them across one, two, three, four, and five-year term, rolling each into a new five-year term at each maturity), or keep it in successive one-year terms until rates go up enough to make you happy.
The following chart shows the downward progression of rates every year across the top cells and the compounding balance of the two strategies across the bottom, and you can see that the GIC ladder wins handily.
You’d have been ahead by over $17,000 by the end of the decade, just by ignoring what you thought rates were going to do and keeping to a time-worn, boring old strategy like GIC laddering.
GIC rates from 2005-2014
But that’s all well and good as rates were going down. Investing in a five-year GIC in 2005 was worth 3.13%. These days we’re staring down the barrel of 1.95%, and you want me to lock that rate in for five years? Interest rates have nowhere to go but up!
Because I like you, I turned the chart around. Now we’re imagining that rates are going to follow the same slow progression on the way back up over the next ten years, but the choice between ladder or rolling one-year terms is the same.
Hypothetical GIC rates from 2015-2024
This time, the GIC ladder wins by $13,000.
I see two emotional biases at work when faced with choices like this: we like the idea of putting off a hard decision until next year when the choices available have to be better than they are this year, and we like to think that interest rates, markets, and economic cycles follow patterns that we can recognize, identify, and use to our advantage because we’re smarter than your average bear.
But – as in every investing decision – emotions shouldn’t enter into the equation. The math holds. So long as a rate premium, however small, is offered for longer terms, the five-year GIC ladder will always win, and so long as longer terms (and GICs) fit your investing purpose, you should always be using a five-year GIC ladder.
Sandi Martin is an ex-banker who left the dark side to start Spring Personal Finance, a one woman fee only financial planning practice based in Gravenhurst, Ontario. She and her husband have three kids under six, none of whom are learning the words to “Fidelity Fiduciary Bank” quickly enough. She takes her clients seriously, but not much else.