Guaranteed Interest Certificate - Explained
What is a Guaranteed Investment Certificate?
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Table of ContentsWhat is a Guaranteed Interest Certificate?How Does a Guaranteed Investment Certificate Work?
What is a Guaranteed Interest Certificate?
A guaranteed investment (interest) certificate is a low-risk type of investment with an assured interest rate. These types of deposits are often issued by banks and trust companies in Canada. Since GICs are low-risk products, they are more likely to have lower returns than mutual funds, bonds, and even stocks. This is why they are often preferred as retirement plans. GICs are commonly referred to as term or time deposits but the same is called a Certificate of Deposit in the USA.
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How Does a Guaranteed Investment Certificate Work?
You are probably wondering how GICs work. Well, the certificate is simply a loan that investors give to a bank or an authorized financial institution. The bank will then pledge to repay the invested capital on a particular date in future. This is mainly done by setting a certain interest depending on the duration of your GIC certificate. The return claims that are promised are supported by a good credit rating and financial strength of the institution. A lot of factors influence the rate of return on a GIC including the length of the term and other interests outlined by the Bank of Canada. It is also highly unlikely to lose your principal unless the financial institution defaults. The Canada Deposit Insurance Corporation guarantees the banks making it difficult to lose your principal investment. How do banks make profits? Most banks will get a tidy profit from the difference between these guaranteed investments and the interest they get from mortgage rates. For example, the Canadian Guaranteed Investments Certificates currently has interest rates lower than 2 percent per year. In other instances, GICs interest rates are pegged on the growth of a stock market index. An example is the Toronto Stock Exchange Index which GICs can use to calculate their interest rates. Such investments are referred to as Market Stock Indexed GICs. GICs, like term deposits, have a set minimum deposit requirement. The interest accrued can be paid on a monthly, quarterly or even annual basis. Some GICs even pay compound interest at the end of their maturity period. Types of GICs There are various kinds of investment certificates such as the aforementioned Market Stock Indexed GICs, fixed-rate GICs and market growth GICs. Another common distinction in the type of GICs includes redeemable and non-redeemable guaranteed investment certificates. Redeemable GICs allow the withdrawal of funds from your invested capital after a set period without charging any penalties. Non-redeemable GICs, on the other hand, have different rules with most providing that any invested sum cannot be withdrawn before the maturity period expires. Common non-redeemable GICs, for example, require you to place funds on deposit for a year and make the funds available once the certificate matures. Some cashable GICs have the same one-year rule and only allow the funds to be withdrawn after an initial period of 30 days. An investor may choose to invest in a cashable GIC if they feel that they may need to withdraw their funds before the maturity date. However, the interest rate of cashable GICs is often lower than that of non-redeemable certificates.