The 5-year GIC Ladder Strategy: No Longer a Scheme to Maximize GIC Returns

Many financial advisors used to recommend setting up a GIC ladder of 5-year GICs to maximize GIC returns. Is this idea now outdated?


What is a GIC Ladder?

To make a GIC ladder, an investor would buy a GIC with a 1-year term, another with a 2-year term, a third with a 3-year term, a fourth with a 4-year term, and a fifth with a 5-year term. From then on, whenever a GIC matured, it would be re-invested for a new 5-year term.

The idea was that this strategy would smooth out bumps in interest rates. Generally, the interest rate for a GIC that cannot be cashed for 5 years is the highest one offered.

When the 5-Year GIC Ladder Strategy Worked Best
This strategy did actually result in optimized earnings for some investors. As interest rates fell year after year approaching 2010, investors found they were still earning good rates on their not-yet-matured long-term GICs.

However, when they went to re-invest, they could not get the same good rates for the new certificates. For example, ING Direct was offering RSP 5-year GICs at 4% in 2008, but their best available 5-year had dropped to 2.3% in 2012.

When does the 5-Year GIC Ladder Strategy Work the Worst?
You can probably guess that this strategy is the most dangerous when interest rates are rising quickly and sharply.

If interest rates are increasing slowly and gradually, perhaps at 0.25% per year, then investor’s won’t lose too much by locking in for 5 years at a time.

However, if interest rates are increasing quickly, say at 1% per year, or sharply, say in a sudden spike of 3% one year, investors could lose a lot by being locked in for a long time at a lower rate.

Here are some examples of these scenarios.
Value of 1000 invested. For simplicity the interest is only compounded at the end of each year.

Year 1 Rate % Year 2 Rate % Year 3 Rate % Year 4 Rate % Year 5 Rate % Year 6 Rate % Year 7 Rate % Final Value
2.5 2.5 2.5 2.5 2.5 2.5 2.5 1189
2 2.25 2.5 2.75 3 3.25 3.5 1209
2 3 4 5 6 6 6 1366
2 4 4.5 4.5 6 6 6 1380

You can see that locking in for 5 years at 2.5% earns less than buying 1 year terms that increase by .25% per year. However, the difference is not painfully large.

Locking in for 5 years when rates are increasing 1% a year or when rates are spiking up 2% every few years however is costly. The investor was lost between $175 and $200 by locking-in. A loss of $200 on an investment of $1000 is a fairly considerable loss in income.

Using a 5-year GIC Ladder Strategy Will Reduce GIC Returns
My conclusion is that using a 5-year GIC ladder strategy right now would result in lower overall GIC returns. I believe interest rates will increase slowly and gradually for a couple of years, and then we will have a sudden spike for one or two years before they settle in to a new long term pattern.

For this reason, I am keeping my GICs invested in short terms and I am prepared to capture any spikes fairly quickly.

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Do you agree that it’s unwise to lock in investments for long terms at these rates? Or do you think you should stick with a rolling 5-year GIC ladder regardless of the rates? Please share your opinion with a comment.

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