GICs | Financial Crooks

Investors are usually torn between conflicting ideals: they want security and high returns. Banks, the first shopping stop for people looking to invest, have tried to create products that satisfy both of these needs. One such product is the non-guaranteed GIC. These GICs don’t guarantee an interest rate. Instead, their return is based on some external index. This is when GICs get risky!

Investing for High Returns with High Security

Occasionally, it seems that high returns can be achieved with high security.

For example, in 1991 I had some GICs invested with a 10.5% interest rate for 1 year. But that wasn’t as good as it sounds, because in 1991, inflation was 5.6%. That means the after-inflation return was only 4.9%. The profit was even less if I used a rate of inflation more realistic than the CPI. So that return wasn’t very high although the principal and interest were guaranteed and insured so the security was high.

Right now I have a few shares in a “blue chip” stock telco stock that pays a dividend over 5%. That rate isn’t as good as it sounds. At any time a company can cut its dividend or its shares can drop significantly in price. For example, if a class action lawsuit was successfully won against Canadian telephone companies, share values might plummet. There currently are several class action lawsuits brewing against the Telcos. So while the return is high, the security is low.

Why Do Banks Create These Specialty Market-Linked GICs?

Banks knew these market-linked GICs would appeal to both the investors need for safety and greed for growth. The banks had another motive, though. By carefully capping the maximum profits the GICs could earn, but by only guaranteeing the principal, the banks guarantee themselves a profit—with a better chance of capturing any upside profit than the investors!

An Analysis of the BMO Blue Chip GIC, a Typical Market-Linked GIC

Here’s an example of these risky non-guaranteed GICs. The Bank of Montreal offers a BMO Blue Chip GIC for 1 year that is RSP eligible. UPDATE: This analysis is based on a product on offer in 2013. The product may have been changed since that time.

The principal is fully guaranteed.
(Not guaranteeing the principal would be a deal-breaker to investors.)
There is a guaranteed rate of return.
(This is honey to lure the bears.)
There is potential for additional returns.
(This appeals to greed.)
It is RSP eligible.
(This is strategic marketing. Many investors want GICs for their RRSP.)
It offers “exposure to a diversified basket of Canadian companies from various industries.”
(Note keywords: diversified; Canadian; various; companies; industries. The use of “basket” gives a picnic feel to the purchase, encouraging warm, cozy thoughts.)
The minimum investment is reported as a low $1000.
(Many conventional GICs can be bought at $500 or lower increments. This appeals to people who don’t have thousands to risk, but it still ties up a substantial amount of money for the investment term.)
It is eligible for CDIC insurance, up to applicable limits.
(They don’t mention the insurance is only on the principal.)
In the Details, they state that the GIC will be automatically re-invested unless other instructions are provided.
(This ensures if you forget it matured it will be rolled over locking it in for another year. This type of negative-option investing is quite favoured by banks. I hope they have improved their system for changing the reinvestment instructions. I had such huge problems with them in the past that I actually stopped investing in GICs with a major Canadian bank.)
It’s interesting that it will be automatically reinvested in a 1-year GIC at the current rate. It’s as if they KNOW you don’t want to re-invest in this Blue Chip GIC!
It is not redeemable prior to maturity and it is not transferable.
(If you get buyer’s remorse you’re still stuck.)

What Kind of Profit Can You Make from a Market-Linked GIC?

If you scroll down in the Details section for this product
Total Return Potential for the Term:
0.10% to 3.65% annually depending on the performance of the reference portfolio.

That’s right. The MOST you can make is 3.65% for the year. That doesn’t sound like a “high” return to me. Investing in BMO stock itself today would get you dividends of 4.608%!

The Three Strikes Against the BMO Blue Chip Market-Linked GIC

Strike One: The Choice of Stocks Used to Calculate the Rate of Return for the GIC

What do you think of when you think Blue Chip stocks? Personally, I tend to think telephone companies, banks, pipelines, and utilities. Here’s what BMO thinks:
AIM, Aimia Inc
PRE Pacific Rubiales Energy Corp.
G Goldcorp
MG Magna International Inc.
T Telus Corp.
TCW Trican Well Service Ltd.
TRP TransCanada Corp.
SC Shoppers Drug Mart Corp.
ESI Ensign Energy Services Inc.
CTC.A Canadian Tire Corp. Class A.

They have assigned a 10% proportion to each of those stocks.

I don’t even know what one of them is! (AIM). And the 3 energy sector related stocks are real no-namers too: No Suncor; No Imperial Oil. (Esso); No Irving Oil; No Husky.

According to their fact sheet, this GIC mirrors investments held 40% in Energy, 30% in Consumer Discretionary, 10% in Materials, 10% in Consumer Staples and 10% in Telecommunications.

Would that be your pick for a Blue Chip collection? As I said earlier, personally I would have expected:
20% Telecommunications; 20% Pipelines: 20% Utilities; 20% Banks; 20% Consumer.

Strike Two: The Dividends Are Not Used to Calculate the Rate of Return for the GIC!

I honestly expected dividends to play a role in the performance of the stocks and therefore in the expected rate of return for the GIC. So I researched the current dividends for the mirrored stocks:
AIM 4.172; PRE 1.931; G 1.86; MG 2.268; T 3.724; TCW 2.169; TRP 1.84; SC 2.669; ESI 2.575; CTC.A 2.029

Then I found the Product Profile sheet and discovered in extremely fine print, it says:
“The rate of return for the term is determined without reference to any dividends or distributions paid on the securities.”

In other words, they ignore the dividends when deciding if you get the 0.1% or the 3.65% !

Now by definition, Blue Chip stocks are chosen as investments because they pay good dividends and are stable companies. They are not usually bought because they have strong growth (capital gains) potential.

Yet the return for this Blue Chip GIC is based solely on the capital gains (growth) of these stocks!

Strike 3: The Method of Calculating the Growth is Subject to Change at the “Agent’s” Whim!

Ok, if the return for this GIC is based solely on the capital gains of the stocks it mirrors, I thought I’d look at the last 5 years of stock prices for each stock. Here’s what I found:
AIM climbing steadily. AIM has a lawsuit against it in the UK.
PRE big drop in 2011 and early 2012
G big drop in 2012, slight rebound in 2013, currently dropping
MG climbing quickly after big drop in late 2011
T climbing steadily
TCW big drop end of 2011 through 2012, leveled off in 2013
TRP climbing steadily
SC flat since 2011
ESI bounces annually but doesn’t really go up for last 4 years
CTC.A very slowly growing

Frankly, that’s not a very promising picture.

But it doesn’t really matter, because in the same very fine print in the Product Profile I found:
“Each variable rate of return is the average of the effective returns on each security in the Reference Portfolio on the applicable calculation date (the “Average Effective Return”). The effective return of each security is based on the actual return of each security calculated as the percentage increase or decrease in the price of the security (the “price returns”) from the second business day after the issue date to the applicable calculation date. The effective return of each security used to calculate the Average Effective Return on a calculation date is determined as follows : if a price return is positive, the effective return is the maximum return for each security as set out in the Terms and Conditions for the GIC; if the price return is equal to or greater than the minimum floor return as set out in the Terms and Conditions for the GIC but less than or equal to zero, the effective return is the price return; and if the price return is less than the minimum floor return, the effective return is the minimum floor return. If market disruptions or other special circumstances affect the calculation of the return, the calculation agent may adjust or delay the calculation or payment of interest, estimate the value of a security in the Reference Portfolio, replace a security and/or determine the amount of interest, if any, that may be payable in an alternate manner.”

I’ll make that last bit legible:
“If market disruptions or other special circumstances affect the calculation of the return, the calculation agent may adjust or delay the calculation or payment of interest, estimate the value of a security in the Reference Portfolio, replace a security and/or determine the amount of interest, if any, that may be payable in an alternate manner.”

Say, what?! Someone just gets to arbitrarily decide the amount of interest IF ANY based on an alternate manner which you have not understood or agreed to? They can “replace a security” without your knowledge?!

I CALL: “FOUL!”

And I call you a fool if you buy this market-linked GIC. (Sorry, Mom.)

Read and Fully Understand All the Terms and Conditions Before Buying a Market-Linked GIC

I suppose there may be some market-linked GICs that make sense. Based on the ones I’ve seen, though, I‘d be very, very wary.

If you lock in $1000 for 1 year with a guaranteed return of only 0.10%, you’ve basically agreed that $1 in interest is acceptable to you. $1. For one whole year. At ING Direct, based on the rate today on a RSP savings account you’d get 1.35% or $13.50 on $1000. I know which one I’d choose.

Background Reading:

Stats Canada, Consumer Price Index Historical Summaries
Financial Post Canada’s Telcom giants face $18-billion class action suit over system access fees. http://business.financialpost.com/2012/06/28/canadas-telecom-giants-face-19-billion-class-action-suit-over-system-access-fees/?__lsa=70f3-e215
Other suits against Telcos
http://www.classaction.ca/classaction-ca/master-page/actions/consumer-protection/current-actions/bell-canada.aspx
http://www.cbc.ca/news/canada/north/story/2013/03/04/nwt-bell-mobility-lawsuit-anderson-911.html
http://www.cjad.com/CJADLocalNews/entry.aspx?BlogEntryID=10491462
Product Profile for the BMO Blue Chip GIC
http://www.bmo.com/pdf/term/BCGICSheet-Eng.pdf
GIC webpage for the BMO Blue Chip GIC
http://www.bmo.com/home/personal/banking/investments/gic/gic-navigator/bmo-progressive-gics/bmo-blue-chip-gic/details?tpFilter=0

Related Reading

Join In
Have you had a bad experience with a market-linked GIC? Did you read the fine print and refuse to sign on the dotted line? Please share your experiences with a comment.

I noticed on a chat board recently that some people do not understand how GICs work. They wanted to know if they could cash their GIC at any time to pay a bill, buy a car, or re-invest somewhere else at a better rate. In short, they wanted to cash their GIC before it matured.

How Do GICs Work? What Is Agreed Between the Issuer and the Buyer?

True Guaranteed Investment Certificates are not bank accounts or cashable term deposits. The issuer is selling the buyer a guaranteed return of their money plus the agreed on interest at the maturity date.

For example, a bank might sell a client a $2000 GIC with an interest rate of 2.3% per year that matures in 2 years. That 2.3% interest rate is higher than what the buyer could earn by putting the money in a bank account or a cashable term deposit at that specific time.
These standard, regular or true GICs cannot be cashed before they mature. You’re agreeing to lock in the money for the term to maturity.

What if Interest Rates Change After Buying a GIC?

If interest rates drift lower, the GIC buyer has guaranteed a good interest rate for two years. If interest rates rise, however, the buyer has locked in their money for the term to maturity at what may now be a lower interest rate. In the first case, it’s great! In the second case, it’s tough.

Standard GICs Cannot be Cashed without the Consent of the Issuer

A regular GIC is a fixed term contract. It cannot be cashed. You can’t get your money out before the maturity date, even if the interest rates have changed, or you have lost your job, or you want to get married.

The President’s Choice Financial “Must Have” GIC is an example of this. It clearly states that the GIC is “non-redeemable and must be held till maturity.” (http://www.banking.pcfinancial.ca/a/products/gic.page?region=ON&language=en&signinop=OB)

You Don’t Have to Buy a Standard GIC

If you aren’t sure whether you will need the money early, consider alternative types of investments. ING Direct GICs are all Cashable GICs. If you need to cash them before maturity, you will get back all of your principal and you may get a small “early redemption interest” payment as well depending on how quickly you cash it after buying it.
(http://www.ingdirect.ca/en/save-invest/gic/index.html)

Most banks offer some type of GIC that can be cashed. These GICs might not offer the length of time you want to invest for, or may only offer a much lower rate than a regular GIC, or they might limit when you can cash them early, or they might charge a fee for cashing early. You really have to read the details for each product you are interested in.

You Can Cash a GIC Early if the Issuer Agrees

The exception is you can cash a standard GIC early *IF* the issuer agrees.

For example, when we bought our first house, our RRSP investments were in GICs. Some of them were in the middle of the term and not ready to cash. Fortunately, we were getting our mortgage from the same bank that held our RRSP GICs. They readily agreed to let us cash the GICs early, without a penalty, so we could withdraw the money under the Home Buyer’s Plan and use it for a down payment.

Paying a Penalty to Cash a GIC Before It Matures

Some issuers will allow you to cash out a GIC early for a penalty.

“Extraordinarily nice” institutions might allow you to get your principal back and some of the interest. ING Direct offers this type of GIC.
“Nice” institutions might give you back your initial cash but not give you any interest. This is not uncommon in the case of a severe unexpected financial problem such as a death.
“Regular” institutions will not pay you any interest and will penalize you part of your original investment. So if you paid $1000 for your GIC they may only give you less than $1000 back.

Re-Selling a GIC Before It Matures

In theory, what the financial institution does when it cashes a GIC early is it looks for someone to buy it. Usually, they will have to sell the GIC at a discount to get someone to buy it. So if it was a $1000 GIC paying 2% interest at the end of a 1 year term (and therefore worth $1020 when in matures) they may have to sell it for $900 to find someone who will buy it.

Only GICs which are transferrable and assignable can be re-sold. Most standard, regular, true GICs aren’t.

In general, you can’t re-sell a GIC yourself. The issuer would have to agree to the sale and most won’t.

What Can You Do If You Need Cash and Your GIC Is Locked Up?

You might be able to ask a friend or relative to loan you the money with a written agreement that on the day the GIC matures you will collect the principal and interest and pay them back. Even if they are good friends, you should give them a promissory note in writing, preferably witnessed by a non-friend. That would mean they could easily take you to court and win if you didn’t pay them back. But since you’re going to pay them back, that would be ok, right?