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 Is this idea now outdated?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.

Written: 2012
Reviewed: 2023
Revised: 2023

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 for a GIC covered by CDIC insurance.

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, one online bank 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 investors 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.

You can see that locking in for 5 years at 2.5% earns less than buying 1 year terms that increase by 0.25% 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.

.Related Reading

• Investing in GICs at the Banks an Exercise in Anger Management to Optimize Earnings
• Maximize GIC Returns by Carefully Considering the Annual Rates Before Locking In Long Term
• Pros and Cons of Buying GICs in a Self-Directed Online Brokerage Account

Join In

Do you think you should stick with a rolling 5-year GIC ladder regardless of the rates? Please share your opinion with a comment.

Let’s consider again why one bank wanted to renew my GICs by locking them in for a five-year term, admittedly to the product with the best average annual return over the life of the product.

Written: 2012
Reviewed: 2023

Here’s a comparison of several offerings from CIBCs website on October 28, 2012.
None can be cashed before maturity. All are for an investment of $1000:

• a 1-year GIC, pays 0.900%
• a 1-year Bonus Rate GIC, pays 1.1%
• a 3-year GIC, pays 1.25%
• a 3-year Bonus Rate GIC, pays 1.45%
• a 5-year GIC, pays 1.75%
• a 5-year Bonus Rate GIC, pays 1.9%
• a 3-year Escalating Rate GIC, pays 1%, 1.1% and 2.55% (effective yield 1.5475%)
• a 5-year Escalating Rate GIC, pays 1%, 1.35%, 1.75%, 2%, 4.05% (effective yield 2.0043%)

And that’s not all of the GIC products they are offering!

Notice the “Bonus” Rate
First, you can see that you can get 0.2% more for a 1 or 3 year term GIC just by buying the Bonus Rate version instead of the regular version. You might get even more if you phone. Buyer beware!

Notice the Increasing Rate
Next, you can see that CIBC expects interest rates to increase over the next 5 years. If they expected rates to decrease, their long term certificates would pay the same or less than their short-term certificates.

Notice the Cunning Marketing Tactic
You can also see a marketing tactic in the Escalating Rate GICs. They offer a very high rate (comparatively) for the final year of the product to catch the buyer’s eye. If you look at the effective yield, however, it’s easier to see the low impact of that one year of higher rate.

Quick Guess of Which to Pick
A quick glance at these offerings suggest that your best decision is to lock in for five years in the Escalating Rate product to earn an effective yield of 2.00043%.

Thinking Critically about Future Interest Rates
But it’s time to apply some critical thinking skills.

Everyone from the Bank of Canada to the local free newspaper keeps stating that interest rates are exceptionally low. Everyone seems to agree that rates have to go up, and fairly soon. (I notice they’ve been saying that for two years already though.)

If Interest Rates Will Decrease then Locking In May Earn the Best Return
If you believe that interest rates will not go up in the next 5 years, or will go down, then yes, the 5-year Escalating GIC is the best option on that list.

If Interest Rates Will Increase What Should You Do?
But if you believe that interest rates will go up 0.5% a year, it’s not best to lock-in to that Escalating Rate 5-year GIC. If rates go up 0.5% a year, you could make almost $4 more by buying a series of 1-year GICs.

More importantly, a series of 1 year GICs would give you the most flexibility for re-investing that money each year depending on rates and other options.

How Does the Bank Predict Future Interest Rates?
Here’s what the bank may be thinking:To keep it simple, I’ve assumed that no interest is earned on interest (compounding) until the start of a new year.

The first row is what CIBC was offering for the Escalating Rate GIC, with the eye-catching 4.05% in the final year.

The second row is probably what they are basing their offering on: If the interest rates step up to 2% for 2 years, and 2.5% for 2 years, the total amount earned by the GIC is about the same. But it doesn’t have the eye-catching rate, so it’s harder to market.

Now CIBC is in the business of making as much profit as possible, so if it is offering interest rates per year for the next 5 years of
1.1, 2, 2, 2.5, 2.5

it is likely expecting to have to offer GIC rates for the following 5 years for 1-year GICs at
1.1, 2.25, 2.25, 2.75, 2.75
or higher.

What would that second set of rates earn?

How Do You Predict Interest Rates?
What if you think interest rates on 1 year GICs will be: 1.1, 2. 2.5, 3, 3.5?

You can see you will lose money if you lock in that Escalating Rate GIC for 5 years if interest rates follow your pattern.

We’re Not Talking Huge $$$ Here
You can see that the total dollar differences between the different scenarios are fairly small.

So why would you lock in for 5 years?

If rates took a high jump, you’d be locked in.

The chance of rates dropping significantly in 5 years seems small. And even if they did, you’d probably be looking at deflation, not inflation, so your money would buy more than it does now.

My Interpretation: Don’t Lock in GICs for Long Terms at Low Rates
My opinion is locking in rates for 5 year terms only makes sense when rates are high and are unlikely to rise any higher. Locking in for long terms when rates are low seems to be a high risk for a low reward.

Related Reading

• Pros and Cons of Buying GICs in a Self-Directed Online Brokerage Account
• Investing in GICs at the Banks an Exercise in Anger Management to Optimize Earnings

Join In
Do you agree that it’s unwise to lock in investments for long terms at these rates? Does it bother you that banks use a marketing gimmick to offer a pseudo-high interest rate by only offering it for the final year of a multi-year term? Please share your opinion with a comment.