What Is A Market-Linked GIC?

Much like traditional GICs, market-linked GICs are investment vehicles that allow you to earn investment income without the risk of losing money. In exchange for locking in your investment for a set period of time, you can earn interest while protecting your capital.

Definition and Key Features

Market-linked GICs are guaranteed investment certificates that pay a variable amount of interest depending on the performance of a group of stocks. When those stocks do well, you get to share in the earnings. If they do poorly, you’re guaranteed to keep your initial investment.

Key features of market-linked GICs include:

• Returns linked to the performance of an underlying index. Rather than a fixed interest rate, market-linked GICs pay a variable rate of interest based on the performance of a defined group of stocks. The degree to which the underlying index affects the rate of return is known as the “participation rate.”
• Fixed terms. Most market-linked GICs require a commitment between one year and five years.
• Principal guaranteed. You are guaranteed to have your initial investment returned to you when the GIC returns.
• Guaranteed interest rate. With many market-linked GICs, you’re guaranteed to earn a minimum amount of interest, even if the underlying index loses money.
• Maximum full-term return. Many market-linked GICs specify a maximum return, even if the underlying index does better.

Comparing Traditional and Market-Linked GICs

At their core, traditional and market-linked GICs share the same general features:

• Both traditional and market-linked GICs protect your initial investment with no possibility of losing money.
• Both traditional and market-linked GICs can be opened in several different accounts, including RRSPs and TFSAs.
• Both traditional and market-linked GICs can be eligible for CDIC insurance.

The differences between traditional and market-linked GICs mostly have to do with how they earn interest:

• Traditional GICs pay a fixed rate of return, whereas market-linked GICs pay a variable rate of return based on the performance of an underlying index.
• Traditional GICs always pay interest, whereas market-linked GICs may not always deliver a return on investment.
• Traditional GICs are available for terms as short as 30 days, whereas market-linked GICs typically require a two-year commitment or longer.

When you invest in a market-linked GIC, you get to earn money based on the performance of the stock market without putting your initial investment at risk.

Participation Rate and Underlying Index

When you invest in a market-linked GIC, you earn interest based on an underlying index and what’s known as the participation rate.

The underlying index refers to the assets the GIC’s returns are based on. Each market-linked GIC is based on a different index. For example, a market-linked GIC could follow the top 60 Canadian stocks, a portfolio of utility stocks, or just about any other index you can imagine. Each bank offers a different selection of market-linked GICs with different underlying indices.

The participation rate refers to how much the underlying index affects the GIC’s performance. For example, a market-linked GIC with a participation rate of 60% would pay 60% of the underlying index’s growth as interest. That means if the underlying index went up 10% over the GIC term, the GIC would pay 6% interest (10% x 60% = 6%).

Capital Protection and Potential Risks

The primary benefit of market-linked GICs is that you can invest in the stock market without risking your capital. Unlike direct investments, which can cause you to lose money, market-linked GICs protect your capital, and many pay minimum returns regardless of how the underlying index performs.

The risk of market-linked GICs is that you may not get the same return you would by investing directly in the underlying index. That’s because most market-linked GICs have a participation rate of less than 100% or put a cap on how much interest you can earn.

Are Market-linked GICs a Good Investment?

Whether market-linked GICs are a good investment depends on your investing goals.

Because they allow you to earn more interest while protecting your capital, market-linked GICs make good low-to-medium risk investments. For example, market-linked GICs may be right for you if you’re nearing retirement age and want to continue growing your wealth without risking what you’ve already earned.

Market-linked GICs may not be right for you if you’re willing to take on more risk for the possibility of higher gains. You may also want to explore other options, such as traditional GICs, if you’re not willing to take the risk that you may not earn money on your investment.

Like all investment products, market-linked GICs have both benefits and limitations. Here are a few of the features of market-linked GICs, as well as some pitfalls to watch out for.

Potential Returns vs. Fixed Income Investments

Most of the time, market investments outperform regular GIC rates despite the added risk. Therefore, market-linked GICs should outperform regular GICs most of the time. Whether a market-linked GIC pays more or less interest than a regular GIC depends on the performance of its underlying index and the participation rate.

Market-linked GICs have the potential to earn much more interest than regular GICs because the stock market generally delivers better returns over the long term. They also have the potential to earn less interest because the value of stock indices can go up and down.

A market-linked GIC’s participation rate can also affect whether it pays more or less interest than a traditional GIC. If the underlying index performs well, but the GIC has a lower participation rate, the actual interest rate may end up being lower than you could have gotten with a regular GIC.

Liquidity and Access to Funds

Another limitation of market-linked GICs is that your investment is locked in for a fixed period of time, known as the GIC term. With market-linked GICs, that’s typically between two and five years. During that time, you may not be permitted to withdraw your investment or you may have to pay a penalty to do so.

Depending on your philosophy toward saving and investing, that limitation may be a benefit. With market-linked GICs, you won’t be tempted to cash out your investment early due to fluctuations in the market. You’ll also have certainty about when your investment will mature.

Market Volatility and Protection of Capital

Market-linked GICs also have benefits and limitations when it comes to how they interact with market volatility and protect your capital.

The primary benefit of market-linked GICs is that they allow you to take advantage of the natural rise in stock market prices while protecting you from occasional downturns. When the market does well, market-linked GICs pay out accordingly. When the market does poorly, your capital is protected.

However, many market-linked GICs limit the interest they pay—even if the underlying index outperforms that maximum.

The length of terms and maturity options for market-linked GICs varies widely among financial institutions and products.

Term Length and Maturity Options

The length of terms and maturity options for market-linked GICs varies from bank to bank and even from product to product.

Most market-linked GICs are available for terms of two, three or five years. Banks prefer these longer terms because the markets tend to be more stable over time than they are day-to-day. For shorter-term investment options, consider either traditional GICs or investing directly in the market.

When market-linked GICs mature, they’re usually paid out rather than automatically renewed. That’s because market-linked GIC offerings tend to change more substantially over time than traditional GIC products. It also allows investors to choose how to reinvest their funds in case their preferences have changed.

Early Redemption Features and Penalties

Market-linked GICs are non-redeemable and non-cashable. For the most part, you cannot withdraw your investment from a market-linked GIC until it matures.

If the issuing bank allows early withdrawal, the penalty will likely be equal to the amount of interest the GIC has earned. In other words, you may be able to get your initial investment back but not any interest.

If you want to invest in GICs with the option of taking out your money early, look into cashable or redeemable GICs. These products offer the same benefits as GICs without the harsh penalties for withdrawing your money early.

Renewal and Reinvestment Strategies

Because market-linked GICs carry a greater element of risk than regular GICs, they typically can’t be automatically renewed. Instead, market-linked GICs are usually paid out as cash on maturity.

If you want to renew your market-linked GIC, you’ll most likely have to do so manually. Set a reminder for your GIC’s maturity date so that you can reinvest your money in the way that makes sense for you at the time.

Market-linked GICs can fit into almost any financial plan as they offer a good amount of flexibility, safety and security.

Diversification and Portfolio Integration

Market-linked GICs can be a valuable addition to any portfolio. They can aid in diversification, help protect capital, and earn more interest than other GICs without increasing the risk you take.

Market-linked GICs can help diversify your portfolio because they follow broad indices rather than individual stocks. By comprising broad segments of the market, they naturally diversify any portfolio they’re a part of.

Market-linked GICs also blend the benefits of stock market investing with the security of GICs. This makes them an excellent choice for preserving capital, which might be your goal if you’re approaching retirement age. Most banks offer a variety of options, including low-volatility indices, which can help further reduce the amount of risk in your portfolio.

Tax Considerations and Account Types

As with most investments, the money you earn in a market-linked GIC is taxable as income. To avoid paying tax on your GIC income, you can hold your market-linked GICs in a tax-sheltered account. A few of the accounts you can hold a market-linked GIC in include:

• Registered retirement savings plan (RRSP)
• Tax-free savings account (TFSA)
• Registered education savings plan (RESP)
• First-home savings account (FHSA)

Investment Goals and Time Horizon

Because market-linked GICs usually require you to lock in your investment for between two and five years, they’re best suited to long-term investors.

If you’re looking to invest your money for a shorter period of time, you might prefer a short-term GIC with a fixed rate of return. Or you may prefer to invest directly in the stock market, which can be done with no time commitment.

As with all investments, the market and economic considerations play a role when choosing to invest in market-linked GICs. The interest rate environment, economic indicators, and historical market performance should all factor into your decision-making process.

Interest Rate Environment Impact

The current interest rate environment is an influencing factor when deciding whether to invest in market-linked GICs.

In times of higher interest rates, it may be better to invest in a fixed-rate GIC. Higher interest rates tend to affect stock market returns negatively, but positively affect fixed-rate GIC returns. When interest rates are up, you may find that you can earn sufficient interest with a traditional GIC without taking on the risk of a market-linked product.

Market-linked GICs may be better in times of lower interest rates. Lower interest rates are associated with higher stock market returns and lower GIC rates.

Economic Indicators and GIC Performance

The performance of the overall economy is also worth considering when deciding whether to invest in market-linked GICs.

The stock markets and economy are closely aligned; when one is doing well it tends to be reflected in the other. A stronger economy is a positive indicator for market-linked GICs, while a weaker economy is a negative indicator. Unfortunately, there aren’t many investments that tend to do well when the economy is struggling.

Historical Market Performance and Predictions

As with all investments, historical performance has no influence on future performance when it comes to market-linked GICs. However you can use past performance to get a sense of how a particular product might perform compared with others.

Related: What To Expect From GICs In 2024

Buying a market-linked GIC is a simple process which involves deciding on the right product, filling out a short application, and providing the funds.

1. Decide on which market-linked GIC you want to buy. Considerations include the underlying index, term length, and minimum and maximum rates of return.
2. Apply for the GIC. Depending on which bank is issuing the market-linked GIC, you may be able to apply online, over the phone or in person at a branch.
3. Fund your GIC. Once your application is approved, you’ll need to deposit the money into your market-linked GIC. If you deposit the funds before the set issue date, you’ll earn interest for that period at an interim rate.