Thursday, May 13, 2010

GIC's do not make sence

Through out my investing career, I've only used GIC's once. I was a new immigrant to Canada. and my dad had given me some money to use for the university tuition that was due in 3 months.

In that situation I had absolutely no tolerance for risk. I had a short time frame. no income, no work visa, little investing experience and there was no way I was going to risk not being able to pay for my university tuition.

That was the first and last time I've used a GIC.  This was as you can see an extremely conservative situation. and I still think it is okay to use GIC's in extreme situations like that.

Yes the G in GIC stands for guaranteed. but who is guaranteeing this money? it is the bank you are buying the GIC from and the CIDC for the first $100,000.

Now the CIDC insurance is for your total cash in all your accounts at this institution. so if you have more than 100,000 in the bank your GIC's are no longer covered by CIDC.

The good news is that banks also guarantee another type of investment. The banks Corporate bonds. If the bank does not pay you what you are owed you can force them into bankruptcy. In other words both your principal and your interest from corporate bonds are guaranteed by the same entity guaranteeing the GIC.

yet the GIC pays you much less.

Okay still not convinced that corporate bonds from say TD are just as safe as GIC's from TD?

Say you've bought a corporate bond from TD. The only way you will not get all your principal or interest is if TD goes into bankruptcy. All TD common and preferred shareholders are wiped out. TD shares are worth $0. They cannot issue more shares because no one is interested in buying the TD shares. and The government decides not to bail out TD by offering them loan guarantees or by buying mortgage backed securities from them which the bank of canada has done before during the mess of last year just in case.

Now this is unlikely but lets say it does happen. How much better off are you holding a GIC? well we are talking about a situation of total economic chaos. A situation where even holding Canadian cash is risky. A situation where your 100,000$ CDIC insured money that you got many months later from the CDIC is probably worthless. The only asset worth anything today is gold.

GIC's are a great way for banks to make money off of your money.

Put money you need for the next 3-6 months in high interest savings account.

Anything for a longer time frame into a portfolio of stocks and bonds.

Never buy a GIC for a period longer than 1 year.

No comments:

Post a Comment