Tuesday 7 September 2021

GICs and Savings Accounts - Which Best Combat Inflation?

Guaranteed Investment Certificates (GICs) and Savings accounts at banks offer a person in Canada the safest possible place to invest money. Both are backed 100% against any loss up to $100,000 by the Canada Deposit Insurance Corporation, an arm of the federal government. That's as safe as it gets.

Safety against outright loss isn't enough for the investor. There is inflation to consider. Annual inflation - targeted by official Bank of Canada policy at 2% - eats away the purchasing power of our cash unless the interest rate on the GICs and savings accounts exceed inflation. If inflation is 2% and your interest received is 0.5%, you've lost 1.5% in real purchasing power.

Unfortunately, the tale told by the numbers is discouraging. The chart below traces the deteriorating trend over time. Data is from the Bank of Canada. Inflation is the CPI (Consumer Price Index) All Items, shown by the red line.


Back in 1981, all was wonderful. Savings accounts, 5-year and 1-year GICs issued by the major Canadian banks all paid interest rates comfortably in excess of inflation. 

Suddenly, in 1994 savings account rates dropped substantially to derisory amounts, well below inflation, and they have never risen within shouting distance since. 

1-year GICs held out till 2002, when they more or less matched inflation till 2009. Ever since 2010, they have paid appreciably less than inflation.

5-year GICs have resisted the best, staying consistently above inflation till 2010. It has been a cat-and-mouse close call since then. The 5-year GIC is really the only option left that more or less provides both rock-solid safety and reasonable inflation protection.One way to invest is to build a ladder of 5-year GICs. Every year, when there is cash to invest, buy only a 5-year GIC. Discount brokers offer a selection of GICs that pay higher interest than the major bank GICs while benefiting from the essential CDIC guarantee. The downside is that your money is locked-in for five years, though there are cashable versions ... but then you get a lower rate and pay a big interest rate penalty if you do cash early, which negates the whole advantage of the five year rate. After five years, the oldest GIC will mature and it can then be spent, such as a retired investor like me might do, or re-invested for the next five years.

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