A reader directed my attention to Meridian Canadian Market Secure GICs (the web page describing this GIC has disappeared since this article was written). This is a GIC whose interest payment is linked to the performance of the Canadian stocks making up the S&P/TSX 60 index. They claim that the “principal is guaranteed,” that “members participate in 100% of return,” and “the participation rate is currently set at 100%.” This sounds too good to be true.
Before finding the fine print, the marketing claims make it seem like investors can’t lose money, but get 100% of the upside of stock investing. Savvy investors know there must be a catch somewhere because banks (or a credit union in this case) don’t give away free money. It turns out that the catch is in the “method of calculation” that I found after some digging (but has since moved again).
When you buy stocks and hold them for 5 years, what you pay is the stock price at the beginning, and what you get is the stock price at the end of the 5 years. With this GIC, what you get is the average price level over the 5 years. So, if the index goes up 8% per year, instead of making 8% on your GIC, you’ll actually get somewhere close to half of that.
But it gets worse. The S&P/TSX 60 index doesn’t include dividends. So, even if the stocks make a total return of 8% per year, you’ll only get about half of the capital gains and none of the dividend return.
To make this more concrete, let’s assume that the stocks make a total return of 8% each year for 5 years, but that 3% of this is dividends. Then the index will rise only 5% per year. The average month-end closing value of the index over 60 months works out to 12.6% more than the starting value of the index. So, the total GIC return is 12.6% over 5 years or 2.4% per year (compounded). Somehow a 100% participation rate in 8% stock returns turns into only 2.4% on the GIC.
What percentage of people who buy this product do you think understand how low their actual participation rate will be?