Thursday, February 20, 2014

Double-Up GIC – the Catch

The point of my Double-Up GIC was to illustrate the tricky rules used in market-linked GICs by taking these rules to the extreme. The advertising of market-linked GICs makes it seem like you have a guarantee to get your money back if stocks fall and can get the market return if stocks rise. This isn’t the case. Market-linked GICs have rules that significantly reduce the return you get if the stock market goes up.

The catch with my Double-Up GIC is that each of the 560 linked stocks must go up during all 60 months for you to get your full 100% return. Any excess return for a stock in a month above 0.00206% is wasted, but any drop in a stock counts fully. Across all the stocks there are a total of 560*60=33,600 monthly returns. If all the negative returns compound to a 50% loss, then these losses will completely cancel all the capped positive returns. So, if one-eighth of the stocks show a loss of 1% or more in the first month, you’re already guaranteed to get only your principal back and no added interest after the 5 years. So much for the dream of a double up.

It would take quite a conspiracy to cause the markets to go up so consistently that this GIC pays any interest at all. If I had no empathy and sold such a GIC to some suckers, I would invest enough of their deposits in a 5-year stripped bond to cover the return of principal and invest the rest in two ETFs that cover the TSX 60 and S&P 500. This way I couldn’t lose on having to pay back the principal, and if stocks happen to perform so magnificently (perhaps due to runaway inflation) that I owe some interest after 5 years, my stock investment would most likely cover the interest I owe.

Of course, the tricks the big banks use to limit interest payments aren’t this punishing, but you have to read through the fine print and do some math to see why market-linked GICs won’t give you much of the returns from stocks.

4 comments:

  1. I'm just happy you use your creativity and intellect for good instead of evil. Some people aren't so scrupulous.

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    1. @Gene: I guess I'm hampered by empathy :-)

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