Tuesday, February 17, 2009

Stepper GICs are Great Marketing

I recently saw an ad for TD Bank’s 5-year “Stepper” Guaranteed Investment Certificate (GIC). The ad made the product seem quite attractive. A sign of great marketing is turning a negative into a positive.

A Stepper GIC offers a low interest rate in the first year with an increase in the interest rate paid each year. It’s like getting a raise each year. Who wouldn’t want a raise? All the major Canadian banks have GICs like this with different names:

Royal Bank - RateAdvantage GIC
Scotiabank - Accelerated Rate GIC
BMO - RateRiser GIC
CIBC - Escalating Rate GIC
TD Canada Trust - Stepper GIC

In TD’s ad, the most prominent part of the picture showing the interest rates is “8.0% In the 5th Year.” Where else can you get 8% on your savings? Here are the advertised interest rates for each year of this Stepper GIC (as of February 2009):

Year 1: 1.5%
Year 2: 3.0%
Year 3: 3.5%
Year 4: 4.0%
Year 5: 8.0%

The average compound interest rate works out to 3.98%. Suppose that this GIC were marketed differently. Imagine that TD offered a 5-year GIC at 3.98% interest with the following penalties for early redemption:

After year 1: 2.38%
After year 2: 3.30%
After year 3: 3.75%
After year 4: 3.72%

This is exactly the same GIC as the Stepper. Through the magic of marketing, the disadvantage of scary-looking early redemption penalties has been turned into a rising interest rate with no mention of penalties. In my description, the highest interest rate you hear about is 3.98%, but TD’s version gets to trumpet 8% in the final year.

I’m not saying one way or the other whether this GIC is a good deal for you. But we should all see it for what it is: a fixed-rate GIC with early redemption penalties.


  1. Perhaps you could defer taxes by taking less interest in the first few years of the GIC?

    Outlook Financial had a similar "escalator" GIC. I figured out the compounding interest, and it was virtually identical to the conventional GIC.

  2. Gene: I'm guessing you're right that you'd only have to declare the smaller amounts of interest in the early years, but I don't know for sure.

  3. A reader, Robert asked a question about how I calculated the percentage penalties:

    "Hi Michael, great post btw on the TD 5 year stepper ! Very clear, and I was especially pleased at how quickly I could find your article via google as it was the first hit when i looked for the TD stepper's effective rate. Good job!

    "Could you help me, a non specialist, understand how you calculated the penalties part ? I assume penalty for given year = effective rate - rate that year. Found I couldn't re-create your findings listed. what am I doing wrong?"

    The short answer is that the penalty percentages I list are percentages of the amount the customer expected to receive, rather than percentages of the original investment. I tend to see interest rates in compound terms rather than simple interest terms. So, an investor who invests $1000 at 3.978% and withdraws it after 1 year expects to get $1039.78, but gets $1015.00 instead, for a penalty of $24.78. Taken as a percentage of the original investment, this is a 2.478% penalty, but taken as a percentage of the amount our investor expected to receive, the penalty is 2.383%. This way of calculating the penalties gives lower percentages, but I think it is more fair.

    This tension between viewing interest in simple terms and compound terms will always exist because they give very close answers for small percentages, and simple interest is easier to calculate. But, interest is more correctly thought of in compound terms in almost all situations.