Market-linked GICs are best for long-term investing, not short-term investing like traditional GICs. You can also choose to invest them for retirement in the registered account of your choosing to reduce or eliminate the amount of tax you pay on your investment and the interest earned. Let’s take a look at how these GICs work at home and how to choose them.
How Market-Linked GICs Work
As we’ve mentioned, market-linked GICs are Guaranteed Investment Certificates that allow you to invest in the stock market through accounts linked to underlying indexes, protecting your initial investment while avoiding direct stock market investing.
Terms for these types of GICs range from one to five years, and they offer a guaranteed interest rate to some degree. There’s a minimum guaranteed return that you can earn, with the potential to earn more with a variable interest rate based on the stocks you invest in. This is known as the participation rate.
When you buy a market-linked GIC, there’s also a maximum full-term return rate. Even if the stock index does better in the same term, what you earn can’t go over the specified amount. However, when you do choose to invest in a market-linked GIC, you can choose to invest in a tax-free savings account or a registered retirement savings account to reduce or defer your taxes, which is known as capital gains. It matters whether you invest in registered or non-registered GICs.
Market-Linked Vs GICs
While market-linked GICs do differ from traditional GICs, they also have some similarities. Both of these GICs protect the original investment and can be invested into different types of accounts. Unlike market-linked GICs, though, traditional GICs are available for terms of less than a year, and they have guaranteed earnings you will get once the GIC reaches the maturity date.
Traditional GICs are fixed-rate GICS, meaning that they have a fixed rate of return, unlike market-linked GICs. Market-linked GICs offer variable rates. They also don’t have guaranteed earnings; they just have a guaranteed range because the returns are linked to how the market performs. While variable rates allow earnings to keep pace with inflation, the cap on earnings can limit earning potential.
Pros and Cons of Market-Linked GICs
Just like any type of investment, market-linked GICs have their positives and negatives. Before you get started investing in this type of GIC, let’s take a look at these.
Pros
One of the great things about market-linked GICs is that they allow you to invest in the market without having to risk your principal investment. How much you earn is based on the portfolio you invest in, and you have more earning potential than you would with a traditional GIC.
Cons
As with any investment, there are disadvantages. Unfortunately, as the investor, you don’t get to keep the full return the index earns. In most cases, you only get to keep 80%. Also, the indexes that GIC issuers generally offer aren’t typically associated with higher returns. The financial institution has the power to choose which indexes are eligible for investment and can select those that are more in its favour.
Many companies also have clauses in their contracts regarding market-linked GICs in the case of extraordinary events. These events, such as market disruptions, allow the bank the right to change how the guaranteed return is calculated.
Minimum Return on Market-Linked GICs
The minimum return on market-linked GICs varies based on the bank or financial institution that you choose to invest with. However, the maximum returns that you can earn are no more than 60% per year. Even if the index earns more than that, you won’t be able to earn more interest.
Minimum Investment in Market-Linked GICs
The minimum investment in a market-linked GIC varies depending on the financial institution that holds it. That said, the minimum is $500; no further investment is required.
The Rates on These GICs
The rates for market-linked GICs will always vary. That said, plenty of different financial institutions offer them at different rates. Most financial institutions don’t advertise their market-linked GIC rates, either. This is because the rates are variable, and each GIC has different minimum and maximum rates.
Are They A Good Investment?
Whether or not market-linked GIC rates are a good investment or not is based on which market-linked GICs you invest in and how much you’re choosing to invest. If the rates are good and you’re looking to use market-linked GICs as a part of your investment portfolio to reach your investment goals, then they can be a good idea.
However, it’s not recommended that these types of GICs be your only investment. Before you invest, though, you should pay attention to your personal financial situation, past performance and time horizon, which will all affect your earning potential.
With these types of GICs, your principal guaranteed investment is safe, but what you can potentially earn isn’t always high. While it’s less risky than other investment products, it also doesn’t have as strong an earning potential as other investments. It’s a good way to keep your principal investment up, though, and reduce the risk of your overall portfolio. How it works for you, though, depends on your financial situation and the investment’s future performance.
The Best Market-linked GICs
In Canada, there are many market-linked GICs to choose from. Here are some of the best market-linked GICs with the top 5 banks. Many of these banks offer direct investments as well as other types of investments. However, no matter which one you choose, you will earn interest. How much you earn is based on the GIC’s equity index performance and ranges based on the financial institutions and stock market indices you choose.
RBC
One option for a market-linked GIC in Canada is with RBC. The one they offer is a 3-year GIC linked to the performance of the S&P/TSX 60 index on the Toronto Stock Exchange. The minimum investment for this GIC is $1,000. You can also choose to receive any returns at the end of a second lock-in anniversary or at maturity.
TD
TD offers a variety of market-linked GICs. Each of these GICs guarantees the principal, there are no fees, you can choose between 3 and 5 years, and only a low investment is required. The minimum investment for RSP, RESP (Registered Education Savings Plan), and RIF investments is $500, and for non-registered and registered TFSAs, it is $1,000. The 3 different market-linked GICs that they offer are:
- TD Canadian Banking and Utilities GIC
- TD Canadian Banks GIC
- TD U.S. Top 500 GIC
Scotiabank
With Scotiabank market-linked GICs, you can get a variety of different GICs that have a minimum and maximum interest rate. The terms of these GICs range between 2 and 5 years as well. The categories that you can find these GICS in are:
- Scotiabank Canadian Top 60
- Scotiabank U.S. Top 500
- Scotiabank Canadian Low Volatility Index
- Scotiabank Canadian Utilities
You can speak to a Scotiabank advisor to find the right one for you.
CIBC
With CIBC, market-linked GICs are based on the performance of different underlying assets. These include equities, equity indices, and interest rates. Based on the type of investment you want, they offer 3 strategies: income, growth, and income and growth. Each of these different strategies offers different growth potential.
With CIBC, the minimum investment is $500. You can open a GIC in a non-registered, RRSP, or TFSA account. These accounts are non-redeemable, meaning that you can only access them at maturity, and they’re available for terms of 2 to 5 years. The interest you’ll get depends entirely on the investment strategy you choose.
BMO
BMO also offers market-linked GICs. Their GICs range from 3 to 6 years and have a variety of interest rates. The ones they offer are:
- BMO Smart Return GIC
- BMO Top Performing Portfolio GIC
- BMO Canadian Market GIC
- BMO Select GIC
- BMO Return-Enhancing GIC
- BMO Fund Linked GIC
- BMO Growth GIC
- BMO Blue Chip GIC
CDIC and Market-Linked GICs
The CDIC, also known as the Canada Deposit Insurance Corporation, covers deposits held with registered financial institutions up to $100,000. In Canada, most market-linked GICs are protected by CDIC coverage, making them a risk-free investment. Even if the bank goes under, your funds are still protected.
The Best Market-Linked GICs at Credit Unions and Online Banks
There are quite a few credit unions and online banks that have market-linked GICs. Let’s take a look at a few.
Coast Capital Savings
- 3-year responsible market-linked
- 5-year responsible market-linked
- 3-year global diversified
- 5-year global diversified
Meridian Credit Union
- Canadian diversified market-linked GIC
- Environmentally responsible MLGLC
- Diversity market-linked GIC
- 3-year financial services market-linked GIC
Affinity Credit Union
- Financial services – 3-year or 5-year
- Canadian diversified – 3-year or 5-year
How the Participation Rate is Calculated on Market-Linked GICS
With Canadian market-linked GICs, the percentage rate determines the percentage of an underlying index’s gains that you’ll get at maturity. This is usually set by the issuer of the GIC when you purchase it and, depending on the specific GIC, can range from 60% to over 100%. It multiplies the index return to calculate the final interest payment.
Here’s an example: Let’s say you invest $10,000 and your participation rate is 70%. If the index gains 10%, then this is how your return is calculated. 10% x70% = 7% ($700)
How the Penalties Work for Cashing Out a Market-Linked GIC Early
Market-linked GIC returns are designed to be entered into the equity markets and held until maturity to protect your principal investment. When you invest in the fund, you enter into a non-redeemable contract, and withdrawing the funds early can incur a penalty.
Here are the 3 different ways that taking out a market-linked GIC early can impact you:
- You forfeit all of your returns. This is due to how these accounts are set up, and not leaving the funds until full maturity makes a difference.
- Losing some of your investment due to market performance. If the market drops, you could lose money and not even receive your guaranteed minimum return, which is the principal amount you originally invested.
- You can’t gain access. In some cases, your funds can be locked for 3 to 5 years, and the bank may not even allow you access. to them
Taxes on Earnings from Market-Linked GICs in Canada
Any income that you receive from market-linked GIC returns in Canada is considered to be interest income. This means that anything you earn is taxed at your full marginal tax rate, rather than at a capital gains rate, which is much lower. That said, the tax situation also depends on the type of account your funds are invested in.
Non-Registered Accounts: There is no tax break for non-registered accounts. This means you pay the full tax amount for the tax year it was earned.
Registered Accounts: The amount you pay depends on which registered plans you use. With a TFSA, all earnings are tax-free, but with an RRSP, the tax is deferred until you withdraw the funds.
The Key Differences Between Market-Linked GICs and Segregated Funds
With both of these investments, you get a mix of market exposure as well as capital protection. That said, they both work differently financially. Market-linked GICs are bank-issued deposit products that have maximum return limits and protect your principal investment. Segregated funds, on the other hand, are insurance contracts that are good for high growth potential, estate planning, and flexible guarantees.
| Features | Market-Linked GICs | Segregated Funds |
| Issuer | Banks, credit unions, and trust companies. | Insurance companies |
| Product Type | Fixed-term deposits are like markets and index funds for index-linked GICs. | An investment fund (similar to a mutual fund) that is wrapped into an insurance contract. |
| Growth | Tied to a specific index with maximum cumulative returns. | Full market participation factor, meaning you keep market returns with cap. |
| Principal Investment | 100% | 75%-100% |
| Liquidity | Locked for the entire return, and can’t be withdrawn in that time frame. | Can take withdrawals, but there may be early redemption fees. |
| Estate and Planning | All funds will have to go through probate. | No probate, and funds will go directly to beneficiaries. |
| Creditor Protection | None | Can be protected with certain beneficiaries. |
| Fees & Taxes | No direct management fees; all returns are considered to be interest income | Higher fees but more efficient tax options like dividends and capital gains. |
How Banks Hedge Market-Linked GIC Products
When the bank invests your money, it does so strategically to reduce both your risk and theirs. This is done in two parts.
- Principal Guarantee: This is achieved by allocating a portion of your investment to ultra-safe fixed-income investments. An example of this is government bonds. The interest that grows is then designed so it meets your original investment amount, which is how they can guarantee your original investment.
- Market Exposure: The remaining funds are invested in call options on a stock index, allowing the bank to capture the index’s gains without holding the underlying stock.
To avoid losses, the bank uses two hedging strategies: Dynamic Delta Hedging and Capping Payouts.
With delta hedging, tanks buy and sell underlying reference shares because call options change in value as the underlying market moves. This allows them to remain perfectly balanced. With capped payouts, they minimize their risk by leveraging participation rates and maximum return caps. This means the cost of the call options doesn’t exceed the interest generated by the fixed-income portion of the deposit.
Market-Linked GICs and a Recession
In a recession, you won’t receive a negative return with a market-linked GIC since your investment is protected, but you likely won’t get any index returns. That said, you can miss out on any recovery interest by locking in at a lower interest rate.
Reading a Prospectus Before Buying a Market-Linked GIC
Reading a prospectus helps you understand how your interest is calculated and how it differs from regular GICs. It shows your principal guarantee, early redemption risks, and minimum and maximum returns. It will even show you special events and your extraordinary events clause.
Final Thoughts
In Canada, market-linked GICs are just one of the many different types of GICs that you can invest in. Unlike other GIC investments, market-linked accounts have variable interest rates, also known as interim interest rates, and different earning potential. However, there are caps on how much you earn, even if the index you invest in earns more. These types of investments aren’t meant to be the only investment that you have. They are meant to diversify your portfolio and help you reach your investment goals.
