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Index Linked GICs - PROs and CONs

The only benefit of these deposits is that the purchasers can participate in the gains of a particular equity index and be guaranteed a return of their capital. Unfortunately they are not all created equal. Read the fine print carefully and have it explained.in detail.

If you do not fully understand the risks of an equity investment make sure the person selling the gic does - your return depends on it. Here are a few points you should consider:

1. You don't get full stock market growth!

These vehicles base your return on the growth of a recognized stock market the TSE 35, the TSE 100 or the S&P 500. Few investors are aware that each stock market index is calculated two ways - with and without dividends on the underlying shares. Index-linked GICs are tied to the index without corporate dividends.

Significant!
Example: TSE 300 for the three years 1994-96 which includes dividends rose 46.7% during that time for an average of 13.6% a year. Without dividends, the TSE 300 gained 37.2% or 11.1% a year. ONE-FIFTH MORE WITH DIVIDENDS!!
2. Averaging may help or hurt your return.

Most of these deposits do not simply calculate the difference between the stock market index at the start of the term and maturity. Instead they use an average index level for the end-point. Often, the institution averages the index level at the end of each of the final 12 months. That means you do not get the full benefit of a stock market run-up during those months.

3. Your money is tied up.

As with a regular GIC, your money is tied up until maturity. Nor can you change your choice of index. Mutual funds let you access any or all of your money at any time and allow you to change your investment choice.

4. If you invest outside an RRSP or RRIF, make sure you understand the tax pitfalls.

Although they're based on the stock market, the returns on an index-linked GIC are fully taxed just like regular GIC interest. You do not get the benefit of the lower rates on capital gains and Canadian corporate dividends.

5. Do you really need downside protection at this point?

You might if you're a risk-adverse senior who is really counting on using that money in just a few years. But if your money can be invested for more than just a few years, the odds are that you're sacrificing growth and flexibility for insurance you probably won't need.

While past performance is not necessarily indicative of future returns,history has shown that the longer your investment period, the less risk you face of capital loss. Let's look at the TSE 300 total index for the 40 years from 1957 through 1996. Annual calendar year returns ranged as high as 44.8% in 1979 to as low as -25.9% in 1974 and the index lost money in 11 of those 40 years. But that changes dramatically when you look at rolling five-year periods(1957-61, 1958-62, etc.) There were 36 of them and only one 1970-74 had a negative average compound annual return. Notice that all 31 of the rolling 10 year periods had positive returns.

	1. You don't get full stock market growth! These vehicles base your return on the growth of a recognized stock market the TSE 35, the TSE 100 or the S&P 500. Few investors are aware that each stock market index is calculated two ways - with and without dividends on the underlying shares. Index-linked GICs are tied to the index without corporate dividends. *Significant!* Example: TSE 300 for the three years 1994-96 which includes dividends rose 46.7% during that time for an average of 13.6% a year. Without dividends, the TSE 300 gained 37.2% or 11.1% a year. ONE-FIFTH MORE WITH DIVIDENDS!! 2. Averaging may help or hurt your return. Most of these deposits do not simply calculate the difference between the stock market index at the start of the term and maturity. Instead they use an average index level for the end-point. Often, the institution averages the index level at the end of each of the final 12 months. That means you do not get the full benefit of a stock market run-up during those months. 3. Your money is tied up. As with a regular GIC, your money is tied up until maturity. Nor can you change your choice of index. Mutual funds let you access any or all of your money at any time and allow you to change your investment choice. 4. If you invest outside an RRSP or RRIF, make sure you understand the tax pitfalls. Although they're based on the stock market, the returns on an index-linked GIC are fully taxed just like regular GIC interest. You do not get the benefit of the lower rates on capital gains and Canadian corporate dividends. 5. Do you really need downside protection at this point? You might if you're a risk-adverse senior who is really counting on using that money in just a few years. But if your money can be invested for more than just a few years, the odds are that you're sacrificing growth and flexibility for insurance you probably won't need. While past performance is not necessarily indicative of future returns,history has shown that the longer your investment period, the less risk you face of capital loss. Let's look at the TSE 300 total index for the 40 years from 1957 through 1996. Annual calendar year returns ranged as high as 44.8% in 1979 to as low as -25.9% in 1974 and the index lost money in 11 of those 40 years. But that changes dramatically when you look at rolling five-year periods(1957-61, 1958-62, etc.) There were 36 of them and only one 1970-74 had a negative average compound annual return. Notice that all 31 of the rolling 10 year periods had positive returns.

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