A Guide to investing in Market-Linked GIC’s

How to choose a Market-linked GIC?

Well, if you’re are looking to get a higher return on your investment but at the same time you want to guarantee the safety of your capital, then a market-linked GIC would be an appropriate choice. You should, however, be willing to accept a variable rate of return and not a guaranteed one. Also known as Equity-Linked GICs, they give you the potential for a higher rate of return than the traditional GIC.

Note that this will depend on the market performance over a period of three or five years. Basically, these products are diversified solutions that involve the combination of how mutual funds, returns of stocks, and/or stock indices perform with the benefit of principal protection. Investors can enjoy the best of security and higher return potential in one packaged solution.

How does Market / Equity-linked GIC Work?

Probably the first thing you need to understand about market-linked GICs is what they promise. One, these products promise a higher rate of return when the Canadian Stock markets go higher. Of course, this doesn’t mean that you’re going to get 10 percent return when the stock market goes up by 25 percent. You might receive about 4 percent instead. What happens is that you receive a partial benefit whenever the stock market goes up. Generally, a three-year GIC whose return is usually linked to how the S&P/TSX 60 Index performs. This index is responsible for measuring how some of Canada’s largest companies perform in the stock market.

Additionally, market-linked GICs guarantee security or rather the safety of your capital (the original investment) up to the acceptable coverage limits. So, we’re saying you’ll receive a return when the S&P/TSX 60 index goes up over the contract period, but what will happen if the market stays the same or even declines?

You won’t receive any return on your market-linked GIC. That’s where the difference between traditional GICs and market-linked GICs comes in. Your return depends on whether and how much the equity market or rather the index increases over the term. With market-linked GICs, just the investment is guaranteed – but the return is not.

It’s important to note that financial institutions offer different products on this model. There are some financial institutions which offer market-linked GICs that guarantee a small return, whether the stock index declines or stays the same.

There are two ways to which financial institutions limit the variable return payment for their market-linked GICs:

  • maximum returns
  • participation rates

The participation rate is defined as the percentage at which the GIC will participate in the equity market’s return. For example, you purchase a market-linked GIC when the index base level is 1,000 with a participation rate of 60 percent. If after the 3-year period, the index settlement level is 1,364, your return would be limited to 60 percent of 36.4 percent, or 21.84 percent. That comes to 7.28 percent a year (not compounded). If you had invested $20,000, your return at the end of the 3-year term would be $4,368.

Benefits of Investing in Market-linked GICs

As with any other investment choice, it’s crucial for you to make an informed choice. Some of the most important things you should be aware of include:

  • When you invest in a market-linked GIC, understand that you won’t receive any distributions or dividends since it’s not the same as investing directly in the equity market of the S&P/TSX 60 Index. This GIC comes with opportunity, costs and potential risks, and the rate of return of your market-linked GIC won’t be the same as the return associated with the equity market.
  • Past performance of the equity market doesn’t indicate anything about future performance or returns. The fact that financial institutions look at the past performance of the index to promote this GIC doesn’t mean it’s indicative of future returns. If you check the fine print, you’ll see that they are not predicting the future.
  • The variable return is usually determined by the financial institution/bank, which may as well exercise judgment and discretion in calculating your potential return. In most cases, the calculations by the bank will be final. That means potential conflicts between your interests and the interests of the bank may arise.
  • Be sure to carefully read through the fine print of this GICs and understand every detail contained in the document. You may find some clauses referring to “extraordinary events or circumstances” where the issuer may have the right to determine and modify how the variable return is calculated.
  • What market is your market-linked GIC tied to? Which sectors make up the bulk of the equity market? These are important questions that you must ask yourself as you try to understand your market and see the level of risk it poses. Consider a diversified market.

Despite the fact that Canadian Market-Linked GIC gives you the opportunity to participate in the gains of the S&P/TSX 60 Index without risking your original investment, it’s important to find out if it’s the right investment option for you. You don’t want to invest in a GIC that doesn’t suit your financial situation. Furthermore, you must be willing and ready to earn a zero return if the equity market doesn’t go up. Probably you should try a more traditional GIC if you’re not sure about the possibility of the equity market going up and if your financial situation doesn’t suit a non-redeemable GIC.

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