Market-Linked GICs: Pros, Cons and What Investors Should Know

Ask MoneySense

My bank is suggesting market-tracking GICs as an investment portfolio for part of my retirement nest egg. What is the deal (pros / cons) with this type of investment?
—Bryan

Should you buy market-linked GICs?

Guaranteed investment certificates (GICs) are a common safe-haven investment available to Canadians. Standard GICs lock in a fixed interest rate for a set term—typically between one and five years—and return your principal plus interest at maturity. Market-linked GICs (also called equity-linked GICs) are a variation that offer the safety of principal protection combined with returns tied to the performance of a stock market index or sector.

What is a market-linked GIC?

Market-linked GICs pay a return based on the performance of an underlying index, sector or basket of stocks over the GIC term. For example, a product might track the S&P/TSX Capped Financial Index, meaning its payout depends on how the banks, insurance companies and related financial stocks perform on the Toronto Stock Exchange during the term. The principal is typically guaranteed, but the interest you receive is variable and depends on how the chosen index performs.

The best GIC rates in CanadaSee rates

The pros and cons of market-linked GICs

Market-linked GICs combine two appealing features: your principal is generally guaranteed, and you have some exposure to upside from the stock market. That principal protection can give peace of mind for conservative savers or people close to retirement who fear market losses.

On the downside, the upside is usually limited. Issuers often cap the maximum return or apply a participation rate—so you might only receive a portion of the index gain, such as 80% of positive returns, or face a fixed maximum over the term (for example, a 25% cap over five years, effectively 5% per year). Those limitations mean you won’t capture the full benefit when the market does very well.

Issuers also structure these products in ways that can favor the financial institution. They may choose indices, sectors or term lengths where historical performance makes strong payouts less likely. In short, the principal guarantee is valuable, but it can come at the cost of significantly reduced upside.

Should you trust financial advice from a bank?

When a bank recommends a market-linked GIC, remember bank employees and branches are not necessarily obligated to provide advice that is fiduciary or in your absolute best interest. That does not imply everything they suggest is bad, but it does mean you should evaluate the recommendation critically.

Often the person recommending a product is licensed only to sell certain products—GICs, for example—rather than mutual funds, stocks or ETFs. Sales incentives and quotas can influence which products are promoted, so a suggested solution may reflect what the adviser can sell rather than the ideal fit for your situation.

That said, market-linked GICs can be appropriate for certain investors: those who want principal protection but want a chance at some market-linked upside and who are not comfortable directly owning stocks. For some conservative investors, these products can bridge the gap between cash and market exposure.

Find a qualified advisor near youUse tool

Ask yourself: Can I handle stock market risk?

Consider whether you are comfortable with stock market risk at all. Market-linked GICs can introduce you to market exposure with a safety net, which some investors prefer. However, many investors would be better served by a low-cost, well-diversified portfolio of stocks and bonds—especially if they have a long time horizon and the ability to tolerate short-term volatility.

Learning the basics of stocks and diversified investing can pay off. Individual stocks can fall sharply or even become worthless, but broad, diversified stock portfolios historically rise over the medium to long term. If you can build a diversified mix across sectors and geographies and you have time, direct exposure through ETFs or similar instruments often delivers better long-term value than capped or participation-limited GICs.

So, are market-linked GICs good investments?

They can be right for some people, but they are not my personal choice. As a risk-tolerant investor with a long horizon, I prefer direct, diversified market exposure through low-cost instruments. For someone who is risk-averse or who wants the psychological comfort of a guaranteed principal while gaining some market participation, a market-linked GIC might make sense.

If you buy one, treat it as a learning opportunity: use the term to educate yourself about markets and alternative investments so that when the GIC matures you can consider other options rather than automatically renewing into the same product.

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.