Nothing ventured, nothing likely to be gained

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This article was published 14/12/2024 (356 days ago), so information in it may no longer be current.

Roger and Cathy were a little dismayed and very confused last month when they received their money back from a popular investment often sold to conservative investors like themselves by financial institutions across Canada.

The Manitoba couple — retirees — had invested in a market-linked GIC (guaranteed investment certificate).

“Considering we never lost any money over that time frame on any of our other investments (including stocks), how we never made any money on this was a shock,” says Roger (the Free Press has withheld their last names to protect their privacy).

The couple called their adviser at the credit union, who had helped them invest in the product, curious why it made no return over three years despite the market index the GIC was linked with — the S&P TSX 60 (Canada’s 60 largest publicly traded companies) — had a positive return of about 17 per cent over that span.

“Then we told our adviser (at another firm) and he was surprised, thinking we should be up,” says Cathy, noting the couple only had the original documentation from when they invested in the GIC three years ago to find an explanation of how they ended up with no return.

The response from the credit union was a voicemail message, citing if their investment hadn’t been guaranteed, they would have lost money. In short, count themselves lucky.

Their disappointment and confusion over the outcome is likely not unique.

Market-linked GICs are offered by most banks and credit unions in Canada and yet they are probably not as well understood as they should be by investors.

“(The couple’s experience) highlights a problem with these products,” says Jason Heath, a fee-only financial planner with Objective Financial Partners in Toronto. “That is, you may not be signing up for what you think you’re buying.”

On the surface, market-linked GICs seem attractive for individuals seeking a little upside exposure to the stock market without putting their capital at risk. Yet these products are often not the free lunch that they appear to be.

“If an investment product has a long list of terms and conditions or you can’t explain it to someone yourself, that is a yellow flag,” Heath says, noting market-linked GICs fit this description well.

A regular GIC may be as straightforward and as low-risk as investments get. You lend a financial institution money; it pays you a rate of interest and your principal is guaranteed.

Market-linked GICs still guarantee the principal, but how they provide a return — linked to the performance of an underlying stock index — is often less clear-cut.

“These investments provide the buyer with a return that is ‘linked’ to the direction of the stock market in a given period,” says Scott Clayton, senior analyst and editor at TSI Wealth Network — a do-it-yourself investor resource.

“But that link depends on a formula or set of rules buried in the fine print.”

Many investors assume, wrongly, when purchasing one that the measure is based on the value of the reference stock market price at the start of the term and its price at the end. The difference between the two, as Roger and Cathy had assumed, forms the return.

Yet the market-linked GIC they purchased calculates its return based on the average TSX 60 index level from November 2021 to November 2024, divided by the starting value in November 2021.

Health points out the average value over that three-year period and the index’s starting value are largely the same.

So while the end value of the index is up nearly 17 per cent from the starting value, “the extended stock market downturn in 2022 brought down the average index level and made this a poor investment based on the formula,” Heath says.

Another notable characteristic of market-linked GICs is the participation rate, which further reduces upside for investors.

Cathy and Roger’s GIC had a participation rate of 75 per cent. “Like what does the 75 per cent participation rate mean?” Roger asks.

Had he understood this at the outset, he would have known their return would only be 75 per cent of the actual increase in the average monthly returns for the TSX 60 over three years.

“They never explained that to us or at least we don’t remember it,” he adds.

Arguably, the only free lunch here is for financial institutions selling market-linked GICs.

“They tilt the odds in their own favour,” Heath says.

Market-linked GICs can make better returns than regular GICs, but it’s by no means guaranteed. “Most (investors) make less in index-linked GICs than they would have made in old-fashioned, plain-vanilla GICs,” Clayton says.

Those seeking better returns need to grasp that those strategies will involve putting their capital at risk. After all, nothing ventured; nothing gained.

Fortunately, Roger and Cathy’s experience will not make or break retirement. They just feel investor’s regret.

“We should have just gone with a regular GIC,” Roger says. “Live and learn, I guess.”

Joel Schlesinger is a Winnipeg-based freelance journalist

joelschles@gmail.com