Have you noticed that interest rates have increased substantially in the last couple of years? This has led to many investors looking at fixed income options. But the problem is that the fixed income market is very complex, and actually about twice the size of the global stock market. So many people don’t really know what to look at or the differences between different products.
Many questions we receive are around the differences between GICs and Strip Bonds. Both are fixed-income investments, but they have some key distinctions. Let's start by defining what each of these investments actually is.
GIC stands for Guaranteed Investment Certificate, it's a type of investment offered by banks and financial institutions in Canada. When you invest in a GIC, you lend your money to the institution for a fixed period of time, and in return, they guarantee to pay you a fixed rate of interest. GICs are considered low-risk investments because they offer a guaranteed return of principal at maturity. However, the trade-off is that the returns are generally lower compared to other investments.
On the other hand, Strip Bonds, also known as zero-coupon bonds, are a type of fixed-income investment issued by the government or corporations. In Canada, government-issued strip bonds are called Canada Strip Bonds. Unlike GICs, Strip Bonds don't pay periodic interest. Instead, they are sold at a discount to their face value and mature at their full face value. The return comes from the difference between the purchase price and the face value. With Strip Bonds, the investor buys the bond at a discounted price, typically at some fraction of its face value. The difference between the purchase price and the face value is the investor's return, which is received at maturity. So, the return is based on the appreciation of the bond over time.
That's a key difference between GICs and Strip Bonds. With GICs, you may receive periodic interest payments throughout the term, while with Strip Bonds, you don't receive any interest until maturity when you receive the full face value.
GICs supply more predictable income during the investment term, making them suitable for investors looking for steady cash flow. Strip Bonds, on the other hand, are more suited for investors who don't need immediate income and are willing to wait until maturity to receive their return.
Another factor to consider is the liquidity of these investments. GICs typically have a fixed term, and if you need to access your money before maturity, you may face penalties or restrictions. Strip Bonds, while also having a fixed term, can be bought and sold on the secondary market, providing some liquidity. GICs are more suitable for investors who want a locked-in investment for a specific period, while Strip Bonds offer more flexibility in terms of buying and selling on the market.
Now, let's talk about risk. GICs are generally considered low-risk investments because they are backed by the issuing institution's guarantee. However, it's important to note that this guarantee is subject to the creditworthiness of the institution. In the case of GICs issued by members of CDIC (Canada deposit insurance corporation) the first $100,000 is essentially guaranteed by the government. However on amounts over $100,000 the promise to pay back your principal is as good as the creditworthiness of the issuer. GICs offer more stability and security, while Strip Bonds may have the potential for higher returns but also higher volatility and no protection under CDIC.
Another consideration is taxation. In Canada, interest earned from GICs is typically fully taxable as income in the year it's received. Canada Strip Bonds, on the other hand, have an annual deemed interest, even though you don't receive any interest payments until maturity. This considered interest is taxable each year, regardless of whether you've received any cash flow. Tax considerations are essential when evaluating investment options, and investors should consult with a tax professional for advice specific to their situation.
Remember, GICs are low-risk, provide predictable income, and are less liquid, while Strip Bonds offer potential higher returns, are more volatile, and have the option of liquidity through the secondary market.
-Stay safe, stay happy, stay well
The CM Group
For more information about this product, please contact your Investment Advisor.