April 17, 2019 | You What?

To earn 3% these days on an investment that carries zero risk, you have to take a lot of risk.

That’s the princely sum paid on a five-year Guaranteed Investment Certificate (GIC) from a well-known, top-of-mind, brand-name outfit like Oaken Financial or Maxa Financial. And this may be the first risk: who the heck are these guys?

Well, Oaken is the deposit-taking arm of Home Capital – the subprime mortgage lender that almost blew up a couple of years ago, was found to have fraudulent activities among its brokers, ran into trouble from the regulators and was rescued from oblivion by Warren Buffett, who then bailed out. Where did Home Capital get the funds to give to dodgy, high-risk real estate buyers that the banks had punted? Yup. From people who gave their savings to Oaken. As for Maxa, well, it’s a digital bank. Good luck when the lights go out.

The second risk in putting money into a five-year GIC to get a great (sort of) rate is illiquidity. It’s locked up. No redemptions unless you have to buy a kidney in Mumbai and convince [email protected] to release you on grounds of humanitarianism. Or stupidity.

Next risk? Taxes. Unless squirreled away in an RRSP or a TFSA (and what an epic waste of tax-free growth room that would be) the returns a GIC investor get are 100% taxed. That is unlike the capital gains enjoyed when an ETF, for example, increases in value, which are 50% tax-free. Ditto for dividends, which offer a healthy tax credit. But with GIC yields, every single dollar in interest is added to your existing income and taxed at the marginal rate.

Now, it gets worse.

You actually have to pay tax on money you haven’t received, and may not for half a decade. Seriously. The ‘fat rate’ of 3% or so at famous Maxa or trustworthy Oaken comes on a GIC whose interest is not compounded, and paid only at maturity. If you buy one today, then maturity happens in 2024. Meanwhile you must declare the imputed interest annually on your income tax return, and fork over Justin’s share. Thus, this is a cash-flow-negative investment. Risk.

There’s more.

The feds reported this week that inflation in March was just a hair under 2%. All eight major components the index tracks were higher and the 2% mark would have been shattered had gas not declined 4% over the last 12 months. Well, with the carbon tax, that’s now over. In fact a litre of the good stuff is damn near $2 in Vancouver this week.

In short, inflation of 2% may become something closer to 2.3% or 2.5% once the impact of higher prices for gasoline, home heating oil, natural gas and propane click in. Plus, municipalities will be increasing property taxes to cover their shiny new carbon bill.

So why would you ever accept a 3% return, fully taxable in advance on an uncashable asset with a negative cash flow from a questionable bunch of guys when you cannot make any money on it? Inflation alone will wipe out the face return. And while a GIC poses no risk of a loss in principal value, it also has no chance of an increase. There’s zero tax efficiency, plus the equity-flipping cowboys at the office will snicker and guffaw when they find out.

The advantages of a GIC? As stated, no loss in the core investment. And the government will back you (hopefully) if the dodgy folks you handed off your money to go paws-up. CDIC will cover up to $100,000 (double for a couple) and some provinces claim full coverage of CU deposits. (In another post we will discuss why some of these ‘guarantees’ are like those offered by Weight Watchers.)

By way of comparison, investment accounts handled by brokerages and containing stocks, bonds, ETFs, trusts and other assets are covered for $1 million per person for non-registered accounts, another million for RRSPs and TFSAs and a further million for RESPs. This is through the industry-funded Canadian Investor Protection Fund (CIPF).

Now, incredibly, more than 80% of the money invested by all the little beavers in the nation with TFSAs – where growth is completely free of tax – is in savings accounts or GICs. And in taxable portfolios across Canada, those hoary old investment certificates dominate. Investors keep shoveling money into the banks for a return of 2% or less, so they can then borrow mortgages at 3.5%. And we wonder why life is a struggle.

Yes, I was going to write about Jason Kenney today. But this is far more exciting.

Garth Turner April 17th, 2019

Posted In: The Greater Fool

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