GIC vs. Mutual Funds – Which One Is Best for You?

When it comes to retirement savings and investment options in Canada, there are plenty to choose from. But depending on your goals and where you are on your financial journey, one option may be better for you than another. Two of these options are GICs and mutual funds. The winner of the GIC vs. mutual funds debate depends on your personal preferences and investment goals.

Fundamental Differences

A GIC (guaranteed investment certificate) is when you lend your money to the bank for a set amount of time, and they agree to pay you a certain percentage of interest as a return. They are sort of like glorified savings accounts.

A mutual fund is a pool of money that the fund manager uses to invest in various products. Mutual funds are traded in the stock market, whereas GICs are not.

GICs offer predictable and consistent income and are guaranteed, hence the name. The CDIC (Canada Deposit Insurance Corporation) ensures GIC investments. There is next to no maintenance required with a GIC making it a reasonably passive investment.

Mutual funds, on the other hand, are more diversified. And although they are less time-consuming than owning and investing in individual stocks, there is still slightly more time commitment required than with GICs. You will want to do a bit of research before investing in a specific mutual fund, as they are not all the same.

Money invested in non-redeemable GICs is locked in for a set time frame (term). If you were to withdraw your money early, there would be an early redemption penalty. Mutual funds don’t have a term and can be cashed out or traded much easier.

Risk – Return

GICs have guaranteed rates. The longer you keep your money in a GIC (the longer the term), typically the higher the interest rate. But don’t get too excited; we are talking about single-digit returns. And just because GICs are guaranteed does not mean they come without risk.

The interest rates on GICs are typically relatively low. And the longer the term, the greater your chance of inflation risk.

Inflation risk is when your money grows at a rate slower than inflation. For example, if you invest in a GIC with a 2-year term and interest rate of 1.5%, but inflation is 2% over that same time frame, your money has lost spending power invested in a GIC. The interest payments don’t even cover inflation. So, even though you did not lose any of your capital, your money is worth a little bit less overall.

Any investment product that has the possibility of higher returns will also come with more risk. Mutual funds are no exception. Because mutual funds trade in the market, they come with more volatility.

The management of the fund and overall market performance will impact the return of a particular mutual fund. There is the possibility for unlimited upside. And the chance that you could lose everything, including your original investment.

Taxation and Fees

GICs tend to have no fees and very low minimums to purchase. The only fee you may run into with GICs is an early redemption penalty if you withdraw money before the end of the term. And although this is not a “fee” per se, it can affect the amount of interest you earn on your money.

To avoid early redemption penalties, you can invest in redeemable or cashable GICs. The only downside is these types of products tend to offer lower interest rates.

Any interest gained on GICs outside of registered accounts is subject to taxes. And because it is interest earned, it will be taxed at your marginal tax rate.

If you invest in mutual funds, you can expect to pay some hefty fees. In Canada, 75% of mutual funds have an average management fee of 2.28%. However, that may not seem like a high number. If you are only making an investment return of 5%, your fees will eat up almost half of that return. And those fees are paid regardless of the return. So if the fund goes down, you still pay the management fees.

Mutual funds may also have transaction fees, delayed service charges, and commission or sales fees.

The taxes you will pay on mutual funds can be unpredictable. Depending on the funds’ management, you may incur taxes when individual stocks within the fund are bought and sold. And you will have to pay tax on any gains if you invest in a non-registered account.

One benefit mutual funds do have is that the gains are often due to capital gains or dividends, and those are both taxed more favourably than interest.

Is There Another Option?

GICs and mutual funds are not the only options for your investment dollars. Index funds and ETFs (exchange-traded funds) offer many of the same diversification benefits as mutual funds without the high fees.

And if you want to take the time to educate yourself and take on a bit more risk, there is always investing in individual stocks. Just make sure you do your homework first. Because although stocks have the potential of unlimited returns, they also come with the most risk.