With guaranteed investment certificates like GICs now offering reasonable rates of return, should investors abandon the stock markets in favour of guaranteed investments?
Not necessarily. While guaranteed investments may seem inherently less risky, in practice, they come with their own set of financial risks, which can leave you with fewer returns and less money in the long term.
Risk of missing out in the market
Investing always carries some risk. There is the risk of price fluctuation, risks associated with inflation, liquidity risk, the risk of deadweight loss, and so on. Financial behaviour scholars have studied the human reaction to financial setbacks and have established that the dismay of a loss is twice as painful as the pleasant feeling of enjoying a financial gain. Nobody wants to see their money shrink, even if it’s only for a short time.
The problem is that GICs tend to be a short-term investment, and therefore may not give you the highest long-term return on investment compared to staying invested in the stock market. Sure, it feels nice to see your investment go up no matter what – even if it’s just by a small amount. But realizing a small gain, instead of riding through volatility toward an even higher gain, is financially short-sighted at best.
Risk of inflation
The other risk you take when you invest in a GIC instead of the stock market is the risk of inflation eating away at your investments. GICs don’t take inflation into account unlike the stock market. Stock market values rise along with inflation, while GICs do not.
It’s about time
When it comes to investing, time in the market, not timing, is what matters. If you have a short-term investing horizon – and don’t have time to let a market-based investment bounce back from any potential downturns – a GIC can be a lower-risk option. On the other hand, if you have a long-term investing horizon, relying too heavily on fixed-income investments during periods of uncertainty comes with its own set of risks, and can give you insufficient returns in the long run resulting in a failed financial plan.