Do Banks Misrepresent GIC Rates?

I thought I had more saved!To say that Canadians aren’t financially literate may seem a touch unfair, but everywhere you look we find testaments to this unavoidable fact. Credit cards, car loans, mortgage rates and even how returns are calculated are a confusing mess for most people. The math that governs these relationships is often opaque and can feel misleading, and its complexity assures that even if some do understand it, the details will only be retained by a tiny minority.

Even relatively straightforward investments can be terrifically misleading. Take for instance a well-known credit union offering a (limited) 90-day rate of 2.5% on a GIC. This advertised rate is not simply featured in the windows of its various locations but is promoted online and on the radio.

Banks and credit unions frequently offer improved GIC rates for a limited time to drive deposits. But how those rates are advertised can be misleading. The aforementioned “2.5% 90 Day GIC rate” has its own website where it contrasts its deposit rate against other major financial institutions, all of them paltry compared to the prominently displayed 2.5%.

90 Day
This seems shockingly dishonest. Also the importance of that footnote seems understated.

At the very bottom of the website there does exist a footnote however. That 90-day GIC rate? It’s an annualized number, meaning that the interest you will earn at the end of that 90 days is 0.62% not 2.5%. The most egregious part perhaps is that it compares its misleading return to the far more understandable 90 day return of other GIC providers.

 

Linked GIC
Sounds good right? Don’t forget to click on the “More Details” button.

 

Other innovations in obfuscation abound. Exploring their website and we find a “linked GIC” which offers to protect your principle while giving you market returns linked to a custom index. The marketing material promises to “give you exposure to the Canadian stock market” and offers you a chance to see it performance results. But if you click to learn more of the details you find out that returns on the 3 year product are capped with cumulative returns of 15%. Not bad until you remember that traditionally returns are annualized in Canada. The maximum returns the product will offer is 4.77% regardless of what the market does in that time. Better than a 3 year GIC perhaps, but potentially far worse than what the market may deliver.

As always, the details are available for those interested. They’re just a scroll farther down, an additional click, or perhaps another page over. So, if there exists full disclosure, what am I complaining about?

 

Important disclaimer
This sentence feels like it should be in the yellow, and not a different webpage towards the bottom.

 

The answer is best illustrated in every search you do on Google. At the top of the page are the websites that have sought to be promoted. 67% of clicks are on the top five results on a google search. 95% of clicks are exclusively for the first page only. Things on the next page barely warrant looking at. It’s just not of interest. Disclosure details may only be a click away, but from the point of view of an average person looking over the details, they may never get around to reading them.

GICs are considered the safest investments for Canadians looking for security, but their function is to provide banks with low cost loans to help finance their own business activities. Every investment made in a GIC may help bring someone comfort at night, but they’ve really entered a business relationship with a bank. Framed as such it seems that better and clearer disclosure should be the primary order, but because our thinking is that GICs are a form of product they are treated as such.

Importantly, I must stress that these banks, credit unions, and other financial institutions are not lying. They are doing what they are allowed to do under the various laws that govern financial institutions. That such rules fall short is precisely why its always smart to talk to an independent financial advisor like myself. Providing context, clarity and advice free from the conflict of corporate proprietary products is how we help people every day, and its what makes us unique.

If you have questions about this article, or wish to discuss an important financial matter please call or email us!

 

 

Is Liquidity Worth the Price?

LiquidityLiquidity is a sacred cow among the investing professional class and the importance of being able to sell and redeem an investment at a moment’s notice is a cornerstone of presumed investor safety and a hallmark of modern investing. In fact, improving liquidity has been a goal of markets and it’s a major achievement that there isn’t a commonly held mutual fund, ETF or stock that can’t be sold at the drop of a hat.

But in the same way that we can overemphasize the benefits of some health trends to the point of excluding other good for you foods, (I’m looking at you gluten free diet) the assumed exclusive positive benefits of liquidity can crowd out some very reasonable reasons to seek investments with low or limited liquidity.

Why would you choose an investment that can’t be sold easily? It’s worth pointing out all the ways that liquidity make investing worse. Volatility is increased by liquidity. High frequency trading, ETFs and trading platforms that let novice investors monitor the ups and downs of the market provide liquidity while magnifying risk. Sudden events best ignored become focal points for sell-offs. Liquidity is almost always the enemy of cooler heads.

HFT

Liquidity also costs money. For investments that are traditionally illiquid, like some bonds and GICs, redeemable options often trade at a discount. According to RBC’s own website the difference between a redeemable and non-redeemable GIC is 25 bps ( a quarter of 1%), which doesn’t sound like much, but when rates are as low as 1.5% for a five year GIC that is a 16% reduction in return.

Picture of the early Dutch stock market
Picture of the early Dutch stock market

The principle of investing has been that buying and holding something over a period of time would result in returns in greater excess than the rate of inflation. That rate of return is based on the associated risk of the enterprise and how long the investment should be held for. But into this mix we have also come to value (greatly) the ease with which we can walk away from an investment. It is the underpinning of a stock market that your commitment to a corporate venture need not be you, but that your financial role can be assumed by someone else for a price (your share).But that feature has come to dominate much of what we both value and hate about investing. Canadians are relieved to know that can sell their investments on short notice, protecting them from bad markets or freeing up cash for personal needs. But by extension things like High Frequency Trading use that same liquidity to undermine fair dealings within markets.

Are there reasons to not choose a liquid investment (aside from your house)? I think the answer is yes. For one thing we may put an unnatural value on liquidity. We pay for its privilege but we rarely use it wisely. The moment we are tempted to use liquidity to our advantage we usually make the wrong choice. Selling low and buying high are the enemy of smart investing, but all too often that is exactly what happens. Every year DALBAR, a research firm, publishes a report detailing investor behavior and its results are sobering to say the least.

Poor investor decisions have led to chronic underperformance by “average investors”. The inability to separate emotions from investing, and the ease with which changes can be made have led to meager returns. In the 2014 study showed that the “average investor” 10 year return was a paltry 2.6%, nothing compared to the return of most indices. That return got surprisingly worse over time, with a 2.5% annualized return over 20yrs and 1.9% over 30. Reduced liquidity could inadvertently improve returns for investors by simply removing the temptation to sell in poor markets; in those moments when our doubt and emotions tell us to “run”.

This is from the 2014 DALBAR QIAB, or Quantitative Analysis of Investor Behavior.
This is from the 2014 DALBAR QIAB, or Quantitative Analysis of Investor Behavior.

So what types of investments are typically “illiquid”? Such products are normally reserved for “accredited investors”, or investors that have higher earnings or larger net savings. These deals are traditionally considered riskier and would be unsuitable for a novice investor (unfamiliar with the risks) or ill-suited to someone who might need to depend on their savings on short notice. That makes a lot of sense and any manager worth their salt would tell you that you shouldn’t tie up your savings if you might need them. But it is worth considering whether we have let our obsession with the convenience of liquidity undermine our goals as investors. Something to consider next time the urge to sell in bad markets comes upon you.