Financial institutions promote Market-Linked GICs and Principal Protected Notes touting risk mitigation and attractive return potential. Readers are very strongly encouraged to read the fine print when researching these products. Initial appearances are very deceiving.
A subscriber recently had a discussion with a broker in which the topic about safety of principal was a topic of discussion. This subscriber has been extremely successful in business and has reached an enviable stage in life where the culmination of years of hard work has provided him with the opportunity to buy back his most precious resource…..TIME.
During his conversation with the broker the subject arose regarding Market-Linked GICs and Principal Protected Notes ('PPN’). Since this reader has worked extremely hard to get to a position of financial freedom, the broker recommended these vehicles for the purpose of protecting wealth created through decades of hard work.
Subsequent to this conversation, this reader reached out to me for my opinion on these two offerings.
I am not licensed to sell these products or to make specific investment recommendations. In addition, I am not privy to this reader’s personal financial situation. Furthermore, it is not my place to delve into highly personal and confidential details.
I do, however, have an opinion about these products after having researched them less than a year ago. What prompted me to investigate these products was the advertising posted within the branches of various major Canadian financial institutions; the percentage returns posted are front and center and are quite appealing.
After researching these product offerings, I walked away convinced that when these products are sold I stand to benefit as a shareholder in the major Canadian financial institutions. As for the unsuspecting Canadian consumer who purchases these offerings….that is a whole different story.
Market-Linked GICs are guaranteed fixed term investments that combine the security of traditional GICs with the potential to earn a higher market-linked return in one simple solution.
For your benefit I provide links to the market linked GIC section of the websites of the major Canadian financial institutions. NOTE: There are multiple pages on each bank’s website related to market-linked GICs. The links found below will just quickly take you to the appropriate area on the respective bank’s website from which you can then look at related pages on this subject matter.
- The Bank of Nova Scotia
- The Royal Bank of Canada
- The Toronto-Dominion Bank
- The Canadian Imperial Bank of Commerce
- The Bank of Montreal
- National Bank of Canada
If you have an inkling of invest in such a product, whether in Canada or in the US, read the material provided by the financial institution offering the product. Pay particularly close attention to the features and the terms and conditions and make your own informed decision.
Sure, you might see some eye-popping interest rate returns. Read the very, very fine print, however, and you see that these attractive rates are not an annual return but rather the maximum cumulative return over the entire term of the GIC.
I also encourage you to investigate the tax implications of investing in Market-Linked GICs. The income from these instruments is taxed as interest. This is because you are not actually investing in the stock indexes themselves but are getting paid interest based on the change in the indexes. This is a drawback because interest is the highest taxed of all investment returns.
While the banks may promote that there are no associated fees with market-linked GICs, let’s not be foolish and naive. Banks do not develop products and services because they are benevolent organizations. They are in business to generate a profit for shareholders like you/me.
After having worked my entire career in the Canadian banking industry, trust me on this one. The bright minds at the banks don’t sit around creating products that will not generate a profit.
Please don’t take my word for it. Countless reviews have been written on these offerings. Perform a search on ‘market linked GIC in Canada’ and read the articles.
After having reviewed the material I strongly suspect you will walk away with an understanding of why the major Canadian financial institutions are so profitable. They are the masters of spin.
Principal Protected Notes (PPN)
PPNs are innovative financial products that combine key investment characteristics of both stocks and bonds. The distinguishing feature of these investments is that the principal amount, your original investment, is 100% protected IF the PPN is held to maturity.
PPNs were completely foreign to me prior to the bursting of the dot.com bubble in 2000. In fact, I don’t think the product gained any significant traction until a several years after it was first introduced.
There are two different types of PPNs. The first is a zero-coupon structure in which you are offered more safety. The second is a constant proportion portfolio insurance structure in which you are offered more risk and more potential reward. Go here for more details.
Both types of principal-protected notes require investors to hold them to maturity. In addition, there are two risks which must be considered.
- The credit worthiness of the issuer;
- Call risk.
These products have a couple of negatives.
The first is to know what you are investing in. The second is that the structure of these notes is often complicated and confusing.
Pay particularly careful attention to costs and fees. Your personality may be such that you typically sign agreements without reading all the fine print. In this case, I can’t stress enough that you MUST read and understand all the fine print.
In addition to the links provided earlier in this article, you may wish to read the following articles.
- The Sharks Are Biting: Wall Street's Structured Products
- Bad Investments: Principal Protection Notes
- Ontario Securities Commission - Principal protected notes (PPNs)
- Principal-protected notes do have downside
- Principal-Protected Notes: What You Should Know About Them
In the How to Apply Logical Thinking to Investing article go to this paragraph:
‘These products offer bank dividend-like payouts with no downside risk - but there's a catch’
As with Market-Linked GICs, banks created PPNs for the purpose of generating a profit.
I do not dispute that these product offerings may, in remote circumstances, be suitable for some investors. I am of the opinion that for the most part, however, investors would be wise to steer clear.
If safety is your primary concern, I think you are better off with ‘plain vanilla’ stocks. No matter what kind of stocks in which you decide to invest, be sure to carefully spread your money across the five main economic sectors: Finance, Utilities, Consumer, Resources & Commodities, and Manufacturing & Industry.
If you diversify your investments across these 5 sectors, you reduce exposing yourself to stocks that are about to slump simply because of industry conditions or investor sentiment.
In all likelihood you probably don’t need the ‘safety’ of Market-Linked GICs and PPNs.
I wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this post. As always, please leave any feedback and questions you may by clicking on “Contact Me Here” at the bottom of this page.
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.