Mutual funds vs GICs: what every investor should know

In Canada, there are many strategies and options that investors can use to accumulate wealth. Two of these investment options are Guaranteed Income Certificates (GICs) and mutual funds. These investments have similarities and differences, and of course their own advantages and disadvantages. So how do mutual funds compare vs GICs?

By gaining sufficient knowledge about these instruments, investors can make informed decisions that are aligned with their financial objectives and risk tolerance.

Whether you are an experienced investor or a novice about to start on investments, this article aims to provide you with valuable insights into these investments.

Read more: How to start investing in Canada: a beginner’s guide

Mutual funds vs GICs: what is a GIC?

A GIC, or Guaranteed Investment Certificate, is one of the most popular low-risk investments in Canada. It guarantees your original amount invested while also allowing the amount invested to earn interest at a variable or fixed rate.

When the GIC matures, you can get back what you invested along with any interest earned. The money is guaranteed by the Canada Deposit Insurance Corporation (CDIC).

There are GICs that have terms as short as 30 days or as long as 10 years. During this time, they earn at either a variable or fixed interest rate. Depending on the type of GIC you choose, the money invested can be inaccessible for the entire term or allow you to make withdrawals without penalties.

In general, investors in a GIC can earn more interest if they choose those with longer terms. However, the interest rates of a GIC tend to be smaller since they are a low-risk investment, although sometimes GICs earn more than usual. Depending on investors’ risk tolerance, this can be a good investment in the short- or medium-term.

There are many types of GICs, but they usually fit into these common categories:

• Cashable GICs - a GIC with a one-year term which can be cashed out any time without penalty, but only after a 30- to 90-day waiting period. Investors who withdraw before the waiting period pay a penalty fee.
• Redeemable GICs - considered longer-term investments with terms of a year or more, and do not have waiting periods. Although the money can be withdrawn anytime, these GICs have an early redemption schedule. This means much lower interest rates are applied on money withdrawn long before maturity.
• Non-redeemable GICs – are the most typical GIC and don’t allow investors to touch the money until maturity.
• Market-linked GICs – work like an index mutual fund in that it’s a GIC linked to the performance of a stock market index. Interest earned is based on stock market performance, but the principal amount is still guaranteed up to the CDIC-stipulated maximum (typically up to $100,000).

Mutual funds vs GICs: what is a mutual fund?

A mutual fund is a type of investment tool that is a collection of stocks, bonds, and other investments cobbled together, then managed by a professional fund manager or portfolio manager.

In a mutual fund, investors can buy into a variety of investments – often known as diversification – to maximize returns and minimize the risk associated with these investments.

A mutual fund can contain as many as 100 or more securities.

Mutual funds vs GICs: what’s the difference?

There are several differences between these two investment types. It’s important to know these differences so you can decide on which instrument is more appropriate for your needs.

1. Difference in accessibility

In a GIC, the funds are usually inaccessible, as most GICs are commonly non-redeemable. You may only access the funds if the GIC you chose was a redeemable one, and withdrawing money from it before maturity has penalty fees.

As for mutual funds, you can withdraw some or all the money in a mutual fund. You will have to pay the corresponding income taxes and fees.  

2. Different returns and risk

GICs have virtually no risk associated with them, unless it’s a market linked GIC where earnings are tied to the performance of the stock market. Even then, you have no risk of losing the original amount, especially if it’s a GIC from a big bank.

On the other hand, mutual funds have greater risk as they are traded on the stock market. But in the hands of a skilled fund manager, the mutual fund can be protected if it’s put together in a way that has enough diversification to lessen potential losses.

The other flipside to a mutual fund’s increased risk is its increased potential for higher earnings – even compared to GICs with the highest interest rates.

3. Difference in associated fees

Investors don’t have to pay any direct fees on GICs, which makes them more attractive compared to other kinds of investments. Probably the only fees GICs require are transfer fees for when an investor moves the GIC’s registered account to a different bank or financial institution.

The only other type of fees paid on a GIC would be penalty fees, which are charged if investors withdraw the money before the investment matures.

Mutual funds require payment of management fees, sales charges, commissions to the fund dealer or manager, and operating costs. This can of course be relatively more expensive than a GIC. And should the fund have a high Management Expense Ratio (MER), this can take a significant percentage of the fund’s earnings.

4. Difference in taxes

When held in non-registered accounts, GICs and mutual funds can have different taxes applied to them.

For a GIC, the tax on its accrued interest is based on your marginal tax rate.

As for mutual funds, their gains, which are usually capital gains or dividends, aren’t taxed as heavily.

If either of these investments were held in registered accounts, such as a TFSA or a Registered Retirement Savings Plan (RRSP), then their gains would be sheltered from paying taxes.

Mutual funds and GICs: similarities

The main similarity between GICs and mutual funds is that they can both be held in registered or non-registered accounts. Both investments come in several different types, allowing investors to choose one or any combination of them to suit their liquidity needs, investment goals, and risk appetite.

For instance, you can go for a market-linked GIC that can offer the best features of GICs and mutual funds. A market-linked GIC can potentially provide higher potential gains as it’s tied to the stock market. It also gives you the security of getting your money back – just in case the market performs poorly.

Meanwhile, you can choose to invest in mutual funds from big banks - the Royal Bank of Canada's mutual funds, for example – or other financial institutions. One such mutual fund that can give good returns and comparatively lower risk is the money market mutual fund.

Mutual funds vs GICs: are GICs for you?

GICs are a more appropriate option if you’re looking for a secure investment that has guaranteed returns. This is good for investors who are extremely risk-averse and prefer not to, or simply cannot afford to, lose any of the money they invest.

GICs are an investment that’s more optimised to meet financial goals in the short- to medium-term. For instance, saving up for an emergency fund, home renovations, or buying a new car often have a timeline of 3 to 5 years. In these cases, a GIC is perfect for funding these goals.

GICs are not an advisable investment if you’re looking for a long-term investment that can provide capital growth. GICs can work well for anyone who needs short-term, guaranteed savings.

A GIC is also a good place to put your money when you’re new to investing and aren’t sure where to begin.

Here’s an overview of GICs:

Mutual funds vs GICs: are mutual funds for you?

For those who want a long-term investment and are geared towards capital growth, mutual funds are a better investment. This is also more suited to investors who have a reasonable amount of risk tolerance and are willing to accept uncertainty and market volatility.

Potential investors in a mutual fund should be okay with the fact that their investments are not guaranteed to bear fruit. Investors should also accept that their money doesn’t have the same protections as the CDIC provides GICs.

Mutual funds are more for the intrepid investor who can take the market’s ups and downs, and generally intend to see their gains grow over a long period of time.

In terms of timelines, mutual funds are better suited to financial goals that will take more than 5 years to achieve or complete. For example, saving for retirement, building a summer cottage, or raising money for a college fund are goals better served by a mutual fund.

Investing in mutual funds doesn’t mean it can’t be rewarding in the short- or medium-term. There are some mutual funds that have good liquidity and can still provide relatively quick returns, like the money market mutual fund. This type of fund is deemed a safe investment that doesn’t usually fluctuate wildly or fluctuate in value.

It’s possible to receive decent returns in the short-term, if managed wisely. Mutual funds also have the option for investors to redeem their investment at any time by selling their fund units.

Here’s an overview of mutual funds’ pros and cons:

Mutual funds vs GICs: which one should I choose?

Clearly, both investments have their share of benefits and drawbacks. Ultimately, investors should base their decisions on their investment goals and the risks they’re willing to take to achieve them.

Before choosing between GICs or mutual funds, investors should consider their objectives and when they’ll need the funds. Is the money for the inevitable RRIF in 40 years or for buying your first home in the next 4 years? These factors can spell a huge difference between picking a GIC vs a mutual fund.  

In 2023, GICs have reached interest rate highs not seen in the past 15 years. While this is not meant to wean investors off mutual funds completely, the following video suggests ways of leveraging the GIC’s interest rates to counteract the effects of inflation and taxes:

We've seen how mutual funds vs GICs stack up; ever wonder how mutual funds compare to ETFs?

Mutual funds vs GICs: closing thoughts

Remember that this conversation about “GIC vs mutual funds” is not intended to suggest going completely all-in with one investment or the other. It’s not unusual for even the most seasoned investors to assemble and maintain a mixed portfolio of GICs and mutual funds.

There’s no reason or rule that says a mixed portfolio can’t be used to achieve their investment objectives. In fact, it's not unusual to see investors move money between the two. In investment circles, it can be common practice to place some of their money in GICs when the stock market is in a downturn, then reinvesting more in mutual funds later as the market improves.  

Read and bookmark our Investments page for updates on mutual funds, GICs, and other tools to help you grow and manage your wealth.

Now that you know the difference between GICs vs mutual funds in Canada, will you invest in one or both? How much of your investment portfolio will you allocate to each? Let us know in the comments!