With interest rates substantially higher, GIC rates are more attractive and have risen to levels we have not seen in 10 years. They are safe and you have the ability to earn a decent rate of return over a relatively short period of time. Coupled with the recent market volatility, from an investor perspective, GICs may look even more compelling.

The Canadian Deposit Insurance Corporation (CDIC), insures GICs up to $100,000. The principal and interest are guaranteed and GICs do not change in value and are insulated from the ups and downs in the stock market.

Purchasing a GIC with no risk to your principal and a guaranteed rate of return may seem like a winning proposition.

But, is it?

Rates on GICs have increased due to the multiple interest rate hikes by the Bank of Canada in an effort to slow spending and therefore economic activity which will tame inflation. The latest CPI reading for January came in at 5.9%.

While a 4-5% GIC may seem enticing, your real rate of return is negative once you factor in inflation and taxes, eroding purchasing power.

When considering an investment, it’s prudent to maximize your after-tax rate of return. GICs attract interest income, which is fully taxable in the year received, making it the least tax efficient form of investment income.

There is also an opportunity cost to owning a GIC. Most GICs must be held until maturity and cannot be redeemed or sold before that date. You are not able to take advantage of new investment opportunities. You will not lose any of your investment but you are not able to add to it. Some GICs may be purchased as cashable and redeemable but to have that flexibility you must accept a lower interest rate.

Understandably, 2022 was a frustrating year for investors. The TSX returned -5.84% and the S&P 500 -18.1%. In the short term, stocks can be volatile but the best returns come when you invest for the long-term.

For example, the average 1yr return of the TSX over the last 5 years is 8.54%. The average 1yr return of the S&P 500 over the last 5 years is 8.99%.

Let’s drill down to specific stocks and compare dividend paying stocks to a GIC, so you can decide which is the better investment.

For example, Enbridge Inc. (ENB), is a household name and a bill you’re probably familiar with receiving on a monthly basis. Enbridge is a Canadian company that is one of North America’s largest energy infrastructure companies with an extensive delivery network of crude oil, natural gas, natural gas liquids and renewable energy.

Enbridge is a dividend stock that is a cornerstone in many investors’ portfolios. It offers both yield and potential capital gains.

The 5-year average annual return as of January 31, 2023 is 10.96%.

The current dividend yield for Enbridge Inc. at the time of this writing is 7.05%. Enbridge (ENB) is a dividend aristocrat with a 27-year dividend growth streak.

This is just one example and we could list many others.

There are no guarantees with investing, but dividend paying stocks offer the potential of a much better return than GICs.

An important consideration in determining where to invest your money is the tax implication of the investment income. Not all investment returns are taxed equally and unlike capital gains and dividends, interest income is fully taxable in the year received.

Below you’ll see the difference of taxation between capital gains, dividends and interest based on $1,000 of investment income.

We are assuming a 46% marginal tax rate.

Interest income

$1,000 x 46% = $460
After-tax amount = $540

Dividend income

$1,000 x gross up of 138% = $1,380
Federal tax ($1,380 x 33%) = $455
Less: dividend tax credit ($1,380 x 15%) = ($207)
Net federal tax $248

Provincial tax ($1,380 x 13%) = $179
Less: provincial dividend tax credit ($1,380 x 10%) = ($138)
Net provincial tax $41

Combined tax ($248 + $41)

After-tax amount ($1,000 - $289) = $711

Capital Gain

50% of $1,000 capital gain is tax free
$500 x 46% = $230
After-tax amount ($1,000 - $230) = $770

Taking all factors into consideration, high quality, dividend paying stocks like Enbridge, is a better option. Its risk is a little higher but with that comes the potential for share appreciation and dividend growth. Your money isn’t locked in for a specific period of time and the investment income of dividends and capital gains is much more tax efficient than interest income.

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