ING Direct RRSP GIC – The price of liquidity

I was looking with curiosity at ING Direct’s RRSP GIC page to get an idea of what the retail risk-free rate would be. They had the following term and rate schedule:

1 Year 1.75%
1 ½ Year 2.50%
2 Year 2.20%
3 Year 2.25%
4 Year 2.30%
5 Year 2.75%

The “blip” in this schedule is the 1.5 year term, yielding 2.5%. The basic short-term ING account offers 1.5% on cash. If you break the 1.5 year GIC, you receive a rate of 0.5% instead.

So what a GIC investor would do is ask themselves about liquidity – how much are they paying to sacrifice liquidity? The quick answer everybody would give is 1%, but this is not correct. The actual answer is that liquidity becomes much more expensive as the term approaches maturity.

For example, if you assume the baseline cash rate is 1.5% throughout the 1.5 year term, if you invested in the GIC and then canceled the next day, your liquidity cost is very minute. In the next month, your cost is still fairly minute – you are paying $16.67 per $10,000 to access your funds.

However, if you canceled 17 months into your term, the cost of liquidity would be much, much higher. Giving a numerical example, at month 17 of the GIC, your accrued GIC interest would be $354.17 on a $10,000 investment. However, if you had to break the GIC to borrow the money (for one month as you would ordinarily be able to access your funds on maturity one month later), you have suddenly paid $283.33 in implicit interest for a one month term. This is approximately an interest rate of 33.7% to access your own funds.

So a rational investor that is considering locked products with penalty for withdraw has to strongly consider any liquidity considerations closer to maturity otherwise they could be paying a very expensive liquidity bill.

Most people willingly give up liquidity for a low cost – don’t.