Here's what to do with your excess savings
There are many investors who remember the days when high interest savings accounts would yield what many would consider a very decent return. But in the era of ultra-low interest rates, high interest savings accounts now yield between one and two per cent.
Are the days of a high interest savings account rate actually being high officially gone?
“I think it's always a function of general interest rates. And if people are getting zero on their money and then an account can pay you three-quarters of a per cent - although it doesn't feel like it - it's still a ‘high interest rate’. So, 1.25 per cent, at the moment, for a daily interest savings account is pretty good,” said Ted Rechtshaffen, president and chief executive officer at TriDelta Financial, in a phone interview.
A scan of rate comparison website RateHub.ca shows most high interest savings accounts offer a rate of below two per cent.
The highest non-promotional rate is offered by Wyth Financial at 1.55 per cent. Wyth is owned by Saskatoon-based Concentra Bank and revealed earlier this month that it would be bought by alternative lender Equitable Group Inc.
In an interview with BNN Bloomberg on Feb. 8, Equitable Group Chief Executive Officer Andrew Moor touted the high interest savings account rates offered by Wyth and Equitable-owned EQ Bank, which is currently 1.25 per cent.
A number of factors are used to determine the rate of a high interest savings account including the Bank of Canada benchmark rate and competition between financial institutions – a lender that wants to lure more deposits might raise its savings account rates to attract customers.
A 2019 survey from BMO Capital Markets found roughly half of the 630 respondents nationwide reported having a high interest savings account.
But as inflation hits multi-decade highs, it’s worth keeping in mind that at the end of the day, money left in a high interest savings account is losing its purchasing power.
“These high interest savings accounts at 1.25 per cent - after inflation and taxes, you're behind the eight ball,” Robyn Thompson, founder and president of Castlemark Wealth Management, said by phone. “So it's really important to try to understand what is the savings account meant for.”
“I think that's the first place to start. What is your definition of savings, and allocating your resources accordingly to make sure that you're not going to continue to erode your purchasing power.”
That definition, she said, could be savings for an emergency, the cash portion of your overall investment portfolio or part of a savings regime for an upcoming big ticket purchase.
Meanwhile, Rechtshaffen said if you need access to your money either immediately or in the near term, a high interest savings account is probably the best place to be. If that’s not the case, that cash could be better off put to work elsewhere.
“We see a lot of people who have a lot of cash in accounts, whether they're getting 1.25 per cent or they're getting zero. […] But a lot of the time, that money is really meant to be longer-term investment money, and either people have sat on it because they don't know what to do with it or because they're too nervous to invest it,” Rechtshaffen said.
'NO FREE LUNCH'
For those looking for a higher yield, a move up the risk ladder is in order – but it all depends on an investors risk tolerance.
“It all comes down to risk and return, and there's no free lunch,” Thompson said.
She said if an investor is looking for an absolute guarantee their money won’t be lost, their options are generally limited to savings accounts and guaranteed investment certificates.
“You're looking at a return rate between two and two-and-a-half per cent, so, still below the rate of inflation and after factoring in taxes, you’re still losing money,” Thompson said.
Beyond that, she said, investors can consider exchange-traded funds, mutual funds or, depending on your knowledge of the market, individual stocks.
“I think for most people, you start to dip your toe into a portfolio of exchange-traded funds or a mutual fund or a product that gives you diversification across the board that has an allocation towards equities,” she said.
“So you have the potential to earn a rate of return beyond inflation, while still keeping your risk tolerance low. So now it becomes a conversation or a dance of how much risk am I willing to take to get the return I need?”
For some investors, high-yielding dividend stocks are also an option.
“These are really the tried and true way to invest your money for higher yields,” Thompson said.
If an investor has capacity and appetite for that level of risk, she said the key is getting an income stream flowing in that supports their cash flow needs so they don’t have to draw down their portfolio.
“I would look for [companies that have a track record of] 25 years of consecutive dividend increases. Most Canadian banks and utilities match this criteria. And you want to see those long-term dividend increases,” she said.
“Dividend yields can essentially drop in value during periods of market volatility, but that dividend that you're getting should provide the cushion.”
A 'PREFERRED' OPTION
Meanwhile, Rechtshaffen recommends using preferred shares as a way to get a higher return at lower volatility.
Preferred shares are a hybrid investment in that they combine characteristics of stocks and fixed income. They’re like an equity in that they give you ownership of a portion of a company and the share price can appreciate or depreciate. They also have a par value, typically have a fixed payout and don’t have voting rights like a bond.
Rechtshaffen said he sometimes suggests rate reset preferred shares to clients, which tend to do well in rising rate environments, and fixed rate preferred shares, where the dividend doesn’t change.
“It's not that there's zero risk in preferred shares because they go up and down for sure,” he said. “Part of it is you have to know what you're buying because sometimes there are a few bells and whistles so you have to understand it.
“Having said that, most of these investments will - most of the time - deliver returns that are significantly higher than what you would get sitting in cash.”
NOT AN INVESTMENT ACCOUNT
Both of these finance professionals agree that high interest savings accounts are best used to house emergency funds, which typically amount to three to six months worth of living expenses.
“Have cash in your high interest savings account to meet those short-term expenses, but do not treat a high interest savings account as an investment account because it's just not,” Thompson said.
“It's there to protect yourself in the event of an emergency,” she added. “So I think from a cash perspective, having access to capital is very important.”
“You don't want to be in a position where you have your investments allocated towards higher risk investments and you need to draw down out of the portfolio to pay off an emergency – because you could be drawing down in a volatile market and you’ll be crystallizing your losses.”