When you earn more income than you spend, the next question is what to do with that extra money. You might decide to repay debt. Debt is income that you have already spent, it must be repaid, and eliminating the interest usually yields a good adjusted return on your dollars. However, you must also look towards your future. For the near term, that means saving money. For the long term, you must invest to provide your future income. Learn about high-interest savings accounts, high-interest ETFs, money market funds, GICs, and bonds as options for saving. Make sure that your money is there for you with as much buying power as possible.
What is saving vs investing?
Saving is setting aside money in a safe way such that it is guaranteed to all be there when you need it. That can take a number of forms. Some are accessible at any time, like cash or savings accounts. Others are locked up for a period of time that you would choose when buying the product, like a Guaranteed Investment Certificate (GIC) or some high-interest savings accounts.
In contrast, investing is putting money into something expected (not guaranteed) to generate a positive return over time. Importantly, an investment also usually fluctuates in value along the way. That is unpredictable and it is possible that your investment value could be lower than expected when you need the money. The higher the expected return, the riskier that investment is. That means that the value is likely to be more volatile and there is a higher risk of losing money, counterbalancing the potential for making more money. This relationship between risk and return is quite strong and if a return seems too good to be true, you are likely missing some of the risks.
High Interest Saving Accounts, ETFs, & Mutual Funds
The safest ways to save involve cash. That could be in physical or electronic form. You should consider both safety and convenience.
While less common in the digital age, some people like to stuff cash in jars, secret compartments, or their mattresses. You may even have used a pig-shaped piggy bank around the same time that dinosaurs walked the Earth.
These methods have the advantage of physically being able to touch your money and get it. One disadvantage is that someone else could physically take it. That is why we have banks.
Bank Savings Accounts
A savings account at a bank benefits from the bank’s security. Your money is also protected by the Canadian Deposit Insurance Corporation (CDIC), or occasionally a provincial equivalent.
CDIC covers up to $100K per account type. So, a personal account and a joint account could have up to $100K X2 = $200K covered. Investment accounts at the same institution (TFSA, RRSP, RESP, cash) also each count as a different type. It is also per institution. So, if you have a savings account at five banks, then you could have up to $500K covered. If you had two different account types at each of those five banks, then up to $1MM insured.
Try to find a balance between safety and practicality. The risk of a major Canadian bank default is not zero, but is very low. There may also be fees, time, and effort for multiple accounts. I have seen relatives forget where they have accounts and GICs stashed whilst trying to spread them out across banks. That is particularly problematic as you get older and may not only forget, but die. You may not want to have all of your eggs in one basket, but don’t leave your family with an Easter Egg Hunt either. If you do decide to become an account spreader, keep a master list in a known accessible (but secure) location, usually along with your will.
High-Interest Savings Accounts
Gone are the days when banks truly paid high interest on deposits for the privilege of using your money to lend and profit from. A better name would be an Okay-Interest Savings Account. Even with the recent rise in interest rates, the rates paid are well below inflation or lending rates. Still, it is better than a regular account, secure, insured, and easily accessible. Nerd Wallet has a good list of Canadian HISA and their rates.
One thing to be aware of is that some HISA’s have introductory rates that decline, minimum balances, or minimum holding periods. So, be sure to determine whether it matches your plans.
High-Interest Exchange Trade Funds (ETFs)
If the money that you want to hold as cash is in your discount brokerage account instead of a bank account, then High-Interest ETFs are an option. The main advantage is that it saves you the hassle of opening up another bank account or transferring money around. Buying one ETF, effectively puts your money into multiple different savings accounts at different financial institutions. That provides a degree of diversification and there are no minimum balances or holding periods. The money is also not protected by CIDC. However, the accounts are at major Canadian banks. If one of them went under, you could lose that portion of the deposit. However, that would represent a major financial system failure and nowhere would likely be very safe. Except for your piggy bank.
You can usually buy or sell them for <$10 just like other ETFs. That means this is not very cost-effective for small amounts of money. For example, a $10 commission buying $1000 of a high-interest ETF represents a 1% commission. Ouch! In contrast, for $100K it would be negligible. There could also be some money lost due to the bid-ask spread. That is hard to quantify, but when ETFs are bought and sold some money is made by the market-makers that facilitate the transaction. If you are holding the ETF over time, then the embedded management expense ratio of the fund may also drag on your return. This is usually ~0.10%/year. Whatbank.ca has a monthly updated comparison of the above costs to give a real-world yield for some common high-interest ETFs.
Another wrinkle in the high-interest ETF story is that some discount brokerages associated with the major banks (TD, BMO, RBC) refuse to let you hold them. Essentially, they want you to use their products instead.
High-Interest Mutual Funds
Another way to get some interest on cash in your brokerage account is to use mutual funds. The big six Canadian banks and a number of other financial institutions offer high-interest mutual funds. Mr. Thrify has a great summary of them on his site. Most have a low or no-load F-series that you can get via your brokerage. Even a discount brokerage – I found most of them on Qtrade (what I use) for the usual low trading fees. They have a short settlement date (Trade+1), pay decent interest rates, and are usually CDIC-insured.
While you aren’t paying management fees per se (the usual fear with mutual funds), the interest rate offerings appear slightly lower than what I have seen for the ETFs. So, they are likely making their money on the interest rate spread instead. Personally, I’d probably take the highest rate if that is an ETF and accept the low risk of financial Armageddon. However, some say that I am a bit loonie that way.
Cash Equivalents (Short-Term Securities)
Cash equivalents are liquid with low risk and a low expected return. This commonly includes short-term GICs, government bonds, and commercial paper (a short-term debt that is not registered as a bond). While there is more risk than a high-interest savings account, these holdings usually mature in 1-3 months, minimizing those risks. You can also buy money market funds that bundle a mix of cash equivalents for a convenient degree of diversification and liquidity at the cost of a management fee (usually in the 0.2-0.3%/yr range).
Since there is some risk, albeit small, with cash equivalents and money market funds, I would expect there to be a higher expected yield than cash or high-interest savings accounts. If it is really close net of fees, then those safer tools may be a better option.
Using bonds or GICs to save for a known time-frame.
A bond or GIC is basically a loan to whoever issued it. You give them your money, they pay a defined interest rate, and they fully repay on the maturity date. For bonds, the interest is paid along the way (called the coupon). For GICs, the interest is added to the GIC value, you owe tax on that annually. Some GICs pay that interest out, and for others, you only get to access that interest when the GIC is redeemed (even though you still pay tax annually).
Since they are both loans, there is creditor risk. For GICs, that is the risk of the bank or credit union defaulting and it is protected by CIDC insurance up to $100K. Just like a high-interest savings account, except that each GIC can be insured separately if a different maturity or institution. For bonds, the risk is relatively low for major governments and a government default would have other major financial implications anyway. Stockpiled food and toilet paper may be the only insurance. Corporate bonds carry more risk and therefore pay more interest to attract investors.
Very high-interest bonds are called junk bonds and are high-risk. So, if you are saving and have little wiggle room, then don’t get sucked into junk bonds because it is “interest” thinking that it is safe. Risk and reward are tightly related. Even with bonds.
Interest is also much more highly taxed than capital gains or dividends. So, most people are better rewarded by taking risk by investing in assets that build equity rather than junky debt.
Interest Rate Risk
A bond will keep its value, if held to maturity, and pay interest along the way. In that way, it is like saving. However, the price of a bond fluctuates between now and maturity. Bonds can be bought or sold before maturing on the “secondary market”.
Bond value before maturity fluctuates based on how interest rates change. If interest rates drop compared to the bond, it is less attractive on the secondary market. Why buy a $100 bond paying 2%/yr when I can get a shiny new one paying 4%/yr? I would expect to buy it at a discount, say $50, to get the same interest per year. That risk of price change due to interest rates is called interest rate risk. Bonds selling below their face value are called discount bonds and those selling above face value are called premium bonds. Premium does not mean better. You will collect more interest, but there is eventually a capital loss. That is an unfavorable tax situation because capital gains/losses are lightly taxed and interest is fully taxed.
Bond Duration & Risk
A measure of factors that affect bond prices on the secondary market is the bond duration. The duration is a mix of how long until a bond matures, yield, coupon, and call options. Basically, it is a measure of how sensitive the price is to interest rate changes. It acts like a lever. A long duration means a small interest rate change will cause a larger change in price. Volatility – exactly what you do not want when you need the money.
Using Bonds or GICs for Saving. Match to your time frame.
If you know the time frame in which you will need the money and are willing to accept some risk, then bonds or GICs are an option. However, it is important to be cognizant of the risks. Stick to low-risk creditors. Also, match the duration of the GIC or bond to the time that you need the money. That way, it matures and you get the money back at the right time and are not forced to sell on the secondary market.
You may be tempted to buy a bond ETF or mutual fund for “saving”. Don’t. Bonds play an important long-term role in investing, but that is different from saving. While a bond ETF offers diversification, the fund is constantly buying and selling bonds on the secondary market. There may be an average duration of the fund, but it will keep extending into the future with turnover. That means that you are still subject to price changes that could fall at a bad time when you need your cash back.
Time Frame & Options to Save vs Invest Money
The above options show that risk and time frame are important in deciding how to save vs invest. It is not a clean line, but rather a continuum. For the very near term, a high-interest savings account or high-interest ETF are safer options, but you should expect a lower return on your money. If you have some wiggle room to take some slight risk, then you may opt for a money market fund or short-term government bond. If using bonds or GICs, then matching the duration to your timeline is critical. The options are summarized in the table below.
The Long-Term Danger of Saving: Inflation Risk
The other risk to consider is inflation risk. Inflation is the gradual erosion of your buying power over time. A dollar today buys less than it did ten years ago. Even one year ago! It will buy less in the future. The safest methods of saving are unlikely to match inflation. So, long-term you will lose buying power. This is why I put under 3 to 5 years for the different saving options above.
In the short term, you must save to ensure that the money is there for you and the effects of inflation should be less. For the long term, you will need to invest. That may be very conservative investing, if your time frame is within the next 5 years. However, a significant loss to inflation becomes more likely the longer your horizon is. We invest not only to mitigate inflation risk, but for multiple reasons that we will explore in the next post.
Over the last 9 months most of my investing cash has been going into these.
For US$ side rrsp, non-registered brokerage I’ve been using BIL ETF. Getting safe 5% returns with payments in US$ which is unheard of in 15 years .
For C$ side I’ve been using ZMMK and CMR. Just storing up cash until the dust settles. However I did buy some TD, CM, ENB with the lows last 2 weeks.
Other downside is that the monthly payments are disbursements and not dividends so they’re taxed as interest.
Thanks Dad MD for sharing what you are using. I was looking at some of the options too. Someone was literally just asking me earlier today! I know that CMR is even commission-free to buy and sell with Qtrade. The US has a plethora of options. There is BIL and Vanguard has a bunch of US money market funds too. Personally, I don’t keep much uninvested cash in my brokerage accounts. I use a corporate LOC and some personal cash buffer for emergencies and invest the rest now that I have most of my big-spends behind me. However, it is nice to see that the recent interest rates have made some equivalent options a much better option for short-term saving than in the recent decade.
Great review LD! I was looking into this earlier as well as I needed to park some short term cash. What do you think of investment savings accounts? https://mrthrifty.ca/investment-savings-accounts-maximize-interest-in-your-brokerage-account/
Seems like a good option if it’s CDIC insured, the rates are not bad at all, but I’d presume still subject to fees/bid-ask/ECN etc, not sure if it has MER?
Interesting and thanks for sharing. They basically look like F-series mutual funds. Looks like I could get many of them through my discount quite easily. I couldn’t find any fees per se. They make money from the spread of what they are paying you and what they make on the other end and price the interest rate that way. A good addition. I will have add a blurb and like to Mr. Thrifty in the article.
I had locked away cash in a 3 Yr GIC at about 5% when rates peaked a few months ago, with the expectation of not being able to afford my downpayment prior to the end of the term.
The tricky thing is that GICs are looking less and less competitive now that the market is starting to price in rate cuts, while inflation has remained sticky. I think the 3 year term at 5% will do well enough, but now the 3 Yr GIC is at best 4.35% and a lot of bonds are even worse. I’d much rather just put more money into stocks, with a better expected long-run return, but sometimes you just need to bite the bullet and find the “least worst” low risk product available.
I was also thinking about this:
My experience at TD was consistent with what you mention. They offer a “mutual fund”–that really just operates like a HISA in disguise–that you can purchase without a fee (according to my banker) via their self-directed trading platform.
The current rate for this “high interest mutual fund” at TD is ~4.1%, which is competitive relative to many HISAs now available, although there is definitely a spread to Cash ETFs (the Horizon cash ETF has a 4.95% yield at present I think?).
I think that for some very short-term scenarios, the convenience of buying this type of product at my own bank may outweigh the spread on buying a cash ETF at a discount broker.
Thanks Zach. I have never been a big fan of GICs personally. Locked in. Often below inflation. Fully taxed. However, you did it at a good time and for a good reason. Long-term, investing is better. However, for short-term security you just have to pick the option that balances liquidity and try to minimize the erosion of your buying power. A real challenge! Hopefully, inflation will continue its downward trajectory, but who knows?