Where to Keep Your Short-Term Money
You are careful with your money. You have made it a general rule to avoid debt – except for the mortgage on your home – in order to force yourself to live within your means. Well, you do use a credit card, but you have set it up so that your bank account is debited automatically every month to pay off your credit card in full. In other words, you lead a financially disciplined life.
The Traditional Bank Savings Account
That disciplined inclination to automate your financial management has also led to a bit of inertia on your part. You have banked with the same financial institution since you were a child putting your Christmas and birthday money into a savings account there. Back then it paid around 4% interest. Although you have opened an investment account for your RRSP, you still rely on a savings account for the money that doesn’t go into the RRSP. You know the interest rate isn’t great these days, but you are at least getting something, right? One day you logged into your bank’s website and looked up the interest rate just to be sure how much you were getting. To your surprise, you discover that you are getting 0.05% per year… if you keep at least $5,000 in the account. That works out to about $2.50 in interest earned per year. You wonder if you get a bit more if you have a larger deposit, but no, it’s still 0.05% even if you held $1,000,000 in that account.
There has to be a better place to put your money than in a traditional bank savings account! What should you do?
How Short is Short-Term?
When I think about short-term money, I am thinking about money that I plan to use sometime within the next five years, but I’m not exactly sure when. For that reason, I am disinclined to use Guaranteed Investment Certificates (GICs) for this category of money. An example of a situation in which you might choose note to use a GIC is after you have sold your home. You want to buy a new home, but nothing appeals to you in the neighbourhood you are interested in. You decide to rent for now, but in the meantime, you need to find a reasonable place to keep your money. You are prepared to buy a place next week if the opportunity presents itself, but you are also willing to wait up to three years if necessary.
If the amount from your house is $400,000, which would not be at all unusual in many parts of Canada these days, I doubt you want 0.05% interest. Maybe you should invest it.
Reasons not to Invest Short-Term Money
I think of investing as putting your money into a security which, in addition to the potential for gains above that of a savings account, also comes with a potential for loss. As an example, in the late 1990s the NASDAQ stock market (symbol: .ICOMP) was on a tear as all these tech companies came to market. Attach .com to the end of the name, and you had winner. If you were invested in tech stocks listed on the NASDAQ, you did pretty well… for a while. During the week of March 20, 2000, the NASDAQ hit a high of 5078. Unfortunately, that was the end of the tech boom for a long, long time. During the first week of October 2002, it dropped to a low of 1108 and never got to its old high until April 2015.
That’s a roundabout way of saying that losses can be significant and enduring. While diversifying your investments, and having a long time horizon, can do a lot to mitigate that sort of loss, for the short term, investments in risky assets are probably not the way to go.
What About Bonds?
Okay, stocks are risky. What about bonds? Government bonds, especially those issued by the federal government, are about as risk-free as they come since the government has the power of taxation available to it. But these days, you are not going to get much of a return for your investment. Yes, you can buy corporate bonds, but that also introduces a greater degree of risk, and in either case, once you buy a bond there is no guarantee that you will be able to sell it at the same price you paid for it. I should note as well that bond purchases are made by using a bid-ask spread quoted by a bond dealer. You buy at the higher price, the ask, and sell at the lower price, the bid, which is how the dealer makes its profit.
Are bond funds an option? Bonds are often categorized by their years to maturity: short, medium, and long. In this situation, a bond fund purchaser would want to select a short-term bond fund to match the expected short term before selling it again. The biggest short-term bond ETF in Canada, XSB, is offered by BlackRock’s iShares division. As I write this, XSB’s weighted average yield to maturity is a mere 0.50%. That’s not a lot, especially considering that bonds are not risk-free assets.
What Are Some Options?
There are some reasonable alternatives to bonds or bond funds that provide more safety for your principal as well as give you a greater amount of interest. Some of these alternatives may be found at an investment firm while others will be found at a bank or credit union. Once you make the choice as to which institution to use, the next choice is the account type in which to deposit your money.
Should I Use an Investment Firm?
If stocks, bonds or bond funds are not practical choices, then why even consider an investment firm? In recent years, a variety of savings type vehicles has emerged as suitable alternatives to high interest savings accounts.
In the world of Exchange-Traded Funds (ETFs), I am aware of five such vehicles. One of them HSAV, from Horizons ETFs, is so new that a Management Expense Ratio (MER) is not yet available. In addition, unlike other ETFs in its category, it typically does not make distributions, sheltering the fund owner from an immediate tax hit. ETFs are beneficial in that they are typically less expensive than mutual funds, which means more yield is left for the owner. However, at most firms, you will be charged a commission to trade in and out of any ETF, so if you only buy a small amount each time, you could quickly find your savings eroded. Nevertheless, if the goal is to buy in excess of $100,000, a $10 commission in and out should not be considered a point of much concern. On a 0.95% annual return, you would still get about 0.93% after commission.
The $100,000 figure noted above was not chosen at random. This is often the threshold the major mutual fund companies use before allowing you to purchase a “premium” money market fund that pays a better distribution yield. For example, TD’s regular money market fund (TDB164) has a yield of 0.41%, and has only a $100 minimum initial purchase size. In contrast, its premium counterpart offers a distribution yield of 0.60% but requires an initial purchase of at least $100,000.
Even these premium funds are not that impressive. This is just a sampling, of course, and you may be able to do better elsewhere.
There is also a class of deposit accounts that are available for purchase in investment firms. As they are considered deposits on a bank, they are covered by the Canada Deposit Insurance Corporation (CDIC), but they can be held inside a brokerage account. However, their yields are in the neighbourhood of 0.25% so they are not that great.
Should I Use a Bank or Credit Union?
After reviewing the options at an investment firm, for the most part I have concluded that you will do better by using a bank or credit union. In particular, I would encourage most people to use one of the low-cost online financial institutions to generate a better return than you are likely to find elsewhere.
One of the best sources for choosing this kind of product can be found at the website Canadian High Interest Savings Bank Accounts. Clicking on the menu heading HISA Chart takes you to a list of a wide variety of providers of High Interest Savings Accounts (HISA). If you click on one of the headings you can sort it according to your liking. For example, if you click on Rate, your listing will be sorted accordingly. One of the great benefits of this chart is that there is a column where you can find a Forum that provides a discussion of the experiences of people who have used that particular account. For example, Canadian Tire Bank currently provides the best rate for a non-registered account at 1.80%. Click on the forum, though, and you will find a posting from a person who said it took 48 days to get the account open.
Another feature is that there is a separate column for the TFSA rate offered by each institution. A few do not offer TFSAs, but most offer the same rate in their TFSAs as they do in the standard savings accounts. EQ Bank is the exception, currently offering 2.30% for TFSA holders.
Should I Use an RRSP?
Since the S in RRSP stands for Savings, perhaps you might be inclined to deposit your savings into your RRSP, assuming you have the contribution room. That is probably not a good idea. Yes, there is a tax deduction for you in the year you make the contribution, but if you take it out 18 months later, 30% of the withdrawal will be withheld (assuming the amount withdrawn is greater than $15,000) and you have permanently lost that contribution room. If your marginal tax rate is greater than 30% you may have to pay even more tax when you file. On top of that, you will most likely pay a withdrawal fee for the privilege of withdrawing your money.
Should I Use a TFSA?
The TFSA seems like the perfect account to deposit this kind of short-term money. After all, it’s called a Tax-Free Savings Account. If you have the contribution room, this can be a good place to deposit short-term savings. However, there are limits. While some people will have TFSA accounts that are greater than $100,000, that is probably because they have been investing the maximum each year and taking a long-term approach. As of 2021, if you have been eligible, but have not contributed since the TFSA began in 2009, your contribution room is $75,500. For that reason, the TFSA would only covers a smallish portion of the $400,000 you might have from a house sale. That doesn’t mean you can’t use a TFSA; a couple can each use their TFSAs to get up to $151,000. Moreover, the tax-free nature of interest earned in the account can save you a significant amount.
Having said that, I encourage people to use the TFSA for investing purposes. If you are in a lower tax bracket, it is preferable to an RRSP since the tax deduction is not that significant. On the other hand, if you are in a higher tax bracket, you may have sufficient income to have maximized your contributions to your RRSPs which makes the TFSA the next logical account type to use.
Should I Use a Non-Registered Account?
That leaves the non-registered account. The interest you earn will be taxable in the year that it is earned, most likely documented on a T5 slip issued by your financial institution.
If your financial institution is a bank with coverage from the Canada Deposit Insurance Corporation (CDIC), remember that the coverage limit is $100,000. If you are dubious about the security of a deposit made to a bank run by a tire company, or by any bank not among the big five, you may want to spread the deposits around.
Referring to the HISA chart again, you may have noticed a column with the heading CU at the top. That refers to Credit Union. You will further notice that the only credit unions listed are covered under MB (for Manitoba) insurance, indicating that these institutions are domiciled in Manitoba. The Deposit Guarantee Corporation of Manitoba guarantees all deposits in any Manitoba credit union without limit so you could consolidate all of your money in a single account (except for the limits imposed on TFSAs). The interest rate, while good, is not necessarily the best available, though.
Trade Offs
As always, there are trade offs in deciding where to keep a large sum of money for the short term:
- Bank vs. Brokerage
- Big Bank vs. Online Second Tier Institution
- Multiple Institutions vs. Limited Insurance Coverage
- Higher Interest vs. Security
- RRSP vs. TFSA vs. Non-Registered
- Tax Efficiency vs. Simplicity
There is almost inevitably a compromise that you need to accept, but with a little bit of work, you can make arrangements that will help you to squeeze out just a little bit more income in our current low-interest environment.
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.