Interest rates on savings accounts and GICs are so low these days that it can be tempting to put your hard-earned savings into the stock market for a chance to juice your returns.
But how and where you save, and invest, depends a lot on your time horizon: When do you need the money?
No matter your age or stage of life, you’re bound to have a mix of short- and long-term financial goals. There’s no question that for long-term goals, such as retirement, you’re better off in the market. U.S. stocks have posted annual returns of 9.8 per cent in the period between 1925 and 2019, while international stocks gained 7.8 per cent annually during that time frame.
Those incredible returns highlight the power of compounding over many, many years. But they also include major market crashes such as the Great Depression and Global Financial Crisis, which leads to my next point: The stock market is no place for short-term savers. If you need the money in less than five years, like for school or a house down payment, then the ultimate safety of that money should be your chief concern.
Need some proof? The illustration, from the Center for Research in Security Prices — part of the Booth School of Business at the University of Chicago — shows the best and worst one-year returns of various asset classes in the last 30 years (1989-2019). Large cap stocks, often considered the safe, blue-chip variety, lost 36.5 per cent during the global financial crisis in 2008. Even a balanced portfolio made up of 60 per cent stocks and 40 per cent bonds saw losses of 13.7 per cent in its worst year.
Now imagine your hard-earned house down-payment fund getting cut nearly in half on an ill-timed investment. The short-term volatility is clearly not worth the risk.
So where should you park your savings when you need the cash in a few years, or even a few months? Let’s look at an example of a couple who just sold their condo and have decided to rent for a year or two before getting into the market again.
They used a portion of the sale proceeds to pay off some outstanding debt and are left with just over $43,000 to invest before they purchase their next home.
They’ve heard a lot of advice about what avenues to use for retirement savings — like index investing or dividend stocks — but they want the best product for short-term goals, such as saving for a down payment on a house
The boring reality is that risk-free investments don’t make for great dinner party conversation. But if you want your money to be there when you need it, then you must keep it absolutely safe.
One solution is to stash the money inside your Tax-Free Savings Account (assuming you have the contribution room). Unfortunately you’ll be hard-pressed to find TFSA savings account interest rates above 2 per cent or 2-1/4 per cent, but such is the nature of risk-free returns these days.
Many online banks and credit unions do offer short-term interest rate promotions between 2 and 3 per cent, but you’ll have to pay attention and move your money around often to take advantage of the higher rates. Outside of several Manitoba-based credit unions, the top TFSA savings account rate belonged to motusbank, an offshoot of Ontario’s Meridian Credit Union, at 2.35 per cent.
Some quick facts about TFSAs:
- You can contribute up to $6,000 per year to a TFSA.
- Any income earned in a TFSA is tax-free.
- Withdrawals from a TFSA are tax-free.
- Unused contribution room is carried forward indefinitely.
- Withdrawals can be put back into a TFSA in future years.
You can have more than one Tax-Free Savings Account, so you don’t have to worry about opening an account at a different financial institution from where you normally bank.
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The nice thing about using the savings account option rather than a GIC is that you can withdraw your money any time without penalty. Also, avoid a market-linked GIC, a product which offers some upside but is mostly rigged in the bank’s favour — not yours.
Two per cent is about the best risk-free rate you can ask for in today’s environment. You can sleep easier knowing your principal investment is safe.
You don’t want to be in the unenviable position of selling your stocks at a loss when you’re ready to buy your next home.