I took some gains in the U.S. tech sector recently and am sitting on about US$50,000 of cash at my discount broker. I feel it’s a good time to stay on the sidelines, but I want to earn some interest. I was looking at the Evolve US High Interest Savings Account Fund HISU-U-T, which yields 5.42 per cent. Will the interest be taxed as Canadian income, or will it be subject to U.S. tax? What alternatives are there for parking U.S. dollars? Am I better off investing in a Canada-based exchange-traded fund due to the tax implications of the U.S. withholding tax?
First, let’s clarify a few things.
Even though it trades and pays interest in U.S. dollars, the Evolve US High Interest Savings Account Fund is a Canadian-listed ETF, not a U.S.-based fund. The same is true of other U.S. dollar HISA ETFs that trade in Canada, such as the Horizons USD Cash Maximizer ETF HSUV-U-T and the Purpose US Cash Fund PSU-U-T.
Regarding the yield, that number you quoted is a bit misleading. That’s the gross yield, before management expenses. Deduct those, and net yield drops to about 5.27 per cent.
As for taxes, in 2022 most of the cash HSUV-U-T paid out was classified as foreign income, with a smaller portion consisting of capital gains, reflecting fluctuations in the Canada-U. S. exchange rate. These amounts are reported on investors’ T3 slips in Canadian dollars, but there are no U.S. withholding taxes. The ETF also had a small, reinvested capital gains distribution, which is taxable but not received in cash.
With those clarifications out of the way, let’s take a closer look at this category of products in general.
With interest rates up sharply and investors looking to take refuge from volatile stock markets, high-interest savings account ETFs have exploded in popularity because they offer yields that traditional savings accounts can’t match. HISA ETFs – also known as cash ETFs – are able to pay higher yields because, thanks to the billions of dollars they rake in, they earn wholesale deposit rates from the chartered banks where they stash their money.
Rates on Canadian dollar HISA ETFs aren’t quite as juicy as the U.S. dollar versions, but they’re still attractive. The largest of the bunch, the CI High Interest Savings ETF CSAV-T, currently yields about 4.97 per cent.
But before you take the plunge, there are a few things you should know.
First, there are looming regulatory risks. The Office of the Superintendent of Financial Institutions, Canada’s banking watchdog, is reviewing HISA ETFs to assess how they affect the liquidity profiles of banks that accept such large, retail-funded deposits. “The purpose of this review is to assess the need for new wholesale funding categories to appropriately reflect the risks of such retail-like wholesale products,” OSFI said in May.
A change in how these deposits are classified could lead banks to lower the deposit rates they pay, which in turn would cause fund companies to drop the yields on their HISA ETFs.
Second, some bank-owned discount brokers refuse to sell HISA ETFs, presumably because they would siphon deposits away from their own in-house savings products. If you have a self-directed trading account with Royal Bank of Canada, Bank of Montreal or Toronto-Dominion Bank, for example, you’re out of luck.
Third, unlike other savings accounts, cash ETFs don’t qualify for deposit insurance. In the highly unlikely event that a bank that holds the ETF’s cash goes bust, investors could lose their savings.
A fourth concern is that, depending on which broker you use, you could face a commission each time you buy or sell units of the ETF. The additional trading costs would reduce – or potentially eliminate – the advantage these products have over traditional savings accounts. For that reason, using a broker that offers commission-free ETF trades would be preferable if you plan to do a lot of buying and selling. It’s also worth noting that, in most cases, interest from cash ETFs doesn’t compound automatically. You’ll either need to reinvest the monthly interest by buying additional units, or by enrolling your units in a dividend reinvestment plan – if your broker even offers one for these products.
(Note: Two “total return” ETFs from Horizons – HSUV-U-T and its Canadian dollar version, HSAV-T automatically reinvest distributions. However, both ETFs have suspended subscriptions for new shares, and Horizons has said it expects the ETFs to trade at a premium to their net asset values during this time. Owing to this expected premium, Horizons says it is “strongly discouraging” investors from purchasing shares during the suspension period.)
If squeezing out an additional half-point or so of interest is important to you, and you’re comfortable with the potential downsides, then cash ETFs may be a fine choice for you. Canadians have poured more than $20-billion into these funds, which speaks to their widespread appeal.
On the other hand, if you are prepared to accept a slightly lower return, your broker’s own investment savings account may meet your needs. You’ll give up some interest, but you’ll avoid trading commissions, get deposit insurance coverage and enjoy the full benefits of compounding. And you won’t have to worry about regulatory changes potentially taking a bite out of your rate.
BMO InvestorLine’s U.S. dollar high-interest savings account, for example, currently pays 4.75 per cent, while its Canadian dollar counterpart yields 4.35 per cent. Unlike cash ETFs, which trade on a stock exchange, these products are bought and sold like mutual funds. Typically, they reinvest distributions by default, but you can also choose to take distributions in cash if you prefer. Other banks have their own versions of these accounts, although rates may differ slightly.
Finally, more important than earning a few extra dollars of interest in the short term is how you ultimately plan to invest your money. The fact that you sold your technology stocks and plan to stay on the sidelines indicates that you are concerned that stocks could be heading south. But there’s an old expression on Wall Street: “The market climbs a wall of worry.” That saying has rung true in 2023, as the S & P 500 has gained 12 per cent year to date.
If you get too comfortable holding cash, you could be watching the market rise instead of participating in its gains. As always, you should aim to have a diversified portfolio – with a mix of equities, fixed-income and cash – that suits your risk tolerance, investing knowledge, age and other factors.
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
John Heinzl