Back when interest rates were low, it was common for people to question the wisdom of keeping money in a savings account.
Savings accounts from alternative banks offer as much as 4.1 per cent interest today, which means a real return of 0.8 per cent after accounting for inflation. Considering the risk level is pretty much zero, that’s not bad. But some people still wonder if there are better options than savings accounts.
Like a dividend stock, for example. Recently, a reader asked if it was better to have money in a “solid blue chip utility stock with a good dividend.” The answer is no. A savings account is better for two reasons - safety and liquidity.
As discussed in a recent column, a lot of big names in Canadian dividend investing have been hammered this year. There are a few reasons for this, but the main issue is high interest rates. Investors can get high returns from risk-free investments like bonds and treasury bills, so why take the risk of a dividend stock?
Depressed prices for dividend stocks mean high yields - as much as 6 to 7 per cent, which beats savings accounts by a lot. Dividends look even better on an after-tax basis in non-registered accounts because they’re taxed more lightly than interest income.
Think of the extra returns from dividends compared to savings as a risk premium. Risk of what? Falling share prices, for one thing. Your attention is drawn to a former dividend stalwart, Algonquin Power & Utilities Corp. (AQN-T), which is down about 47 per cent in the past 12 months. The reason for this decline highlights another risk, that of dividend cuts. Algonquin lowered its dividend by 40 per cent earlier this year to shore up its financial position.
Dividend cuts by blue chippers are quite rare, but the list of companies that have trimmed their payouts in the past does include names like Manulife, SNC-Lavalin, Telus and TC Energy, back when it was TransCanada PipeLines.
Savings accounts are backed either by Canada Deposit Insurance Corp. or provincial credit union deposit insurance plans, so there’s no risk of losing money if you stay within coverage limits. Savings accounts also offer superior liquidity. If you have an unexpected expense, you can often pay the bill right from the savings account, or e-transfer money to someone. With a dividend stock, you’ll need to sell, wait for the trade to settle and then transfer the money to your chequing account. And what if the market’s way down on the day you need to sell?
One final thought is that you don’t need to settle for the returns of bank savings accounts. Investment savings accounts sold like mutual funds offer yields as high as 4.55 to 5 per cent these days – they’re typically protected by deposit insurance and can be bought through most online brokers at no cost.
-- Rob Carrick, personal finance columnist
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What’s up in the days ahead
Gordon Pape will take a look at the state of dividends in the Canadian energy sector.
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