A generational opportunity to earn a strong return on your money with virtually nil risk has emerged in the past 12 or so months.
And people are grabbing it up. With rates of up to 5 per cent and more available, sales of guaranteed investment certificates, high-interest savings exchange-traded funds, investment savings accounts and high-rate savings accounts have surged. So much so that it’s time to ask if the flood of money into safe havens is going too far.
The wealth of Canadian households is held in a variety of assets, including real estate, stocks, bonds, chequing accounts and savings vehicles such as GICs. In the pandemic lockdowns, a surplus of money built up in chequing accounts. A recent report from CIBC Capital Markets noted that this excess of money has migrated into GICs and other products that pay high interest.
One takeaway here is that a lot of this money is locked in to some extent and thus unlikely to fuel consumer spending that, on one hand, supports economic growth and, on the other, contributes to inflation. Another is that people are emphasizing safety over the drama – and potentially higher returns – of diversified investing.
Stocks and bonds did nasty things to household wealth last year, but they remain essential to long-term wealth-building. As ever, you will have trouble reaching your financial goals in life with an all-safety approach.
Bank savings accounts pay as much as 4.1 per cent these days, while investment savings accounts packaged like mutual funds and exchange-traded funds offer between 4.55 and 5.3 per cent. In GIC-land, you can get 5 per cent or more for terms of one- through five years.
As I was writing this, an e-mail from one of the big banks popped up with a special GIC offer of 5.25 per cent for one year and 5.3 per cent for two years. If you’re Gen X, a millennial or Gen Z, having safe returns of 5 per cent or more fall into your lap is a new experience. If you’re a boomer or older, these rates are like the reappearance of an old friend gone missing.
You are doing nothing wrong by exploiting these rates, which stand up well on an after-inflation and risk-adjusted basis. The cost of living increased 3.3 per cent on a year-over-year basis in July, so a 5-per-cent interest rate gives you a real return of return of 1.7 per cent. With virtually no risk of losing money, that return looks even better.
Tax-wise, interest income ranks third-best behind dividends and capital gains in a non-registered account. But using a tax-free savings account or a first home savings account solves that problem.
GICs and investment savings accounts are great for savings, where preserving your money is paramount. These products can also be integrated into your long-term investments as a supplement for bonds.
But investing with GICs and savings accounts alone is problematic. When inflation settles down and interest rates fall, expect rates on these products to drop like an anvil. You’ll either need to find more money to contribute to your savings and investments in order to reach your goals, or have some exposure to stocks.
Stocks tank every now and then – that’s how they roll. But if you hold for the long term, say 10 or more years, you should expect returns before fees in the area of 6 to 8 per cent. For the 10 years to July 31, the S&P/TSX composite index made an average annual return of 8.3 per cent with dividends included, while the S&P 500 made an unusually robust 14.8 per cent in Canadian dollars.
This is an age of anxiety, with much to worry about for ourselves, the country and the world. Stashing your savings in GICs to eliminate the worry that a financial market tantrum will shred your wealth is tempting, but counterproductive in the long term if you over-do it.
When the GICs you’ve been buying mature, think about getting into a diversified portfolio of stocks and bonds. If stocks fall hard, consider moving some of the money parked in investment savings accounts into low-cost exchange-traded funds tracking major indexes.
Ten or more years from now, this money is almost certain to outperform money parked safely.
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Rob Carrick