There is no avoiding risk. Even a high-interest savings account could lose its purchasing power. So, what’s the safest option: saving or investing?
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I am not sure what to do. I have a promo rate of 5.25%, and I will soon open a Tangerine account to have their 6% promo.
I know a lot of people are saying that the best way is to invest that money in the stock market. But having that kind of return with absolutely zero risks and having interest paid monthly seems like such a good deal compared to ETFs or other investments. I am not sure what to do.
I do have some investments, but it’s less than 10% of all my money.
What do you think, am being I too conservative?
—Grace (name changed)
Are interest rates better than stocks?
It may be appropriate to leave $100,000 in a high-interest savings account (HISA). It’s your money, your life and your future. You are the one that must live with your decisions. Ultimately, savings and investment decisions come down to a combination of emotions, knowledge, products and ambitions.
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Savings versus savings bonds: which is better?
To help you decide, let’s take a historical look at the returns of investments and 30-day Canadian Treasury bills, after inflation. Currently, the 30-day CND T-Bill yield is 5.04%, a little less than your promo rate on the high interest savings.
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Historical inflation-adjusted returns from 2003 to 2022
All figures are in Canadian dollars, even the S&P 500 Index, and are adjusted for inflation.
The main purpose of investing in equities is to grow your money faster than the rate of inflation. And the reason you want to do this is to protect your purchasing power. That’s so what you can purchase today you could purchase in the future for the same inflation-adjusted dollar.
When you look at the chart above you can see that both the S&P 500 and TSX had positive, after inflation returns over the last 5-, 10-, and 20-year time frames. Both, however, have a big negative return in 2022, and that is the risk part you are concerned about.
Look at the T-Bill returns after inflation. They are all negative, and that is before adjusting for tax, which would make the returns even lower. What’s not shown in the table, though, is that if you invested the $100,000 in the T-Bills, you would not have seen it drop in value. You would always have, at a minimum, $100,000.
No risk, right? Not exactly.
Are there any risks with interest income? Is inflation a risk?
The risk with holding T-Bills, and I would add HISAs and guaranteed investment certificates (GICs), too, is that the rate of growth may not keep pace with inflation. So, although it seems you’re not taking a risk, you do risk purchasing power. That’s a different type of risk than what you mentioned. In cases where inflation is not a big concern, a HISA or a GIC can make sense. Examples of such situations may include saving for a near term purchase, transitioning from accumulation to decumulation, or as you age and get closer to death.
The other reason you may want to include savings in your portfolio is because there’s no way to know for sure when equity investments will be positive. The table above shows equities were positive over the last 5, 10 and 20 years. But that’s not always the case.
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From 1965 to 1981, U.S. monthly T-Bills returned 6.6%, and the S&P returned 6.33%, as reported in the DFA matrix book. That is a 16-year period where T-Bills beat equities.
It happens. How often does it happen?
The table below shows the number of rolling time periods Canadian equities have performed better than T-Bills from June 1973 to Dec 2022. The market is the S&P/TSX Composite Index, the T-Bills is the FTSE Canada 30 Day T-Bill Index. There are 440 overlapping 10-year periods, 500 overlapping five-year periods, and 548 overlapping one-year periods.)
Terms
Percentage of the time Canadian equites beat T-Bills
As you can see, Grace, even after 10 years, there was an 11% chance you would have been better off in a high-interest savings account, not adjusting for tax. The shorter the time frame the greater the risk that equities will do worse than a HISA.
To summarize, there can be risks associated with both HISAs and equity investing, like stocks. Understanding those risks and the reason you are saving or investing will help you to determine which product is best suited for the job. Then you must do what you are comfortable with, even if friends, family, and professionals are telling you to do something else with your money.
With over 30 years as a financial planner, Allan is an associate portfolio manager at Aligned Capital Partners Inc., where he helps Canadians maintain their lifestyles, without fear of running out of money.
Due to the large volume of comments we receive, we regret that we are unable to respond directly to each one. We invite you to email your question to [email protected], where it will be considered for a future response by one of our expert columnists. For personal advice, we suggest consulting with your financial institution or a qualified advisor.
Are there significantly higher tax implications for interest income vs. capital gains realized via stock value increases ?
Due to the large volume of comments we receive, we regret that we are unable to respond directly to each one. We invite you to email your question to [email protected], where it will be considered for a future response by one of our expert columnists. For personal advice, we suggest consulting with your financial institution or a qualified advisor.