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Alternatives to ‘high yield’ savings accounts

by | Feb 18, 2022 | SELF-PUBLISHED

No need to settle for nothing

You may as well face facts: You can’t “save” a million dollars. A recent survey of the market showed that the highest rate paid in a standard, plain-vanilla high interest deposit savings account (the kind that most banks and large financial institutions offer as a place to put your cash) ranged from a low of 0.05% (at TD Bank among others) to 2.0% at DUCA Credit Union.

With this kind of return, you will not be able to “save” up much of a nest-egg. But another fact is that you can still retire wealthier once you unshackle yourself from the savings account trap. Here’s how.

The “anti-saving” account

Let’s say you decide to put your money in a typical bank savings account, at an interest rate of, say, 2% annually. Starting at age 30 with $1,000 and adding $200 per month for 35 years, you’ll wind up with a total of about $168,000. 

That’s a long way from a million bucks. And only about $47,000 of that would be the interest you’ve earned. 

Factor in inflation, currently running close to 5.0% (4.8% in December), about 30% tax on the interest income, and the monthly fee the bank charges you just for keeping your money on deposit, and you’re actually losing money – plenty of it – on every dollar you’re allegedly “saving.”

It’s not easy. But with the right guidance, there are ways to invest your money with a much higher return, at a risk level that lets you sleep nights, with a decent return to boot. 

Guaranteed investment certificates 

If you don’t need to access some of your money for a period of time (anywhere between one and five years), consider a guaranteed investment certificate (GIC). 

The interest paid on most GICs is higher than on savings accounts, but depending on the type of GIC (cashable/redeemable vs. non-redeemable) your money might be locked in for the full term. If so, and you need the cash quickly, you will lose any interest you’ve earned.

Mutual funds, exchange-traded funds 

A plus is that GICs are insured by the Canada Deposit Insurance Corporation (CDIC) up to $100,000. The best GIC rates currently range from around 2% for a 1-year term to around 3% for a 5-year term. It’s still not great, but it’s better than a near-zero percent savings account. In a rising rate environment, talk to your advisor about a “laddering” approach, buying GICs in different maturities and rolling them over into higher rates as they mature.

Mutual funds open up a universe of investment alternatives. These are still the investment of choice for hundreds of thousands of investors. IFIC – the Investment Funds Institute of Canada – reports that Canadians invested $2.03 trillion in mutual funds in 2021. 

Some mutual funds have been around for 20 or 30 years and more. And some have posted an average annual compounded rate of return of 9% or more over those 20 years. 

As an example, let’s be conservative and defensive and use an even lower rate of return. At an average annual compounded rate of return of 5%, that same initial $1,000 with a $200 monthly investment you would have put in a savings account for 30 years would grow to about $170,000, with nearly $100,000 of that coming from investment return. It beats a “savings” account hands-down. And if you use a Tax-Free Savings Account to invest, you’ll never pay a cent of tax on any of that income! 

Raise the monthly deposit amount (which most people do as they advance in their careers) and the rate of return, and you’ll soon be closing in on that million-dollar nest egg. Starting with, say, a $5,000 deposit, investing an additional $400 per month (increasing at a 2% inflation rate), at an average annual compounded rate of return of 9% for 35 years, will give you a nest egg of about $1.4 million. 

There’s plenty of choice in every asset class. So while it’s difficult for individual retail investors to invest directly in bond and Treasury bills because of the large amounts required, it’s easy to do through an investment fund. 

Is there risk?

Yes. Mutual funds and ETFs are not covered by the Canada Deposit Insurance Corporation. There’s no guarantee of returns, and values fluctuate with the market. By the same token, there’s a range of risk profiles from very low to very high, depending on the type of fund and the kinds of investment strategies it uses. 

For example, bond and income funds are at the lowest end of the risk curve, while equity and alternative investment funds are at the highest. Fortunately, risk ratings are carefully calculated for all mutual funds, and you can find these on such useful website as Fund Library or Morningstar.

High dividend stocks

These are a tried-and-true way to invest your money for higher yields. But, like any equity investment, high-dividend stocks can still fall in value. So using a portfolio of such stocks as an emergency fund isn’t a good idea. But allocating a portion of your savings to these stocks can increase your overall yield. 

For example, high dividend stocks often yield 3% to 4%, and some yield a lot more. As a rule, the most reliable high dividend stocks should meet certain criteria: For Canadian stocks, they should be listed on the TSX; they should be shares of a large-capitalization company; they should have 10 years or more of annual dividend increases. Most Canadian banks and utilities meet these criteria.

A long-term record of dividend increases is important. Regular and increasing dividend payout provides a cushion in times of market volatility as companies with a long history of payouts are extremely reluctant to cut or stop dividends. A history of dividend increase not only provides yield but gives the shares potential gradual price appreciation.

© 2022 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited. This article is for information only and is not intended as personal investment or financial advice.

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