Give your cash with the respect it deserves
Everyone needs a little cash sitting around.
There are many reasons we hold cash: for day-to-day expenses, as an emergency fund, for a planned trip, a new car purchase, a down payment on a house, or sometimes just because we don’t know what else to do with it.
Despite its simplicity, even cash deserves to be treated well. Not all cash should sit in your chequing account or even a savings account.
If you have cash sitting in a bank account just because you aren’t sure what to do with it, it’s time to figure that out. If it’s money put away as long-term savings, decide whether it should go into an RRSP, TFSA or another kind of registered (tax advantaged) account and get it invested. Procrastinating on doing something with your cash means that inflation is eating away at its value.
Cash that is meant for short-term use is a different story. You do not want to put this into the stock market. In my opinion, you need a minimum of a three-year time horizon to invest in the market. Five is better. Short-term money needs a safe place, hopefully earning interest.
The amount of interest you’ll earn varies depending on where you put the money. There are three main factors that determine how much interest you will earn on your cash:
Market rates: Market interest rates are determined by a variety of factors. At a high level, rates are determined by the state of the economy. For the past decade, interest rates have been very low but they are finally rising. This is bad for borrowers, but very good for savers.
Time: The longer you are willing to tie up your money, the higher the rate of interest you’ll receive. This is called the term structure of interest rates, which is the relationship between time invested and the rate of interest paid. Normally, the line on the line graph goes up and to the right: the longer the time period, the higher the rate.
Flexibility: Like anything in life, you pay for convenience. If you want instant access to your cash whenever you want it, you’re going to get a lower rate of interest. If you’re willing to lock it in, you’ll get more. Without getting into the weeds, the main reason for this is that banks like to have predictability in terms of the cash you deposit so it can better plan its business. They will pay more to get this predictability.
Different needs, different savings choice
The time horizon for your cash needs can run from immediately (to buy groceries) to a number of years, or even indefinitely (an emergency fund).
For the cash you need for your daily expenses, your chequing account is the place to stash it. Chequing accounts allow you to make many transactions in a month for a flat fee (or no fee, for some online banks).
For money you are putting aside for less frequently-paid bills like property taxes, house and car insurance (if you pay in an annual lump sum), vehicle maintenance, short getaways and so on, there are more options.
Savings account. Savings accounts differ widely, depending on who is offering it. Providers of savings accounts often charge per transaction so your fees will be high if you are moving money out regularly. When choosing a savings account, look carefully at the fees because the terms can vary greatly. In some cases, you’ll be charged $5 for every withdrawal, or you might get free transfers between accounts at the same institution. Also look at how the interest is paid: sometimes you’ll get 0% on low balances.*
GICs: Guaranteed Investment Certificates (GICs) come in a variety of terms, and for short-term savings you can invest for 30, 60 or 90 days. You need to be careful about how long you’re investing for because GICs are (generally*) locked-in and you can’t get the money before the maturity date. GICs are super safe because you are guaranteed to get your money back plus the interest.
If you’ve got money tucked away for a slightly longer-term expense like a vacation, you have a few more options.
Longer-term GICs: GICs with terms of 1 to 5 years might work if you know you won’t need the money for a while. Rates on these longer-term deposits are a lot better than the short-term rates.
Money market mutual funds and ETFs: These funds invest in cash equivalents and are very safe investments, with low volatility (and low returns). Unlike a GIC, the returns on these funds are not guaranteed so you won’t know ahead of time how much money you’ll make. Money market funds are most often used in investment accounts like TFSAs and RRSPs to park cash.
Where to park your money
What kind of rates to expect
Interest rates vary a lot depending on who is offering the product. Often you’ll get better rates from a credit union than a bank and online banks can also offer better rates and terms. When looking at rates, be aware of special offers, which can quote juicy rates but usually offer these rates only for a limited time period, after which you go back down to the regular (lower) rate.
The rates below I sourced from CIBC, TD, and Simplii Financial to give you a sense of what’s available. This is not a comprehensive market review. If you want to see a list of rates, have a look at Rate Hub. It’s a good starting point, but don’t forget to look at the details and not just the headline rate.
The reality is that the money you’ll earn in a savings account is so small that it’s not usually worth getting fussed about. For example, on a $10,000 balance you’ll earn $50 a year in an account paying 0.5%, and that’s taxable as regular income if it’s in a regular, non-registered account. If you can use a GIC, even if it’s a 30-day term, consider doing that.
*Two notes about GICs
1. How interest rates are quoted: All rates are quoted on an annual basis. A 30-day GIC at 1.2% doesn’t mean you’ll earn 1.2% on your money. You’ll earn 1/12th of this. For example, if you invest $5,000 in a 30-day GIC, the interest you’ll earn is $5, calculated as $5,000 x 1.2% = $60 per year, divided by 12 months.
2. Some GICs are cashable, meaning you can take your money out before the maturity date. Of course, the rate you’ll be paid on this is lower (less predictability for the bank).