Cash is king during times of economic trouble. Working families need emergency savings to pay the bills in case of job loss or a reduction in wages. Retirees or near retirees need a cash cushion to avoid selling stocks at a loss. But should you park your cash in a high interest savings account or a GIC?
For a short time, not too long ago, we lived in the golden age of high interest savings. The competition was lively, as online banks and credit unions pushed interest rates well above 2 percent (LBC Digital briefly paid 3.3 percent). Rising interest rates on savings deposits made GICs look less attractive. GICs paid the same rates or lower, yet savers had to lock-in their deposits for 1-5 years. Where did the liquidity premium go?
High Interest Savings Account rates
The situation quickly changed when the coronavirus pandemic forced central banks to take emergency action and cut interest rates. The Bank of Canada lowered its key interest rates by 50 basis points on two occasions. The ripple effect caused high interest savings account rates to plummet.
LBC Digital had already lowered its rate to 2.8 percent – now it sits at a still respectable 2.25 percent. Wealthsimple Cash had arguably the worst-timed launch when it came out with a 2.4 percent interest rate for its chequing/savings account hybrid. That rate was quickly dropped to 1.9 percent, and then lowered again to 1.4 percent.
EQ Bank lowered the interest rate on its Savings Plus account to 2 percent, while motusbank dropped its rate to 1.75 percent. What a difference a month makes!
Here are the top high interest savings account rates today (March 25, 2020):
As always, savers need to look beyond the big banks to maximize the interest earned on their deposits. If inflation averages 2 percent, then you need to earn at least 2 percent on your savings to maintain purchasing power. Even still, at best you’re treading water.
Despite the recent drop in rates, a high interest savings account is still the best place to park your emergency savings. You never know when you’ll need to access cash for an unexpected bill, or to pay for your living expenses during a period of unemployment.
A high interest savings account is also a must-have for retirees and near-retirees to stash one year’s worth of spending – the first bucket in the three-bucket approach to retirement income planning.
What this current rate crisis has highlighted is the fact that high interest savings account rates are not guaranteed. Those who eschewed GICs to chase higher yielding savings accounts now find their savings account paying 0.50 – 1.00 percent less than it was a month ago. Not ideal.
One of my clients recently alerted me to an email sent by Oaken Financial advertising an increase in GIC rates. Its one-year GIC now pays 2.5 percent, which is a full 25 basis points more than the top-paying high interest savings account. Oaken’s five-year GIC now pays 2.95 percent interest. It looks like the liquidity premium is back.
You’ll easily find one-year GIC rates paying at or above the best high interest savings account rate.
|Canadian Tire Bank||2.50%|
|Wealth One Bank of Canada||2.40%|
Longer-term rates vary widely so be sure to shop around for promotions. Here are the top five-year GIC rates as of this writing:
|Wealth One Bank of Canada||2.60%|
|Canadian Tire Bank||2.55%|
Readers should know that GICs are typically non-redeemable, so you should be absolutely certain that you won’t need the money when you lock it in for 1-5 years.
That means GICs are ill-suited for an emergency fund, but ideal for a goal with a specific time period.
Using High Interest Savings Accounts and GICs for Retirement Income
For retirees and near-retirees, GICs are best-suited for “bucket two” in your three-bucket approach to retirement income. Bucket two is where you build a GIC ladder with three to five years of annual retirement spending.
Let’s assume that your annual spending is $60,000 and you expect to receive $12,000 from a defined benefit pension plan, $8,800 from CPP, and $7,200 from OAS. You have a total of $28,000 from these sources, meaning you require an additional $32,000 per year from your retirement savings.
You’d ideally put $32,000 into a high interest savings account for this year’s living expenses – transferring funds to your chequing account as needed. This is bucket #1.
Then, you’d put $32,000 each into a one-year, two-year, and three-year GIC (total of $96,000). This is bucket #2. When the one-year GIC matures, transfer it to a high interest savings account to replenish bucket #1.
Bucket #3 contains your investment portfolio of stocks and bonds (ideally in low cost ETFs). Each year you may sell bonds to replenish the money in bucket #2, and then rebalance your investment portfolio (potentially selling stocks to replace your bonds).
Using a high interest savings account and GICs in this way provides retirees with a safety net of retirement income so they’re not forced to sell stocks during falling markets. Practically speaking, that means a retiree could delay withdrawals from his or her investment portfolio in a down year like this – knowing there is four years of spending available in cash and GICs.
Cash (or access to it) plays a crucial role in any financial plan. Its importance is highlighted even more during tough economic times, when we’re faced with massive layoffs and falling stock prices.
Well-prepared savers have even been hit by declining interest rates on deposits. My advice to savers is twofold:
- Park your emergency fund or short-term cash in a high interest savings account that pays 2 percent or more. Respect CDIC limits ($100,000) and ideally keep no more than one year’s worth of expenses in this account
- Put additional cash savings into a GIC (or GICs) while being mindful of when you’ll need to access the money. Is it worth an extra 25 basis points to lock your money in for five years? Consider a shorter term or a GIC ladder approach.
Readers: Where are you parking your cash these days?