Interest rates on savings accounts and GICs are abysmal these days, so it can be tempting to put your hard earned savings into the stock market for a chance to juice your returns. But how and where you save and invest depends a lot on your time horizon – when do you need the money?
No matter your age and stage of life, you’re bound to have a mix of short and long term financial goals. There’s no question that for long-term goals, like retirement, you’re better off in the market. Canadian and U.S. stocks have annual returns of 9.6 percent and 11.4 percent respectively in the period between 1935 and 2015.
But the stock market is no place for short-term savers. If you need the money in less than five years, like for school or a house down payment, then safety should be your chief concern.
Need some proof? Check out this historical investing chart and note the 43 percent drops in 2000-2002 and 2008-2009. Time it wrong and your down payment nearly gets cut in half!
So where should you park your savings when you need the cash in a few years, or even a few months? One of our readers, Lisa, recently sent an email and asked that very question.
Should I invest my house down payment?
“We’ve just sold our condo and are now renting for a while before we buy again. We’ve used a portion of the sale proceeds to pay off some outstanding debt but we’ll have just over $13,000 to invest and build up to purchase our next home.
I see a lot of advice on what avenues to use for retirement savings – like index investing or dividend stocks – but what is the best product for short-term goals such as saving for a down payment on a house?”
Here’s my take on Lisa’s situation:
Risk-free investments don’t make for great dinner party conversation, but if you want your money to be there when you need it then you must keep it absolutely safe.
I’d recommend stashing the money inside your tax-free savings account (if you have the contribution room). Unfortunately you’ll be hard-pressed to find TFSA savings account interest rates above 2 percent*, but such is the nature of risk-free returns these days.
*Many online banks and credit unions do offer short-term interest rate promotions between 2 and 3 percent, but you’ll have to pay attention and move your money around often to take advantage of the higher rates.
Here are some quick facts about TFSAs:
- You can contribute up to $5,500 per year to a TFSA.
- Any income earned in a TFSA is tax-free.
- Withdrawals from a TFSA are tax-free.
- Unused contribution room is carried forward indefinitely.
- Withdrawals can be put back into a TFSA in future years.
You can have more than one tax-free savings account, so you don’t have to worry about opening an account at a different financial institution from where you normally bank.
The nice thing about using the savings account option rather than a GIC is that you can withdraw your money any time without penalty. Also, avoid market-linked GIC’s, a product which offer some upside but is mostly rigged in the bank’s favour, not yours.
When it comes to risk-free returns, 2-3 percent is about the best you could ask for. You can sleep easier knowing your principal investment is safe. To be clear; investing that $13,000 in the stock market is not a good idea when you need the money soon for a house down payment.
You don’t want to be in the unenviable position of selling your stocks at a loss when you’re ready to buy your next home.