While writing my blog post on GICs last week, I also took a look at some of the high interest savings accounts out in the market today.
In the past, I have ridiculed high interest savings accounts, so most readers correctly got the impression that I think you should avoid them.
In a broad sense, that is still true. Most of the savings accounts in the Canadian market today are so utterly pathetic you may as well save yourself the hassle and keep money in a free chequing account where you do all your daily banking.
Thanks to the rising interest rate environment, a few bright spots have opened up in the savings account market over the past few months.
Right now, EQ Bank, a second-tier federal bank, is paying a whopping 2.3% interest on their savings account. Oaken Financial, another second-tier federal bank, is paying a solid 1.5% interest on their savings account. While Tangerine and Simplii are paying 1.25%.
All of these banks are CDIC insured, so provided you don't have more than $100,000 in a savings account with each bank, your money should be very safe. I go into more details on CDIC protection in my GIC post, so I won't bore you with those here.
Savings accounts should be used pretty sparingly for most people. But it varies depending on your stage in life. There are some reasonable uses for savings accounts.
Savings Accounts for Accumulators
Accumulators are working hard, earning as much as they can, maintaining a high savings rate, and investing aggressively. Savings accounts should not really be in the financial picture most of the time. Even for emergencies!
An accumulator should conduct their daily banking in their free chequing account while maintaining a small balance there. I personally don't see any benefit with keeping more than one month's worth of expenses in your chequing account at the low points.
For most people this means their chequing account will fluctuate from around $2,000 on the bottom end to maybe $10,000 on the top end. Your numbers depend on your pay schedule, your spending rate, when your bills are due, how often you contribute to your investment accounts, if you share a bank account with your partner, and so on.
The key for an accumulator is moving as much money as fast as possible from the chequing account (where income is deposited and bills are paid) into an investment account where it can be put to work.
In most investment markets, the more you invest as early as possible the better off you will be.
For emergencies you should have an already-approved personal line of credit waiting for you at the bank.
Your personal line of credit should have a credit limit equal to six months of expenses at the high side. However, you should not touch this available credit at all unless it is a true emergency.
True emergencies include income emergencies (job loss, severe illness, etc.) and some spending emergencies (unforeseen house or vehicle repair, death in the family, supporting a loved one who is in an income emergency, etc.).
If you have to use it, your aim should be to pay your line of credit off as fast as possible, even if that means setting aside new investment contributions for a few months.
The one scenario where a savings account may be worthwhile for an individual in the accumulation stage is when you are saving money for a specific large expense (well over $10,000) which is coming in the near future. This might be a vehicle, home renovation, home purchase, other something of that nature.
Savings Accounts for Retirees
When you are at the stage in life where you primarily live off your investment holdings, you need to become a lot more careful about how you manage your finances.
The majority of your money should be in your investment accounts invested primarily for growth. Alternatively, you could invest in a timing strategy for downside protection. Better still, consider two strategies to diversify your investment returns.
Depending on your personal situation, a good portion of your spending needs may be covered for through regular income. This can include CPP payments, OAS benefits, dividend income (from stocks or stock ETFs), interest income (from bond ETFs), or even some part-time employment or business income.
To keep things easier to manage with fewer manual electronic transfers, once you are retired you can set up your non-registered investment account so dividend income comes straight into your chequing account. Most dividend paying ETFs pay out quarterly or semi-annually while most bond ETFs pay out monthly or quarterly.
It is important to have some cash set aside for daily living expenses which are not covered by your regular income. It doesn't make sense to pull money out of your portfolio every month, triggering capital gains and trading costs while taking up your valuable time.
Instead, use a systematic method to pull money out of your investment account on an intermittent basis. Once or twice a year is good.
You should try realize gains or withdraw money from registered accounts in the most tax efficient method. The exact combination of RRSP withdrawals, TFSA withdrawals, and capital gains in your non-registered accounts will depend on your personal situation at that time.
If you have a high spending year, your spending may be tilted towards TFSA withdrawals and realized capital gains. In a low spending year RRSP withdrawals may form the majority of your investment income.
Since the withdrawals are not made frequently, they can be quite substantial in value. It would not be uncommon to need tens of thousands of dollars a year in these forms of income.
These large lump-sums should not be put in your chequing account. Chequing accounts pay no interest (typically), so your money will actually erode in value thanks to inflation costs.
Instead, set up a high interest savings account to hold this money. Shop around for an account that offers a higher interest rate along with free monthly money transfers such as Interac e-Transfer or electronic funds transfer to your chequing account.
Keeping this money in a high interest savings account will ensure your money generates moderate interest income while you are waiting to spend it.
Use of savings accounts in retirement can be instead of, or alongside a GIC Ladder. Just keep your overall cash balance in mind. Cash might be comforting, but too much cash is a problem.
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