What do you think of when you hear the words: savings account?
Perhaps you think of an account at a bank that earns nothing and yet is subject to an endless slew of fees – a place where the buying power of your principal is continuously eroded by inflation.
Maybe you are thinking about the account with your emergency funds in it – something that needs to be there when you need it.
When I say Tax-Free Savings Account, now what do you think of?
Do you see it like that savings account at the bank, the one where you don’t earn a return, pay fees to use and see the erosion of your buying power?
If you do, you aren’t alone.
According to a survey of TFSA holders by the Bank of Montreal indicates that the majority of TFSA accounts are held in cash.
65% of accounts.
However, the purpose of the TFSA wasn’t to act as a traditional bank savings account. The idea was to allow the flexibility of savings with an investment component. The investment element enables you to preserve and grow the buying power of your funds for when you need them.
It also means that instead of the bank taking the spread on your money in the traditional savings account, you get to keep what your money earns. And you don’t have to think about the taxes either.
Now the challenge with an investment account is the preservation of principal. You want to invest and earn a return, but you may need a certain level of liquidity. And you probably want something that is better suited to a passive approach.
The Government of Canada has outlined a series of products that are suitable for investment in a TFSA. These include traditional options like stocks and bonds. They also include low risk and low volatility options like GIC’s. In addition to these products, the government allows for investment in your TFSA in products like Mortgage Investment Corporations.
Current return on a number of these products is relatively low.
For cash sitting in your TFSA you are likely getting somewhere between .45% and .8% depending on the year and the institution. You read that right; your cash in your TFSA is getting less than 1%.
For one-year government bills your rate has varied from around 1.6% to a little over 2% and at 1.7ish percent in April of 2019.
In the stock market, you have the potential for a higher return and liquidity, but you also get the added risk and volatility. From April 2018 to April 2019 your return on the S&P TSX index was 6.77%, but the range was +9.4% to -14.3% to get there.
If you invest in a typical one-year GIC, you are getting somewhere between 2% and 2.75% depending on the issuer.
Another option is a Mortgage Investment Corporation (MIC). In this case, your return for one year was somewhere between 7% and 10% depending on the issuer and paid monthly or quarterly.
MICs exclusively focused on residential mortgages with a low cost structure may have the higher return and a favourable risk profile. MICs that include exposure to commercial real estate mortgages will often have a higher cost structure and lower return.
As a TFSA holder, the challenge is balancing your return options with investment choices with the safety of principal being paramount. With TFSA lifetime contribution room in 2019 at $63500, do you really need to have most or all of that in cash?
Holding cash in a TFSA means losses due to inflation and the opportunity cost of missed investment returns, neither of which serve you as a saver. And it means that you aren’t taking full advantage of this registered account for your own benefit.
Emergencies are by definition rare, so in the meantime, shouldn’t you be earning money tax free by investing your TFSA funds instead of just holding cash in your account?
Nest Capital www.nestcapital.ca