As we grow up, we learn that savings is an important tool for wealth creation or planning for your golden years. The stakes get higher and adult concerns like interest rates start to matter. Saving money becomes more important than ever.
But why aren’t we told earlier on about the power of investing? Granted a parent explaining investment vehicles to a toddler with tooth fairy money sounds preposterous, but investing education remains the knowledge of the self-educated. You mostly have to learn it yourself, even though it is arguably a better long-term plan for your money. Let’s discuss the pros and cons of investing versus savings to see which is right for you.
What is a high-interest savings account?
Most banks and credit unions offer high-interest savings accounts designed for one-way use – money going in, but not coming out. By getting higher interest you accept giving up the convenience of making frequent withdraws, at least without a cost. That’s what your chequing account is for.
High-interest savings accounts are advisable if you need a safe place to accumulate money for a short-term goal, like going on vacation to Fuji. Compared to investing in stocks, high-interest savings accounts are a safe harbour where you don’t have to worry about losing wealth due to crashing financial markets beyond your control.
However, most banks like to tier their savings interest rates, meaning the more money you allow them to hold, the higher your return rate. An example would be TD’s current High-Interest Savings Account, which does a big fat zero interest on balances below $5,000, and then a whopping 0.05% above $5,000. So, if you had $20,000 in that “high-interest” account, you’re looking at a grand total of $10 bucks in interest gains per year. That’s lacklustre to say the least. All the more reason to consider investing.
Not all savings accounts are created equal
If you feel like the stock market is too risky and high-interest savings accounts are a losing proposition, there are other investment savings vehicles to consider. Two of the most popular in Canada are RRSPs and TFSAs. There is constant debate about which is better, but the general consensus is TFSAs are more flexible, while RRSPs can deliver better returns when you’re old and grey.
RRSPs are generally safer than stocks because you can invest in government bonds (an interest-paying IOU), which are considered perpetually stable. The returns will vary, but the average annual return for an RRSP is around 4%. So, if you had $20,000 in an RRSP you could see a yearly return around $800. The catch is you can’t withdraw that money without a big tax penalty, unless your income drops to retirement levels.
The “s” in TFSA is a bit misleading because although it stands for savings there’s much more you can do with a TFSA besides the conventional savings account. You can use it for GICs, mutual funds, stocks, bonds and more. And unlike the interest earning in a regular savings account, you don’t have to pay any tax on it. Plus, you can withdraw your money any time without penalty.
How much do I need to start investing with?
Most financial experts will tell you – start investing as soon as possible no matter how big or small your starting principle. What’s more important than a big initial sum is the benefit of time. The longer your money collects compound interest, or increases along with the stock market, the more you will get in returns.
Let’s look at it in terms of real numbers. Say you manage to save $200 a month. That’s $2,400 a year and $48,000 over 20 years, plus accruing interest. If you invested each month in the stock market you might have doubled your money, but that comes with risk. The point is there is no amount too small to get started investing. That being said, one of Canada’s top online investment brokers, Questrade, requires a minimum $1,000 to get started trading stocks.
One of the easiest ways to get started investing is to check with your employer about RRSP or company stock matching programs. Many companies in Canada offer employees RRSP matching and convenient automatic deductions off your paycheques. Talk to your benefits coordinator about payroll investing options.
How do I choose what kind of investment account to start with?
After you’ve explored what your employer has to offer in terms of investment options, it’s time to break out on your own. All banks and credit unions will offer a buffet of investment options from mutual funds to GICs to stock trading accounts. It can be head-spinning trying to figure out where to start.
It’s important to understand the fees that come with investing before you get started. Banks will gladly take your money and invest on your behalf for a certain percentage off your principle each year. Those are called management fees and they usually range around 2%. Another option is what’s called “robo-advisors,” like at WealthSimple, where they use computers to track the stock market and create automated investments for you. The fees are considerably lower compared to the banks.
If you want to escape fees and start picking the hot stocks, you can open a no-fee trading account at WealthSimple or pay per trade (usually around $6) with an online broker like Questrade or with the big banks like CIBC and TD. WealthSimple’s no-fee trading is unique and one of the only ways to invest without giving a little something to the middleman.
What kind of return can I expect from investing vs savings?
Interest rates have been nosediving in recent years, especially in pandemic-stricken 2020, which has been great for borrowers looking to take out mortgages. For those trying to save money? A nightmare.
Most big banks in Canada will offer less than half a percent if that. You need to seek out “alternative banks” and credit unions to get anywhere close to 2%. Remember, inflation is around 2% so if your money is earning less than inflation then you’re theoretically losing money.
The stock market on the other hand typically delivers 5% per year. But that hasn’t been the case in 2020. The tech-heavy NASDAQ composite index, for example, is up 25% while the S&P 500 index is up 10% as of mid-year. And that includes an epic crash in mid-March when COVID first turned the world upside down.
How much should you save before investing?
There is more risk involved, but investing in stocks is currently a much stronger performer for your money. However, while you invest you should also keep enough saved for fast access to cash in an emergency situation. That means having the equivalent of three to six months of your expenses OR three to six months of income according to the Financial Consumer Agency of Canada.
Tackle debt first
You can save AND tackle debt at the same time, but as a general rule of thumb you should always pay down high-interest balances before putting your money into investments, especially the stock market. Credit card balances will eat away at your income faster than any investment vehicle will earn you capital gains.
If you have multiple high-interest debts hanging over you, then consider a debt consolidation installment loan. Fresh Start Finance offers funds of up to $15,000 and a payment schedule that alleviates the stress of multiple debts and helps you get on the path to a brighter financial future. Get approved today!