Savings accounts are definitely a popular option for those who want to put aside some money for a rainy day – but they aren’t the only option. There are many other vehicles in which people can invest their savings. In this section, we take a look at these alternatives and see how they measure up against the traditional savings account.
Before we begin, here is a chart that summarizes the alternatives on a range of key features:
*In a normal bond, your principal should be returned per the contract with the issuer, but it’s not insured.
Chequing accounts typically earn little, if any, interest, so on this score they don’t compare well to savings accounts. However, strictly from a capital preservation standpoint, they are on par with a savings account. Chequing accounts are CDIC-insured and your money is accessible at any time. The added bonus of a chequing account is that the number of transactions allowed without incurring fees is much higher than a savings account.
High-interest savings accounts
These are quite literally the high-interest version of a traditional savings account. However, with that higher interest rate, there is often a minimum balance requirement. As with traditional savings accounts, high-interest savings accounts are not intended for day-to-day banking, but they are CDIC-insured so your principal is safe.
Guaranteed investment certificates (GICs)
If you don’t need to access some of your money for a period of time (several months to years), then a guaranteed investment certificate (GIC) is also something to consider. The interest paid on most GICs is higher than on savings accounts, but depending on the type of GIC (cashable/redeemable vs. non-redeemable) your money might be locked in. If it is locked-in, then getting it out immediately may come at the cost of foregoing all interest accrued till that date. That said, GICs do protect your initial principal, and they are CDIC-insured up to $100,000.
Bonds and savings bonds
If you’re interested in capital preservation and income generation, bonds are another alternative to consider. We can separate this category into government savings bonds and “regular bonds”.
Government savings bonds, either issued by the federal government or a provincial government, pay a fixed rate of interest and are only sold at certain times of the year. The interest rate tends to be very low and, unlike corporate bonds and some other federal and provincial bonds, they do not trade daily. With these securities, your principal is considered safe, although there is always the risk of inflation eating into the value of your holdings. (For example, a bond could pay 1.00% interest while inflation is 2.00%.) While not CDIC-insured per se, government savings bonds are a legal obligation of the government, so for all intents and purposes they might as well have CDIC protection.
All other bonds include the debts of the federal and provincial government that are widely traded in the market, as well as debts issued by corporations. These bonds pay a set rate of interest (known as the ‘coupon’); however, the interest rate they pay is not necessarily the percentage return you receive. Here’s why: Let’s say General Electric issues a bond that pays 4.00% interest. After you buy, interest rates on the market start to decline for similar securities deemed to be very safe, such as government bonds. Investors will then bid up the price of the General Electric bonds on the open market, so that they now return what similar bonds in the market are yielding.
Your principal in a bond is a legal obligation of the company or government that issued it. And for most issuers, you will be paid back, with interest. But some companies do fail, and that means with high-yield (a.k.a. junk) bonds, in particular, your capital is definitely at risk. And unlike savings accounts and GICs, the CDIC does not insure regular bonds. Furthermore, if you sell your bond early, you may suffer a capital loss, even if you ultimately might have been paid back
Mutual funds/the stock market/ETFs
When interest rates are low on savings accounts and bonds in a low interest rate environment, many people turn to the stock market to grow their savings. This can be achieved in two ways: either by purchasing stocks yourself, or buying a basket of stocks through a mutual fund or exchange traded fund (ETF).
Unless you have the time to devote to managing your investments, buying individual stocks isn’t a wise idea, nor will it achieve the goals of a diversified investment portfolio. Mutual funds and ETFs, such as index funds, can mirror the performance of a major stock index like the Dow Jones or Toronto Stock Exchange.
The advantage of investing in the stock market is the potential for capital gains, as well as the dividend income you will receive; it is certainly possible to earn more on a savings account or GIC. On the flip side, there is also the chance you could suffer a large capital loss (and one that exceeds the dividends you’ll get). Not surprisingly, nothing connected to the stock market is CDIC-insured.