If a 30-year-old couple opened their first Tax Free Savings Accounts today, they could contribute up to $82,000, which is a big reason why such accounts are starting to be serious money for many Canadians.
As far as investing the funds, they could choose cash, GICs, stocks, bonds and preferred shares, as well as use vehicles such as mutual funds and exchange-traded funds to hold those investments.
According to a BMO study from October 2014, 48 per cent of Canadians have a TFSA. What is shocking is that 60 per cent of TFSA owners’ accounts are primarily made up of cash and 20 per cent are primarily made up of GICs.
Most of the cash and GICs are earning 0.5 to two per cent. Anything more is usually a very short-term teaser rate.
Why would you be happy earning such a paltry amount and why is so much sitting in cash?
There are a few reasons.
One is that many institutions initially didn’t really promote TFSAs because it was just a $5,000 or $10,000 account. The company that did a great job promoting it was ING Bank (now Tangerine), and it primarily offered high-interest cash accounts.
Another reason is that many Canadians still don’t know that they are able to invest in virtually anything in a TFSA — just like they can in an RRSP.
Finally, many Canadians were so nervous about stock markets when TFSAs started in 2009 that they didn’t want to have any risk in their TFSA savings, so that became their safe money investment — and it never changed.
If, however, your TFSA is meant for retirement savings, it is simply bad money management from an investment perspective to have funds that are guaranteed to earn less than two per cent as a key piece of your long-term strategy.
For a wide number of reasons, stocks over the long term have significantly outperformed cash savings and GICs.
Based on information provided by Morningstar, here are the following rates of returns since 1950 for different investment indexes:
- U.S. large-cap stocks in Canadian dollars: 11.2 per cent
- Canadian large-cap stocks: 9.9 per cent
- Canadian long-term bonds: 7.5 per cent
- Five-year GIC rates: 6.7 per cent
- 90-day T-bill rates: 5.5 per cent
These percentages clearly show that over the long run, stocks outperform bonds, bonds outperform five-year GICs, and five-year GICs outperform 90-day T-bills, but these rates of return do not truly show the impact.
To put it a different way, if you invested $5,000 in each of those asset classes, and they earned those rates for 30 years, this is the amount you would end up with:
- U.S. large-cap stocks in Canadian dollars: $120,813
- Canadian large-cap stocks: $84,899
- Canadian long-term bonds: $43,775
- Five-year GIC rates: $34,987
- 90-day T-bill rates: $24,920
Displayed this way, it is very clear what you are potentially giving up by making long-term investments too conservative.
In addition, while we do not know what the next 30 years will bring, we do know for certain that the five-year GICs will pay you two to three per cent, and savings accounts currently pay 0.5 to two per cent. None of those numbers comes close to the long-term average returns of stocks or long-term bonds.
Some will say that now is not the time to start taking more risks with TFSA assets, but that’s egotistical thinking. You would be saying that even though the long-term history suggests cash is a weak investment, you know what is going to happen in the stock and bond market, and you know that it is better to be in cash for the next short-term period.
If you believe that, you may turn out to be correct for the next three months or even 12 months. But you may also be very wrong. And I am very certain that over the next decade or two, you will be making an investment mistake to have your TFSA sitting in cash or GICs.
Now that TFSAs are starting to be real money, it is time to rethink your low-risk TFSA investment strategy. With $82,000 of investment room for a couple, it is time to get serious about this important part of your retirement savings.
Reproduced from the National Post newspaper article 29th May 2015.
