High Interest Savings Accounts

Posted by David Pett - Financial Post

Share on Facebook

Tweet on Twitter

Like going through the motions in a long-dead love affair, the federal government announced rates for its Canada Savings Bond program Monday, but the record low payments no longer make them a viable investment vehicle for most investors.

The new series 120 Canada Savings bonds will pay just 0.4% this year, the lowest annual return since 1946, the year Ottawa first began selling the retail savings instruments. Net of current core inflation, which the Bank of Canada lists at 1.6%, a purchase in CSBs would lose investors money.

“It’s a bit of a joke. I think investors can find better places to put their money,” said Robert Floyd, lead manager at R.A. Floyd Capital Management in Mississauga, Ontario.

The new savings bond issue on sale until Nov. 1 has a 10-year term until maturity, and as always, can be cashed anytime, said the Department of Finance, which also released interest rate details for its series 70 Canada Premium Bonds.

These bonds will offer investors 1% in the first year, 1.4% in the second year and 1.8% in the third year. Unlike CSBs, the government premium bonds can only be cashed on the anniversary of the issue date and 30 days thereafter.

The Bank of Canada has dropped interest rates to historically low levels this year as part of a plan to promote lending and keep the economic recession at bay. At the moment, the central bank’s key overnight lending rate is at 0.25%.

At the same time, investors have increased their cash positions in the wake of the financial crisis and the stock market collapse of 2008. Even though equity markets have rallied hard this year and longer-term bond yields offer better returns, total cash equivalents remain inflated from this time last year, says Investor Economics based in Toronto estimates that

The total of money market funds combined with CSBs, provincial savings bonds and bank deposits was estimated at just over $1-trillion this past June, compared with $948-billion in June 2008. In June, 1998, there was $578.5-billion sitting on the sidelines.

The vast majority of this current cash hoard is invested in bank deposit accounts, guaranteed investment certificates, which like CSBs also offer historically low short-term interest rates. At the high end, a no-fee savings account at ING Direct pays 1.05% annually, the new bank ally offers a high interest account at 2.0% while a 30-day GIC at TD Canada Trust pays just 0.15%.

“The psyche of the consumer is still pretty fragile and a lot of people continue to put money into money market vehicles. They are so shell-shocked they don’t want to lose anything, but they aren’t gaining anything either. I think there are better alternatives,” said Mr. Floyd.

In fixed income portfolios for his clients, Mr. Floyd leans towards dividend paying stocks which are yielding current dividends well above current rates of guaranteed investments, granted at slightly higher risk. In a recent move to cash, he bought BCE Inc. at a yield of near 6%.

“Even if you buy a large cap stock with a decent dividend, the after-tax yield is way better than a CSB, which is taxed at 100%. It’s important to choose defensive stocks in a steady rate of return business to mitigate the additional risk.”

Over the past two decades, Canada Savings Bonds have dwindled in popularity and their share of the overall money market has fallen dramatically. In 1987-88, $17.5-billion worth of CSBs were sold and $53.5-billion savings bonds were outstanding. By 2000, gross sales had fallen to $3.2-billion, with $26.6-billion outstanding. Last year, only $1.9-billion were sold and the balance outstanding in the market was down to $13.1-billion.

With waning appeal and not insignificant advertising and adminstrative costs, there has been a debate in recent years, whether it makes sense to keep the program running.

“It’s a relatively expensive way to raise money,” says Michael Gregory, BMO Capital Markets senior economist.

But given federal Finance Minister Jim Flaherty’s admission last month that Canada will take longer to emerge from its current economic downturn and run higher deficits for longer than previously anticipated, Mr. Gregory, thinks it is incumbent of the government to look at all the alternatives to funding a deficit expected to hit $55.9-billion in 2009.

“I’m sure that while the discussion to do away with these things popped up when Canada was running deficits, I suspect no one is going to complain.”