Navigating High Interest Rates: A Guide for Canadians on Holding Cash

With the Bank of Canada’s overnight interest rate now sitting at 5%, as of April 25th, Canadian investors are facing a markedly different landscape compared to just a year ago. This rapid pace of monetary tightening – the most aggressive since the 1990s – has significantly impacted both borrowing and saving.

Mortgage rates have more than doubled, making homeownership increasingly unaffordable for many. Meanwhile, yields on savings accounts and guaranteed investment certificates (GICs) have risen sharply, providing better returns for risk-averse investors.

With inflation stubbornly high, and the Bank of Canada expecting it to reach its 2% target no sooner than 2025, any future rate hikes, however unlikely, are not off the table entirely.
This means Canadians should prepare for interest rates to likely remain elevated well into 2025. In this new higher-rate environment, investors need to re-evaluate how they manage their cash holdings.

Best Ways to Invest Money in Canada to Combat High Interest Rates

Staying in cash isn’t the most beneficial investment strategy. When inflation rates tick higher, the value of cash diminishes over time, eroding potential investment returns. To protect against loss of purchasing power and missed growth opportunities, investors should seek options that offer returns at least on par with, if not exceeding, inflation rates.

Here are some key strategies to consider:

Savings Account Yields Help Offset High Interest Rates

With interest rates elevated, interest rates on savings accounts have become much more attractive. Many of the major banks and online institutions are now offering savings account rates of 4%-5% or higher. By parking cash in these high-yield savings accounts, investors can generate a healthy return without taking on significant risk.

The key is to shop around and compare rates across different providers. Online banks and fintech firms often offer the most competitive savings account yields, so it’s worth exploring these options in addition to the big banks.

Consider GIC Investments

GICs are a silver lining amid rising interest rates and have become a more appealing cash management instrument in the current economic environment. They provide guaranteed returns and are favoured for their low-risk profile. Depending on the lock-in duration, GICs can pay a juicy yield ranging from 4% to 5.5%, as of April 2024, providing a relatively risk-free investment option.

As a GIC matures, investors can reinvest the funds into another low- to medium-term GIC, effectively creating a rolling portfolio of fixed-income investments with predictable income. This strategy allows investors to capture higher yields as rates rise, without being locked into a single long-term GIC.

Short-Term Bond Funds

Investors with slightly higher risk tolerance and seeking better returns than savings accounts or GICs could consider short-term bond funds. These funds invest in a diversified portfolio of high-quality, short-duration fixed-income securities, providing better yields than cash while maintaining relatively low volatility.

What makes short-term bond funds particularly attractive is their ability to swiftly adjust to rising rates. As lower-yielding bonds mature, the fund can use the proceeds from them to invest in newer bonds that pay higher interest. This keeps the overall interest earnings of the fund stable even when interest rates tick higher.

Alternative Cash Management Strategies

Apart from traditional savings accounts and fixed-income instruments, Canadian investors may also want to explore the following cash management strategies:
High-interest checking accounts: Some banks and fintech firms are aggressively offering checking accounts that pay interest rates comparable to savings accounts. Many of them would entice consumers to switch their providers in exchange for a time-bound high interest rate, far exceeding what your current account may be offering.

Money market funds: These are investment funds that typically invest in short-term, high-quality debt securities and could offer slightly higher yields than savings accounts. They provide investors with a safe and liquid way to earn a modest return on their cash holdings. Many Canadian financial institutions and investment firms offer this low-risk option for investors seeking stability and liquidity in their investment portfolios. Moreover, these funds are subject to regulation by securities regulators.
Ultra-short-term bond funds: These are investment vehicles (including mutual funds or ETFs) that invest in fixed-income securities with short-term maturities, usually less than a year. These funds provide investors with a relatively safer way to invest their cash, while also potentially offering higher returns compared to conventional savings accounts or money market funds.

Similar to short-term bond funds, but with an even shorter duration, these funds can be useful for parking cash in a rising rate environment.

The key is to carefully evaluate the risk-return profile of any alternative cash management strategy and ensure it aligns with your investment objectives and risk tolerance.

The Balancing Act

Cash holdings can be detrimental to long-term investment objectives, including retirement planning. While optimizing cash holdings is important, it’s also crucial for investors to maintain a well-diversified portfolio that includes other asset classes, such as international stocks, commodities and, in some cases, real estate.

Cash should typically make up a relatively small portion of a balanced investment portfolio, with the majority allocated to growth-oriented assets.

The specific allocation to cash will depend on an investor’s individual circumstances, including their time horizon, risk tolerance, and investment goals. As a general guideline, financial experts often recommend keeping three to six months’ worth of living expenses in easily accessible cash or cash equivalents, with the remainder of the portfolio invested in a mix of stocks, bonds, and other assets.

By striking the right balance between cash, fixed-income, and growth-oriented investments, Canadian investors can navigate the higher interest rate environment while still positioning their portfolios for long-term success.

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