Today we would like to discuss the effects that inflation and taxes can have on the return achieved in a high interest savings account and why this makes it so critical for savers to shop around for the highest available interest rate. We will do so with the help of an example.
Let's examine how much money one would have made by parking some cash in the Tangerine Savings Account (formerly knows as the ING Direct Investment Savings Account). With over 1.8 million clients and over forty billion dollars in deposits
1, it's safe to assume that there are many Canadians out there who have some cash sitting in the Tangerine Savings account.
As you can see from our index of financial products,
this account is currently paying an annual interest rate of 1.30%. We can also glean from our trusty index of financial products that this rate has been in effect since early March (March 7, 2014 to be exact). Prior to this, the rate was only slightly higher at 1.35% per annum. This means that from October 2013 to October 2014, the account paid, on average, 1.33%.
Although most would agree that this was not a high rate of return, it was at least a positive rate of return that could have been obtained without incurring any risk whatsoever given that this deposit would have been covered by the Canada Deposit Insurance Corporation. Many, no doubt, would take comfort in the knowledge that, at least, they did not lose any money, nor was there ever a possibility that they could have lost any money throughout that twelve month period.
But is this correct? Can we claim that no money was lost during that time period? The answer, unfortunately, is no. A saver would actually have lost some money during this time period because Tangerine's 1.33% average rate of interest was below the rate of inflation.
We can determine the Canadian inflation rate for any twelve month period by having a look at the consumer price index (often referred to as the 'CPI'). This index tracks the cost of purchasing a fixed basket of goods and services through time.
2 Every month, Statistics Canada determines what it would cost to purchase that basket of goods and services. This allows us to see how inflation is increasing the general cost of living. A quick look at the CPI over at the Bank of Canada website shows that from October 2013 to October 2014, the CPI increased by 2.4%.
3 What this means is that if it cost you 30 thousand dollars to live last year, it would likely cost you $30,720 to cover your basic costs this year. As the cost of everything you buy has increased, the value or purchasing power of any money saved has diminished.
Now we see the problem with Tangerine's 1.33% rate of return. While your saved money has grown by 1.33% over the past year, the cost of everything you need to live has increased, on average, by 2.40%. Put another way, the cost of living has increased approximately 80% faster than your savings stashed in a Tangerine savings account. You have, in fact, lost purchasing power as the value of your savings has diminished through the year.
As bad as this seems, it gets even worse if we consider the effect of taxes. If you had kept your money in a taxable account at Tangerine (i.e. something other than a TFSA or RRSP account) you would have also had to share some of that 1.33% in interest earnings with the government. For example, if you were at the top marginal tax rate in Ontario during that time period, you would have had to give up approximately 49.5% of that interest income.
4 Suddenly, that 1.33% interest rate become a 0.66% effective rate. With inflation running at 2.40%, you would have lost around 1.75% of the purchasing power of your money.
The bottom line is as follows: Regardless of your marginal tax rate and regardless of whether you earned that interest in a taxable or a non-taxable account, you would still have lost money in real purchasing power terms. The loss would be between 1% and 1.75% depending on the taxable status of your account and your marginal tax rate.
This is why we believe it is so important for savers to shop around for the highest available interest rate when deciding where to place their liquid cash savings. Our
index of financial products is an easy way to quickly compare the interest rates available on virtually all of the savings accounts currently available in the Canadian marketplace. It is updated every 24 hours and allows you to sort by various criteria, including the rate of interest.
By finding the highest possible interest rate, you can ensure that you lose less of your hard earned savings to the ravages of inflation. A one or two percent annual loss on your savings may not seem like much, but it adds up over the long term and can significantly erode the value of your savings.
We should note that even the best available savings account (currently Achieva Financial is yielding 2% and it yielded 1.8% during most of our sample time period) would still have resulted in a loss between October 2013 and October 2014. But, at least that loss would have been smaller than at Tangerine, given the relatively higher rate of interest offered. Given that everyone needs some liquid cash savings on hand (whether it be as an emergency fund or savings towards a particular goal such as a house down payment), it is imperative that we all seek the highest available rate of interest for those savings so as to minimise these losses as much as possible.
