The term “assault on savers” is coming up more and more in commentary on how the world’s central banks are dealing with the financial crisis.
It’s a fair description. Central banks in the developed world set the trend for miserably low savings rates by holding their benchmark interest rates near zero. Central bankers like U.S. Federal Reserve Board chair Ben Bernanke and Bank of Canada Governor Mark Carney claim low rates are vital to supply the fragile financial system with cheap money to prevent the economy from freezing up.
But at the same time they reward already overleveraged borrowers and punish savers. Hard working people who don’t want to risk their savings in the market are left with few alternatives to keep their nest-eggs ahead of inflation.
And the Banks Take Their Cut
To make matters worse, the investment industry has joined in on the assault by imposing fees that were set in the days of high interest rates. The average investor saves for retirement through mutual funds. Those mutual funds are normally managed as a portfolio by a financial advisor. The advisor and the mutual fund companies are compensated through an annual fee based on a percentage of the amount invested called the management expense ratio (MER).
Under that structure savers who want to steer clear of market risk can either keep their money in cash or put it in a money market fund. Cash earns virtually no interest but a money market fund grows by investing in safe short-term debt securities like treasury bills.
This is where the tide has turned against the saver. In this low-interest rate environment a good money market fund can earn two per cent in a year, but the average MER is one per cent. Stripping out the annual fee, the average Canadian money market fund returned a paltry 0.37 per cent over the past year. In many cases an additional fee, called a load, is imposed when the fund is bought or sold. Factoring in fees and inflation savers are likely paying a manager to lose their money.
Squeezing the Most From Your Savings
Unfortunately for savers, most mutual fund accounts only allow transfers among various mutual funds, and cash or money market funds are the only choice.
There are, however, options for savers outside of mutual funds. Competition has sprung up from some unlikely sources to provide high interest savings accounts. Rates are still relatively low but in most cases there are no fees because the institutions make their money by investing your savings in vehicles that pay out higher rates.
Online lending broker RateSupermarket tracks the best rates on high interest savings accounts. Currently President’s Choice Financial and ING Direct have the highest payback rates at 2.5 per cent annually on savings of over $5,000.
In both cases PC Financial and ING Direct offer the same rate on savings in a tax free savings account (TFSA). That means any interest accumulated on savings is not taxed as income.
PC Financial also offers a 2.6 per cent return on savings of over $5,000 in a registered retirement savings plan. Saving in an RRSP allows savers to deduct the total contribution from their taxable income, boosting their return by their highest tax margin. An RRSP also postpones taxation on the entire amount until the funds are withdrawn at a lower tax rate in retirement.
Other competitive players in the high interest savings game are Canadian Tire Financial Services and Meridian. The best the major Canadian banks can do is 1.2 per cent.
Saving for retirement in an age of rock-bottom interest rates is no easy task, but savers can at least get the upper hand until they are justly rewarded.