Cash is King.. Except as an Investment

I was recently shown a fantastic tool, which is the Bank of Canada 'Inflation Calculator'.  Entering a simple parameter of $100 000 from last year, shows the present value needed to remain equal is $101 870. An inflation rate of 1.87%.

Often times, I see individuals who think holding the bulk of their 'Nest Egg' savings in short-term savings accounts is the best option. In which case, I like showing the outcome of how 1.87% inflation deteriorates the value of funds while held in a short-term non-tax sheltered account.

If this individual was to be earning 1% in their short-term savings account to net them $1000, they would still be losing $870 in the year due to inflation, not including taxes [$100 000 x  (0.01 - 0.0187) = -$870].

I use 1% as a base rate because this is the common benchmark among the Canadian Financial Institutes as a base rate.  Most offer incentives that go above and beyond 1% which I see as increasing competiveness among the growing number of online offers being present.  For example:

• BMO currently offers 1.6% as long as the account balance increases $200 each month.  In comparison to their other short-term savings options which offers 0.8%.
• RBC currently offers a promotional rate of 2.5% for new deposits in place of their base 1%, averaging out to 1.375% for the year given the 2.5% is only for 90-days. [(1% x 0.75) base + (2.5% x 0.25) promo = 1.375%]
• Scotia currently offers a 1% base with a premium depending on a pre-determined time commitment i.e. 1% premium if held 360-days, as well as, a bonus 1% for a quarter of the year averaging 2.33%. [1% base + 1% premium + (1% x 0.25) bonus = 2.33%] *does not include preferred client bonus which is  a bonus of 0.05% - 0.10%.

According to Rate Hub, the best current short-term 'High-Interest Savings Account' in Alberta is 2.6% (2.5% if <$100 000); giving a nominal return of $2600. Taking account of inflation, a real return of $730 [$100 000 x (0.026 - 0.0187) = $730]. Taking account of taxation of the $2600 earned at the lowest tax bracket, 25% in Alberta, this individual is paying $650 in taxes [$2600 x 25% = $650]. Netting them a total $80 for the year on a $100 000.  $5 if $99 999 is invested and earning a rate of 2.5% [($99 999 x (0.025 - 0.0187)) - ($2500 x 25%) = $5].  Essentially breaking even for anything <$100 000 invested.

Is this a good use of funds that go above an beyond an individuals short-term requirements? Absolutely not!  I expect $100 000 to net more than $80/year let alone a month.  Take advantage of a tax-deferred/-free investment vehicle and be mindful that short-term rates, although appealing, are not always the best solution for excess funds.  Yes, keep funds in a liquid short-term savings account, but not more than 3-6 months worth of expenses for emergency purposes or a specific short-term savings goal (<1-3 years).  Cash is King.. except as an investment.