I keep my Tax Free Savings Account (TFSA) money in cash. It’s actually kind of embarrassing. How can I hope to get decent TFSA rates of return if I scatter my money among meager vessels of usury? (Spoiler: my average return, in savings accounts and a guaranteed investment, is about 3.5%!)
That’s right. I don’t have my TFSA in equities. I don’t hold a high yield junk bond fund. Not even a low-risk AAA debenture.
Despite my extremely low-risk approach, I think my TFSA rates of return are reasonable. What the heck do I have my money in?
At the end of 2011, my TFSA rates and holdings were as follows:
- 2% on $10,000 (plus accumulated interest) in a “high” interest savings account at Ally Bank.
- 5% on $5,000 (again, plus accumulated interest) in preferred shares from my credit union. For some reason, the income from my preferred shares would be treated as interest rather than a dividend (if it were held outside a TFSA). I consider this investment to be “cash”-like. I’m allowed to pretty much redeem it at will — the interest rate, which we’ll discuss in the next paragraph, is crazy good. I think the credit union needed money to acquire or build a new branch so they paid a big premium to get capital. Interest rates have remained so low, I think they want to offload these shares for cheaper financing.
Hence I had all of my TFSA in cash or near-cash accounts with financial institutions. A quick calculation based on my TFSA rates shows my portfolio yield is 3%. The actual effective yield was a bit lower because I’d accumulated more interest on my cash savings (contributed in 2009 and 2010) than on the credit union shares (which I bought with my 2011 contribution room). I’d tell you the precise portfolio yield, but I’m doing this from memory rather than looking up my exact portfolio holdings as of December 31st, 2011. The individual TFSA rates, however, are correct.
To me, an overall yield of 3% is not bad. If I were paying taxes on that 3%, it’d reduce the yield a lot. Interest income is taxed more heavily than dividend income. But these securities are in a TFSA, so they’re tax-free. To me, it’s more efficient to keep equity investments in taxable accounts where I’ll enjoy the slightly-discounted tax rate on capital gains and the immensely lower tax rate on dividends.
Early this year, I was spurred to seek out the best TFSA rates and improve my returns. There were two catalysts:
- I had $5,000 in additional contribution room as of January 1st. If I put this $5,000 in my Ally account, my overall portfolio yield would drop from 3% to 2.75%. I held my nose and did it, since it was better to earn 2% tax-free on $5,000 than 2% in taxable interest — at least until I could find a better rate. I was lazy and left all $15,000 (plus interest) with Ally for a while.
- One of my TFSA rates changed at the end of March. Ally dropped their TFSA rates (and their rates for other “high-interest” savings accounts) to 1.8%. Considering Ally loans out savers’ money in the form of high-margin products like car loans, I found the spread to be disgusting.
The quest commenced. The best TFSA rate on a cash account offered by a CDIC-insured institution that I could find was 3% from Canadian Direct Financial (CDF). It wasn’t one of the best TFSA rates, it was the best. If anybody has found better, please share it.
I’m kind of embarrassed to say that I didn’t act on my find for two months. I could give excuses like “I was busy,” but the truth is that I am a fallible, sometimes money-stupid, procrastinator. My money was exactly the same, whether it was at Ally or CDF. The only difference was how hard my money would work for me. Even worse, the extra 1.2% that I could have earned for those interim months would have been tax-free. But I did it, and I’m not earning 3% on about three quarters of my TFSA portfolio. Here’s the new allocation:
- 5% on my credit union preferred shares (about one quarter of my TFSA portfolio)
- 3.04% (3% per annum, because it’s compounded monthly) on my CDF high-interest savings account
That means that my overall TFSA portfolio yield is about 3.53%. Earning over $700 a year, tax- and risk-free isn’t too bad. Sure, I could make more in the markets – but I could also lose more. I’m much less scared of a taxable investment taking a dump — it wouldn’t affect my contribution room for a tax-sheltered savings vehicle if the investment went to 0 or if I had to sell the investment and thus realized the loss. Further, I have a pretty efficient setup from an income tax perspective. Finally, I kind of like the idea that I could cash it out at any time – even though I’d be loath to do it.