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Which of the following is a better investment for long term investing and why?

  • High interest savings account paying 2.3% interest, no account fees and the funds are protected by the Canada Deposit Insurance Corporation (CDIC) (which is federally backed) in case the institution defaults.

OR

Note that the interest rate on the high interest savings account is subject to change (but this is true for bonds as well). Based on the above figures, it would seem that the bank account is better but are there any other considerations to take into account to determine which is a better investment long-term?

  • 1
    What's the fine print regarding that 2.3% account? (In the US, such accounts come with requirements such as a minimum number of debit card transactions per month, and a maximum balance of $5000.) – RonJohn Oct 1 '17 at 21:52
  • @RonJohn Surprisingly there there are no minimum transaction or balance requirements. One can have a maximum balance of $100,000 and the other "fine print" is that the interest rate can change anytime but this bank has offered between 2-3% for the past two years. – Index Hacker Oct 22 '17 at 3:12
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You are not exactly comparing apples to apples - the historical average returns of the bond fund would be based on past returns. ie: returns before the Bank of Canada raised the prime interest rate by ~75 basis points over 6 months.

The interest rate you are seeing now, is the rate advertised after those rate increases have occurred. If you took an average rate of return over a similar savings account over the past 12 months, you might find it to be similarly worse.

All else being equal, a CDIC-protected savings account is lower risk than a bond fund. But the rate on such an account would change at the drop of a hat. Investing in a bond fund would include bonds bought today that would mature years from now, meaning that if interest rates dropped, you would still see increased performance from your bond fund until those old bonds matured.

Which is better will depend on your circumstances.

  • Let's say that I rebalance my overall portfolio if the actual weightings deviate from the target excessively. If there a market downturn occurred, the price of any bond funds I hold would go up whereas a savings account would not change (except maybe the interest rate). So seems like bond funds would have the advantage that I could rebalance the extra value from price increases. Would you agree with this and would there even be a huge bond price increase in a market downturn or just a minor increase? I like your user name btw. Very Canadian. – Index Hacker Oct 22 '17 at 3:18
  • @IndexHacker If interest rates in Canada go down, and you hold bonds with a fixed interest rate (or, you hold an index fund which itself holds bonds with a fixed interest rate), then your bonds would continue to give you the same interest rate every year [note that as your bond fund holds bonds constantly maturing, as those maturing bonds are replaced with new bonds, the average return of your fund will approach the market rate], while your savings account would give you less income as the interest rate there is 'floating', based on the market rate. – Grade 'Eh' Bacon Oct 23 '17 at 12:54
  • On the flip side, if interest rates in Canada go up, your fixed-rate bond fund will continue to give the same amount of interest, where your savings account will increase its return, as it floats with the market rate. So what does this tell us? In some aspects, a fixed-rate bond has less interest rate risk than a floating-rate savings account. With risk comes the chance to do better or worse over time. – Grade 'Eh' Bacon Oct 23 '17 at 12:55

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