Why Are Investors Only Using GICs and High Interest Savings Accounts In Their TFSAs?

by Mike Holman

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Apparently most investors are using their TFSAs for safe instruments such as GICs and high interest savings account, even though they are eligible for equities, such as stocks and bonds.  I’ve seen a couple of instances where the name “Tax Free Savings Account” was blamed because it contains the word “savings” which apparently is confusing. Gordon Pape brought it up in his article and Jonathan Chevreau wrote a whole post on the theory.

For some background, here is my post on TFSA rules.

The name has nothing to do with it – think about this – RRSP is a very successful account used by many Canadians.  What does the “S” in RRSP stand for?  Wait for it….yes, “Savings”!

How is that Canadians are comfortable putting equities in their RRSavingsPs, and yet they are so confused by the TFSavingsA, they are stuck investing in GICs and high interest savings accounts?

People who think that you can only buy GICs in TFSAs are the same people who think you can only buy GICs for the RRSP or worse – they think you “buy an RRSP”.  That issue is just plain investor ignorance.  No name change can combat that sort of thing.

Here are my reasons why investors like having GICs and high interest savings accounts in their TFSA

Advertising

The banks advertise more.  ING in particular, easily smoked every single other financial institution out there with its marketing and implementation when the TFSA came out.  People associate banks with GICs and high interest savings accounts, which is one of the reasons for a lot of investors playing it safe.

Simple marketing

If you are trying to attract customers to sign up for a new type of investment account, the last thing you want to be doing is confusing them.  The TFSA has a set of new rules to be learned, adding more investing options like stocks and mutual funds doesn’t make for good advertising.

Good implementation by the banks

ING was the first institution to offer a “pre-TFSA” account in the fall of 2008, so you could make your contribution early.  They didn’t really put the money in a TFSA account, but rather a non-registered account.  The interest in a non-registered account is taxable so they doubled the interest payment to cover the taxes, in effect creating their own temporary synthetic TFSA account.  On January 1, 2009 they transferred the money to a TFSA account and everyone was happy.  They have continued to offer this “bonus” every fall.  Obviously they spent a ton of dough on advertising, but it seems to have paid off.

What were other companies doing? Not much – I recall Scotia allowing people to set up their accounts early, but I don’t know about the other banks.  What about the discount brokerages and mutual fund companies?  They did nothing, while ING and the banks got all the TFSA money.

I’m not trying to play the blame game here – it really doesn’t matter to me which companies have more TFSA assets.  However, the point is to show why most people set up TFSAs with their bank and invest conservatively.  It’s not because they are stupid or are poor investors – it’s because the TFSA was a new investment account and the banks (especially ING) were the only visible option at the time.

Small account size

TFSA contribution room was only $5,000 per person in 2009.  In the grand scheme of things – this ain’t much.   GICs are easy – some of this money will get converted to mutual funds and stocks/ETFs over time.

Emergency fund

I can’t speak for anyone else, but my wife and I decided to start an emergency fund.  This has to contain liquid investments which means a high interest savings account.  The interest on this money, while puny, is considered taxable income.  Putting this money in a TFSA is the smartest choice for us.

Tax sheltering makes sense

You can talk about different tax strategies until the cows come home, but the fact is that if you are going to own investments which produce interest income – putting them into a tax-sheltered account makes the most sense.

Short term investment horizon

The TFSA is far more suited to short-term investments than the RRSP.  Someone who is saving for a house downpayment, a new car, a vacation, a house renovation will have a fairly short time line for that money and needs to keep it safe.  Hello GIC!

Fees

A lot of discount brokerages charge a lot of money for trading stocks and ETFs – it’s just not worth it for a smaller account.

What will happen in the future?

Going forward, I think the amount of TFSA assets invested in equities will increase as investors have more contribution room to play with.  The TFSA account is still pretty new – as more investors learn the rules, more will open accounts that can invest in mutual funds or stocks and ETFs.

If you are thinking about moving your TFSA from one company to another – check out my TFSA December strategy to save transfer fees.

What do you think?  Any particular way the TFSA should be used or is any method ok?

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{ 15 comments… read them below or add one }

1 Steve Zussino

Savings in these low interest vehicles does not even keep up with inflation. Poor advice in my opinion from their advisors.

Steve

2 Michael James

I haven’t even bothered to open a TFSA yet because the contribution limit is so low. Maybe I’ll open one in 2011 now that my wife and I can contribute $30k. But we’ll be investing in stock indexes.

3 Balance Junkie

My husband and I have TFSAs and we keep them in savings accounts for many of the reasons you mentioned: This is our emergency fund, so it needs to be liquid; the amount invested is still pretty small; and if you’re stuck earning 1.5%, it may as well be tax free.

I think you’re right. In the future, more people will put stocks and bonds in their TFSAs as well. You just have to remember that if you take a loss in a TFSA, you don’t get to claim it against your gains.

4 Financial Cents

@Michael James – great idea, that would be a sizeable contribution and likely yield you guys some tidy dividends or distributions.

@Mike – Great post. My wife and I long since cancelled our TFSA in a HISA. Didn’t make sense to me to keep it there. Over the last year or so, our TFSAs are now in a discount brokerage account and we hold some cash and bonds but mostly equities in there. Long-term I foresee some nice passive income coming from our TFSAs.

5 Mike Holman

@Steve – It depends on what the investor is planning for the money. If the money is needed in the short term, equities are not a good choice.

@Michael – Good idea. Wait until it’s worthwhile.

@BJ – Good point about losses – but you also don’t pay taxes on gains.

@FC – Glad to hear you moved your TFSA into appropriate investments.

6 Echo

I think it’s because of the account size being too small. I can remember the discount brokers would even charge you a $50 admin fee if your balance was under $25k (hello, I can’t contribute more than $5k right now!). They have since waived that fee, but things like that probably didn’t help get people into equities right away.

I just buy a couple of Cdn dividend payers each year within my TFSA, and in 30 years I will hopefully live off the tax-free dividends.

7 Mike Holman

@Echo – Sounds like you are on your way to riches! :)

8 Chad Tennant

The TFSA high interest/GIC question is a very good one. An account holder has an opportunity to benefit from interest, dividends and capital gains without the tax erosion factor. High interest in the form of a “great savings rate” according to ING and others means your money isn’t keeping up with inflation. If your investor profile is conservative, there are plenty of fixed income options available offering higher yields – 3% – 5% for example.

Some folks think the contribution limit is to low. However, the TFSA is a great vehicle to increase your disposable income over the long haul to ensure greater lifestyle options. If you contribute $50.00 a month to a TFSA over a 20-year period at a 5% return rate, this will equate to total net savings of $20,637.32. Your TFSA could also be used as an emergency fund for untimely life events or home/auto repairs.

9 ldk

We are using our TFSA’s to hold GICs and HISAs right now, and the primary reason is the small contribution limit. If you are going to hold cash/equivalents anyway, they may as well be sheltered. In a few years when the limit is higher ($50k, say) than we would want to have available to us in cash, we will get a little more creative with it.

10 youngandthrifty

I agree with Steve, a TFSA with GIC’s doesn’t even keep up with inflation..

fantastic post- so true about the big banks marketing-a lot of people think that a TFSA means a high interest savings account. It didn’t help when the banks started off by charging a $50-$100 adminstration fee per year. Nor does it help when buying equities would cost you $25-$29 of your $5000 contribution :(

What I ended up doing with my TFSA was get a Tax Free “Investment” account with Questrade and buy income trusts for 2010. The extra $1600 I cashed out a month ago was so much better than any $50 I would have gotten from a GIC TFSA.

Another strategy (though even riskier) is to invest in something that you know/think will double/triple, but that’s speculating not investing, I suppose :)

11 jesse

For me it isn’t worth the bother to set up a separate account for what is currently a relatively small amount of money. If the up the limit to $20K/year it might garner my attention.

12 Mike

@Chad @Young and Thrifty – yes, I agree that GICs won’t keep up to inflation, but that is not an issue if you are using the TFSA for short term savings.

@Idk – Agreed.  That’s another reason I’ve just used my TFSA as an emergency fund.  Later on, if there is more money I’ll probably get into equities.

@Jesse – $20k per year!  We run in different circles, my friend!

13 ChrisG

We’re using it to save for a fairly expensive trip next year, so beating inflation isn’t a big deal for us.

14 BeatingTheIndex

Rates will potentially remain subdued going into 2011, there are better alternatives out there than GICs. TFSA is a great vehicle to build a tax free passive income stream. The payoff would be felt after several years!

15 The Passive Income Earner

I am with BeatingTheIndex, my TFSA is an account to generate tax free money from either capital gains or dividends. I prefer it over RRSP. I agree with your post that banks advertise heavily and they are the face of many investors and that’s where the education stops. It’s surprising how many do not understand that TFSA, RRSP and RESP are not investment in itself but a type of account in which you hold investments.

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