“How much am I going to make?”

That’s likely the most reasonable question that an investor could ask. When you sign up for a savings account or GIC it’s usually the rate of return that lured you in, or got your attention. We know that many savers are ‘rate chasers’. They go from bank to bank, playing each bank against the other bank, asking for more, asking for a higher interest rate on their savings account or GIC.

I often had clients brag to me that they could get a savings account at 1.5% at so-and-so bank or credit union. I’d reply “That’s great, go for it, but I work in investments, I’m talking about earning triple or quadruple or more than that rate over time.” Of course, I would always qualify that there was the potential to earn that greater rate or return.

Did I mention that 1.5% don’t impress me much?

Of course, at this stage of the conversation I would probe the client’s savings accounts and whether or not they had a more than ample Emergency Fund. Typically, advisors will suggest that you hold 3-6 months of total spending needs in a savings account. That said, everyone knows their own personal situation and what types of emergencies that might pop up – and potentially the costs of those emergencies.

Separate short-term and long-term money

Another important practice is to separate our short-term monies and our long-term monies. Once we’re covered with that short-term emergency bucket, we move on to growth and try to make our long-term monies work real hard. You will also have day–to-day monies in a chequing or savings account.

One of the biggest mistakes Canadians make is to have too much money in “high interest” savings accounts. Guess what? That 1-2% is not going to take you to the retirement promised land. In fact, monies in a savings account are usually going backwards, it’s not making you a dime once you factor in inflation. A long term historical average for inflation is in the area of 3%. If you’re earning 2% in a savings account, you’re losing 1% spending power, each year.

Your $100,000 that you have today might feel like (or spend like) $90,000 or less in ten years. Start to extrapolate that over a few decades and the effect is greatly exaggerated. Inflation is nasty. Here’s an example that will also show my age. When I was a kid, I would take 25 cents to the movies to buy treats. With those 25 pennies I would be able to buy a pop and chips, I think I may have also been able to buy a 3-pack of gum. Yes, I also spent a lot of time in the dentist’s chair. Can you get anything for a quarter these days? I didn’t think so. Talk about losing spending power. And no, I did not grow up in the era of the Great Depression. I ‘grew up’ in the best decades of all time: the 60s and the 70s.

Only stocks can outstrip inflation

Now certainly, the 70s experienced some ‘hyper’ inflation so the effect was exaggerated. But inflation is there and it’s powerful, even in the 2.5 – 3% range. Continue Reading…