What are the advantages of high-interest savings ETFs?
There are several advantages to owning a high-interest savings ETF:
- Competitive interest rates. The ETF invests their assets in deposit accounts at major banks, which offer interest rates that are similar to high-interest savings accounts.
- Liquidity. Generally speaking, much like a stock, a high-interest savings ETF can be bought and sold fairly quickly on a stock exchange. You can easily get your money out and invest it elsewhere.
- Diversification. Although modest, most ETF managers will invest the assets into a few banks’ high-interest savings accounts in order to provide some interest rate and default risk diversification.
- No minimum balance, no holding period and no penalty for early redemption. That’s three advantages in one!
What are the disadvantages of high-interest savings ETFs?
While there are advantages, there are also disadvantages:
- Past performance doesn’t help you. Unfortunately, how an ETF has performed in the past can’t help you predict how it will perform in the future.
- Unlike high-interest savings accounts, an ETF is not CDIC-insured. If something were to happen to the assets of the ETF for whatever reason, there’s no government insurance to secure your investment. For instance, if the ETF placed its money with a bank that failed, the ETF’s shareholders could lose a significant amount of their principal.
- The second risk may seem technical but it’s worth discussing. ETFs represent underlying investments, whether in stocks, bonds, currencies, etc. At the end of every trading day, there is a value per share calculated, which is called the net asset value (NAV). In addition, there is the actual value of the shares on the stock exchange. In almost all cases, the NAV and the value per share will be nearly identical. This is because large market players stand ready to profit if they see a large difference between the NAV and the price per share. However, it’s also possible that the price per share of a high-interest savings ETF could be significantly less than the NAV of its investments. If this happens, an investor in the ETF will suffer a loss when they sell their shares. This wouldn’t happen with comparable investments like high-interest savings accounts or guaranteed investment certificates (GICs), where the bank is legally obligated to pay you back your principal plus interest.
What fees are associated with high-interest savings ETFs?
With any ETF, you must be prepared to pay two fees: trading commissions and management fees.
When you purchase a high-interest savings ETF, you’ll have to pay trading commissions to your brokerage whenever you buy and sell the shares. Even if you’re using a discount brokerage (which doesn’t provide advice but merely processes the transaction), you’ll still probably pay around $9.95 when you buy the ETF and another $9.95 when you sell the ETF. That $20 may not seem like much, but if you only purchased $2,000 of the ETF to begin with, that commission would represent 1.00% of your principal ($20 / $2,000). If the return on the ETF was only 1.35%, commissions would almost completely wipe out what you would’ve earned in interest.
For this reason, it makes more sense to buy a high-interest savings ETF with a more substantial amount of money. The commission is usually a fixed amount so the commission will represent less of your investment. In addition, keep in mind that high-interest savings accounts can come with transaction fees, so depending how you use them, they could end up costing more than the commission you would pay to buy and own the ETF instead.
That said, the company that operates the high-interest savings ETF charges a management fee. Looking at Purpose Investments again, they charge a 0.10% management fee (the 1.35% figure we used above is net2 of this expense). Think of this as the convenience charge for not opening up a high-interest savings account yourself.
Depending on how much you have to invest, this fee may or may not be worth it. For example, let’s say you have $300,000 to save; the management fee on this balance would be $300 ($300,000 x 0.10%). To save that amount of money, most people would be happy to give up an hour to open an account by themselves. But if you only had $20,000 to save, you might be happy to pay the $20 ($20,000 x 0.10%) management fee, in order to save your time and effort.
Lots of risk for little extra gain?
If you shop around, you can earn as much in a high-interest savings account or GIC as you can in the high-interest savings ETF. The main difference is that with the savings account and GIC, your principal is insured and you won’t be hit with trading commissions.
However, it may make sense for people with larger deposits to consider a high-interest savings ETF. Since the commission is fixed (i.e. $9.95 per trade), the more shares of the ETF you purchase, the less you’ll pay in costs as a percentage of your investment. And there is something to be said for the ease of buying ETFs. Because they trade like stocks, you can buy and sell them very quickly without the hassle of opening up another bank account.
References and Notes
- As of July 24, 2015.
- The net yield is the interest earned by the ETF on the savings accounts minus a 0.10% management fee paid to the ETF provider.
