Something that is often forgotten in the personal finance field is that young kids have a massively long time horizon. The finance industry tends to ignore the compounding capability between ages 0 and 20, only to think of people as savers once they start working.
Sadly, this is detrimental to children. Because young children have such a long time horizon, a fairly small amount of savings can go a long way due to the benefits of compounding. Effectively, savings and investments made during childhood can give a child a massive financial head start.
So why is this cohort ignored?
The personal finance industry – made up of advisors and asset managers – earn fees on dollars that come in the next quarter. The larger those dollars the larger the fees. So it doesn’t pay to provide advice to people with small account sizes. I’m hoping this article can help fill the void.
The following idea starts even earlier than high school, is easy to implement, financially feasible and doesn’t depend on a child’s ability to find work. Frankly, anyone can do this and help give their child/grandchild a massive financial head start.
Most newborns have four grandparents. If each grandparent contributes a manageable $25 per month into an investment account earning 7%, the child would have accumulated $51,430 by age 20. Imagine what a 20 year old could (responsibly) do with this money: pay college tuition, make a down payment on a property.
But why would the grandparents fund the account alone? What if the parents also each contributed $25 per month? In this case, the child would have accumulated $77,145 by age 20. Just that additional $50 per month results in a massive increase in value. This alone gives the child a massive financial head start.
Let’s say the child at age 20 pretends this money doesn’t exist.
What if at age 20 the child opted to leave that money invested until retirement without making any additional contributions?
By age 65 the child would have accumulated $1,620,227. Of course, this doesn’t account for a higher cost of living down the road, but no matter how you look at it $1.6 million is a huge sum of money. Especially considering the child never had to invest a penny.
Of course, like most of us, the child would likely contribute to his own investment portfolio. What if – after receiving the portfolio at age 20 – the child continued to contribute $150 per month until age 65? By age 65 the child would have accumulated $2,153,876!
Time is on a newborn child’s side. Unfortunately, that time is typically wasted. An extra 20 years of compounding early in a child’s life can add massive amounts of financial wealth for little upfront investment. So if you or someone you know is about to have a baby or already has a young child, share this with them.
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I have cash I need to tuck away for a while. I’ll probably need this cash in under two years (could be in 2 months, could be 2 years…timing is unpredictable in this case). So what do I do?
Standard Bank Accounts Pay Crap
Deposit rates for standard accounts at the major Canadian banks are minuscule. So that’s not an option, unless I want to see my cash get eroded by inflation (recently reported as 2.4% in Canada).
My next option is some of the bank alternatives like Motive Financial or Simplii Financial. If you time it right you can open an account or GIC with a big-bank alternative and get a rate between roughly 2-2.8%. B2B Bank seems to lead with a 3.3% rate on a savings account.
I think these are all excellent choices. However, opening an account and transferring money can be a bit of a hassle. Moreover, accessing large amounts of money (i.e. more than allowed at most atms) from these accounts probably either requires linking accounts or using cheques. It’s no Manhattan Project, but it does require time and effort. I just want to park my cash, earn a little money and withdraw the whole lot when I need it.
Introducing: PSA and CSAV
I found two other options I can easily access within my existing online discount broker. No account openings required. Simply buy/sell an ETF. The two ETFs I’m referring to are PSA (Purpose High Interest Savings ETF) and CSAV (CI First Asset High Interest Savings ETF).
These two ETFs are similar in many ways. They both pool investor money and invest in high interest savings accounts at various financial institutions. Because of the volume of cash at play, I presume they have negotiating power and can get decent rates. While they don’t yield as much as some bank alternatives, they do produce a respective cash flow, as shown in the table below.
Forward 12mth Distribution Yield
Risk of Underlying Insolvency?
The ease and speed of accessing high interest savings yields via a simple trade appeals to me. However, I wonder if there might be a downside.
Because an ETF (an institutional entity, as opposed to an individual) is putting money into various bank deposits my understanding is the underlying deposits do not qualify for CDIC insurance. So with the very small risk that an underlying bank becomes insolvent there is a remote chance that an underlying deposit is not honoured.
While this is a small probability, it can also be a catastrophic risk for someone putting a large amount of their wealth into one of these ETFs.
One only has to go back a decade to find a time when banks were teetering on insolvency. So insolvency is a non-zero possibility. With CDIC insurance, deposits are back-stopped by the Federal Government (indirectly the printing presses at the Bank of Canada). Without CDIC insurance, depositors are left on their own.
One way to mitigate this risk is to diversify. It’s no different than diversifying away idiosyncratic risk of individual companies in a stock portfolio. If one holding blows up, hopefully the others remain intact.
The pie charts below show the latest holdings breakdown of PSA and CSAV, using their most recent Fund Facts documents. As you can see, PSA has a disproportionate amount (80%) in just two financial institutions – National Bank and Scotia Bank. In contrast, CSAV holdings are evenly distributed across five banks. I think it is fair to question why PSA is so concentrated.
Don’t get me wrong. I’m not saying either of these ETFs are particularly high risk at the moment. However, I do think it is noteworthy that 1) these types of investment structures are untested during a financial crisis, and 2) the asset allocation profiles of these two ETFs are so different.
Canadian banks appear to be well capitalized and stable. But with the extremely high debt-to-income ratios within Canada I fear something could someday unravel, leaving banks vulnerable. Are banks and uninsured depositors prepared for a tail-risk event? That’s another fair question.
Risk of Run on Deposits?
PSA and CSAV have a combined $3.7 billion in deposits (CSAV alone has gathered $1.3b in assets since June 2019) at a variety of banks. These asset levels are growing rapidly because these ETFs are popular.
I wonder if there could eventually be a mis-match of liquidity (remember, banks use deposits to fund their operations and are reliant on the assumption that depositors won’t all withdraw at the same time) if investors were to suddenly sell the ETFs en masse.
While such a scenario is unlikely, bank runs do happen. The ease at which investors could sell their ETF holdings almost instantaneously could pose a risk to the banks that provide deposit services to the ETFs. This is a long way of saying that I believe Canadian security regulators may permit these ETFs to suspend redemptions if the redemptions pose a systemic risk to the Canadian financial system via a run on deposits at a particular institution. This is another improbable but very inconvenient risk if it were to occur.
In the end I decided to still use both these ETFs (in addition to a short term bond ETF) to park my cash while I investigate the risks further. Maybe I’m wrong but I believe the questions raised in this article deserve answers. In fact, I really hope someone shows me that the real risks are a lot lower than I suspect, because I think these ETFs provide good value to investors looking to park cash. The ability to easily and quickly invest in a range of high interest savings accounts really is quite innovative.
I will update as I uncover more answers. Stay tuned…