This is a guest column by Mike Holman, the blogger behind Money Smarts Blog.

I get distressed when I hear about people who want to invest in “something better” than high interest savings accounts, because interest rates are so low. For most of us who like to think of 5% or 6% as a decent interest rate, it can be disheartening to see posted rates of 2% or 1% or even less.

There are a couple of problems with this way of thinking which might get you into trouble. I’m going to cover the reason you shouldn’t care too much about the interest rates in your savings account, as well as why looking for higher rates can cause you grief.

Interest rates don’t matter

First of all, let’s consider the idea of “real return”. With respect to bank accounts, the real return on your money is the actual return (determined by the posted interest rates) minus the inflation rate.

The real return indicates how much extra purchasing power you have over time.

For example, let’s say you are earning 3% in your bank account and the inflation rate is also 3%. If you deposit $1,000 today, then in one year’s time you will have approximately $1,030 in the account. You may feel $30 richer, but inflation has increased the price of everything you might want to buy by 3% or $30 as well.

As a result, the purchasing power of your original $1,000 deposit has not changed over the year, even though you now have $1,030. Of course in reality, the official inflation rate probably won’t correspond exactly to all the items you spend money on, but we’ll assume that is the case for this article.

In our example, the inflation rate is equal to the bank account interest rate. If that is always true, then it doesn’t matter if the posted rate is 2% or 22%, your effective wealth increase will be zero.

This is also true if the inflation rate is different than the posted interest rate, but the spread is constant. For example if the posted interest rate is 3% and inflation is 1%, then the real interest rate is 2%. If the interest rate is 30% and inflation is 28% then the real interest rate is still 2%.

My impression is that most people are happier with the higher interest rate scenario because they feel like they are getting a better return on their money, when in actual fact – both the high and low interest rate scenarios are pretty similar.

The bottom line is that the increase or decrease of your purchasing power, which is expressed in terms of the real interest rate, is what you should be concerned about, not the posted interest rates.

You are better off with lower interest rates in a taxable account

Usually when someone talks about high interest savings accounts, they are referring to taxable accounts. In that case, any interest payments are taxable income which means that the higher the interest rate, the higher the tax.

In the first section of this article, we assumed that interest rates are similar to the rate of inflation. If you are paying income taxes on the interest payments, then there is a good chance that your posted interest rate minus tax is actually lower than the rate of inflation and you are losing purchasing power.

One of the problems with being in a high inflation/high interest rate environment is that the higher interest payments will result in more income taxes. If you earn 3% interest on $1,000 and you are in a 40% tax bracket, then you will owe taxes of $12.00. If interest rates are 20% then the taxes will be $80.

The person in the high inflation/high interest rate scenario loses more of their purchasing power due to taxes than the person in the low inflation/low interest rate scenario. The reason this occurs is because the loss in purchasing power is the difference between the posted interest rate (less taxes) and the inflation rate which is a percentage. This percentage translated into a dollar figure which is higher in the high interest rate scenario. This chart is from a spreadsheet I did which hopefully illustrates this point.

Rate Tax Inflation Deposit Gross interest Tax Net interest Real return Change in purchasing power
3% 20% 3% $100,000 $3,000 $600 $2,400 -0.6% -$600
23% 20% 23% $100,000 $23,000 $4,600 $18,400 -4.6% -$4,600

Just to be perfectly clear, I’m not saying you should shop around for the lowest interest rates to save on taxes. I’m just comparing someone who is in a low interest rate environment to someone who is in a high interest rate environment.

Don’t invest in higher risk investment products just to get a higher return

There is nothing wrong with shopping around for higher bank account or GIC rates, but don’t make the mistake of increasing the risk of the investments for the sake of a higher rate.

It is very tempting to look for higher paying, albeit riskier investments in a low interest rate environment. Buying dividend stocks, REITs, lower quality bonds (probably in a mutual fund), are examples of investment opportunities that pay a much higher rate than any savings account.

The problem is the risk level. Buying junk bonds is far riskier than having the money in the bank, so the return has to be higher to make up for the extra risk. There is nothing wrong with any of those high yield investments I mentioned, but the question you have to ask yourself is:

Is it my goal to invest in riskier investments to get a higher potential return on this money?

If the answer is “yes”, then why did you have the money in the bank account in the first place? Why didn’t you buy REITs or stocks or whatever to increase the potential return?

I think the answer is most likely to be “no”. You had the money in your bank account because you need it in the near future. Maybe to pay for groceries next week or maybe for a vacation at Christmas. In this case, your main goal is to not lose any of your money. Interest payments are a bonus. Riskier investments are more suitable for longer time horizons.


  • Bank account and GIC interest rates are not meaningful without subtracting inflation. Just ignore the fact that interest rates are “low” or “high”.
  • Determine what your goals and time line for your money is.
  • Figure out an appropriate investment type in terms of risk, liquidity.
  • Shop around within that investment type for the best rates.

About the Author: Mike Holman write about Canadian personal finance at Money Smarts Blog and also wrote The RESP Book: The complete guide to Registered Educational Savings Plans for Canadians available only at Amazon.

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I’m happy with the low interest rates right now… I’d rather have a low rate on my large mortgage than get a high rate on my small emergency fund.

Very clear example Mike and I definitely agree with you on all your major points. The only issue I have with it is if you are an investor that is comfortable with risk and are willing to invest with anything with reasonable risk. In that case you are obviously going to choose the stock market or other investments when bank interest rates are low.

However, if bank interest rates are almost as high or even higher than the expected return of the other riskier investments you are willing to invest in then you would be a fool to choose the riskier investments. Of course, this is all assuming a constant rate of inflation as well.

As you say, people who are uncomfortable with risk should never invest in riskier investments vehicles no matter what inflation or guaranteed interest rates are doing.

The main problem is in how the official inflation rate is reported. CPI excludes food and energy as they’re deemed too volatile. Since most of us need to eat, put gas in our car and heat our homes, these two items are pretty important.

Almost all food prices are up about 20% year to date. Cotton, silver, gold and many other commodities are near all time highs. The box of KD in your pantry out performed the Dow Jones that produced only a 10% ROI!

Your make a good point in that our Government taxes interest as income, severely cutting into returns. For that reason alone, these types of investments should be held in a TFSA or an RRSP account.

If people are risk adverse, and want to simply preserve the purchasing power of their hard earned dollars, they need to get out of dollars and into hard assets like silver and gold if they can afford to stay invested for the long term.

Inflation takes time to really set in. As a result, many people don’t realize what’s happened to the purchasing power of their currency until it’s too late.  Some may see themselves as actually getting richer when they sell items for much more than the price that they originally paid.  However, when they go to purchase new goods with their “profits”, they’ll quickly  realize just how little their money actually now buys.  They may blame higher prices, but the reality is that their dollars have been debased.

Low interest rates are far more harmful to an economy as they create speculative bubbles. The dot com and real estate market are examples of what happens when interest rates stay too low for too long. Canadian debt levels are at all time highs as people have taken advantage of the low rates and “cheap money”.

Higher interest rates force people to save and take less risk as the cost of borrowing becomes far more expensive. This has the immediate effect of creating a more prudent approach and avoiding/paying down debt.

Sure, higher rates also reduce GDP initially as consumer spending accounts for about 70% of that calculation. That’s another story though, as consumption does not equal real economic growth. Only an increase in productive output thus creating more real paying jobs can do that.

I’ll leave you with a link to a couple of charts showing the purchasing power of both the Canadian and US dollar relative to gold over the last 10 years. This tells the real story of just how much inflation has impacted our savings.

@Tom – That’s a great point. Coincidentally, my mortgage is a bit higher than my emergency fund as well. :)

@SavingMentor – Absolutely. My point about putting up with low interest rates is only applicable for money that you want to keep safe, such as an emergency fund. If you have money that you want to invest more aggressively, then go for it.

Yeah, right now my biggest expense is my mortgage (and a looming car purchase) so keep those rates low Mr. Carney!!!

But I like that you bring the inflation and tax perspective into the picture. It’s definitely something people overlook and advisors never talk about. Certainly because you get a regular statement showing much money you “made” but no one ever sends you a statement showing how much money you “lost” from inflation (yes, there are news reports and the Stats Can web site but they’re not personalized, they’re not about “your” money).

@Tom, you are right on the money (pun intended ha/ha). I would rather earn less on my savings then pay more to own my house. Too many people forget that if interest rates are higher then all are higher.

Real interest rates are definitely worth looking at. The effects of inflation on our money is real. But I would disagree that low rates are always good, especially if you are a senior relying on fixed income products. The ideal situation, I suppose, is to have interest rates a little higher while keeping inflation where it is – or lower. As you said, only the spread counts.

Real interest rates in Canada were about 10% in 1990. Sure, nominal rates were around 15%, but inflation was around 5%. Those numbers are very rough, but I would still rather retire with real rates at 10% – or even 5% – than their current level near zero (depending on whether you use core or total CPI.)

The nature of today’s low rates is a bit different as well, having been largely engineered by central banks rather than real economic factors. These low rates essentially benefit people in debt and harm savers.

The other thing to remember is that inflation affects all investment returns, whether they’re from stocks, bonds, or savings accounts. It’s important to factor inflation into all investment return calculations.

Thanks for raising this important issue Mike. :)

@Duncan – Yes, your personal inflation rate will undoubtedly vary from the official rate. Not sure that buying gold and silver is risk adverse.

@Schultzer – The even bigger problem with investment performance numbers provided by advisors or financial companies is the lack of comparison to an appropriate benchmark (ie the TSX).

@Balance Junkie – I don’t think high rates of real return are sustainable.

The reported inflation rate is always a big fat lie. I don’t know what their goal is when they report those fake interest rates. It’s always a lot higher than they say.

I understand from a tax perspective that you are better off with interest bearing investments in a taxable account. But with the measly returns from a GIC or HISA, why would you bother at all? In this environment, my emergency fund is a low rate line of credit.

And short term savings aside (which is just about capital preservation, you are not going to make any money), you have a pretty decent shot at getting a real return rate over 5% by investing in the stock market for the long term.

i disagree with you!!Lots of cdns are getting to use to “LOW” interest rates.Saving rates and gic should be 4-6.5% in the next 2-4 years.
And lots of people should brace for higher rates sooner rather than later. For one I would enjoy interest rates around 5.50%.In a non taxable acct like tfsa.
Stocks offer RISK and REWARD.Not sure where we are in that cycle right now.

If someone takes on a long term fixed debt with variable rates that can spell bad news. The real problem with low rates is that many debtors don’t properly hedge their exposure to future interest rate increases.

Savings accounts are meant to be short term. It is a place to put money until you have enough to invest. If you are trying to live on the interest, another option may be more appropriate.

With current interest rates roughly equal to inflation (before tax) saving your money in a GIC or other such financial instrument is really just a way to keep your money in pace with inflation rather than have it go flat in a non-interest bearing account. It’s certainly not an “investment” from a growth perspective like it used to be a decade or two ago. Times have changed and I don’t suspect they are going to change any time soon: there is too much currency floating around out there trying to chase the low returns and this makes it very likely that real returns will continue to be less than the inflation rate unless you are willing to invest in riskier assets. This has HUGE implications for the masses set to retire over the next decade or so and want to keep their money in “safe” interest-bearing investments.
This breaks many of the old retirement models where you could assume rates of return well above the inflation rate (I still see many calculators allowing you to assume a real return of 3-4% over inflation!!). Unless you are willing to take some substantial risks in your investments, a 3-4% real return is entirely impossible. I wonder how many money managers have broken this sad news to their aging, soon-to-retire clients.
Take your favorite retirement calculator and change the assumption to 1-2% real return over inflation and you will notice a substantial increase in the amount of money you need to save.

This is a great article about interest rates. I see all the time about ‘low interest’ for loads, and high savings account, and sometimes wonder if it really makes much of a difference in the long run. Looks like you answered that question :D

Low rates for an extended period are NOT a good thing… the stunning amount of personal debt than Canadians have accumulated in the past few years is proof of that. When interest rates rise, look out…

I think people are complaining about low real interest rates. Since inflation doesn’t vary a whole lot in Canada, complaining about low real rates and low nominal rates amounts to much the same thing.

Thanks Mike for pointing out the effect of taxation on investment decisions. Too often people only consider interest(return) and inflation without considering the tax implications.
@ Duncan – I don’t agree that low interest rates are harmful to the economy: low interests with low inflation stimulate economic activity and after tax income for savers. The fluctuation of interest rates at any level can cause problems with debt levels.

I’d appreciate it if the BOC takes its time before raising rates as within 3-4 years I aim to become mortgage free! (bar any unforeseen financial disasters)

I agree to a point, except for with my excessive student loans, which are capped by the government at a 6.8% rate and are (in this climate) nearly impossible to consolidate at a lower rate, etc., it obviously does matter to me what the interest rate and inflation is. I am hoping for a rate of rapid inflation so it would be easier to pay off my loans. Unfortunately, inflation has been very low or even non-existent (even with the “quantum easing going on” which is another reason why paying back student loans for my generation (or our parents who took out the loans for us) has been harder than ever before. The other reason being that the price of college has exceeded inflation to a ridiculous extent for over a decade.

@chris You need to look at the broader picture. Yes, it’s true that low rates stimulate economic activity (ergo encouraging borrowing to consume or invest).
The challenge is that inflation doesn’t effect everything equally. For instance, the low rates as of late helped fuel speculation in real estate and stocks. That created inflation in those sectors and a subsequent rise in prices.
Sure it’d be nice to have rates as low as possible in a low inflation environment. Officially, that’s what we have right now. Unfortunately, the reality is that inflation is far higher than the “official” rates. This works its way into our lives in the form of higher prices for almost everything we purchase. Unless income outpaces the price increases, we experience a reduced standard of living over the longer term.

@Broke Professionals – You raise a great point: Why is cost of education rising far faster than inflation?
The reality is that the Government has created inflation in education prices by subsidizing and backing student loans.
If people had to pay for higher education out of their own savings, or qualify for a loan based on their credit worthiness and income level, most of the population couldn’t afford it.
This would have the result of reduced enrolment and a decrease in revenue for the institutions. They’d have to adjust prices and their efficiencies to offer education more in line with what the populous could afford. Thus, we wouldn’t need massive loans just to attend school.

@Money Smarts Blog Holding Gold or Silver for the long haul is far less risky than holding dollars.
It can’t be argued that the only long term trend of any fiat currency is debasement. Sure, there are several examples in recent history where countries have devalued their currency only to see it bounce back again, albeit in the short term. Long term however, all fiat currency experiences a continual decrease in purchasing power.

Just look at the value of an ounce of gold relative to US dollars over the last 10 years and draw your own conclusion. Better yet, remember that prior to 1974, an ounce of gold traded for $35.00 US. Long term, ask yourself what you’d rather have your net worth tied to? Fiat dollars or hard assets? Theories are great, but facts don’t lie.

Low interest rate is a bad thing. Individuals may get low mortgage costs etc … and think it is good for them. The financial system is made for the big financial components and players.

When the interest rate is low, the asset valuation becomes crazy. Think about this, the interest is very low now, companies can borrow money cheap, but do you get discount price for products and commodities, such as, food? No, because when money is cheap, people bid up the price of products.

In the last 100 year or so, the inflation is about 4.2%. The borrow cost is about 6.2% or so. At this rate, people who borrow to buy or speculate can feel that there is a cost. If a company can’t make money 6.2% +4, it shouldn’t be in the business in the first place.

Look at the of asset price and stock price in the last 20 years, this is craziness.

The market should set interest rates, not the Fed.

Super low interest rates encourage reckless borrowing and over leveraging. The only reason the entire system isn’t collapsing right now is because of the super low rates… and I don’t forsee that rates will be able to be increased much over the next several years. At some point in the not to distant future, we’re going to hit another recession, and at that point we will not have the luxury of lowering interest rates to stimulate the economy and so the money printing presses will be put in to high gear.

This can’t end well.

givejonadollar: The market does set interest rates. The Fed only sets the benchmark interbank lending rates. The market determines what the Treasury can actually borrow at by determining the interest rate on treasury bills, upon which everything else is calculated. The reason interest rates remain so low on those is because there is a large demand for US treasury bills as a safe haven from other currencies around the world. As long as this demand remains, interest rates will be kept low. The moment this demand stops, or worse, reverses, interest rates will climb and the Fed will have to resort to even more aggressive “quantitative easing” (aka money printing).

Some people get excited about that 5% cd they just got, but don’t realize their credit cards are just under 30% APR.

I think if more people took a look at their blended interest rate they’d have a better understanding of just how much they’re paying on overall debt, and maybe make better decisions about how they invest.

I agree with Duncan.

The problem with low interest rates is the bubbles. Most evident this year is the bond market bubble, which will eventually pop* and cause havoc.

I agree w/ Robb (Stark): Carney has also said during on numerous occassions his concerns for personal household debt levels. We’re at our highest levels yet and people are simply getting too comfortable with the low itnerest rate environment.

The article about how the high interest accounts are not that beneficial is excellent! For the people who feel richer from gaining a few dollars from a higher paying interest accounts, its sure not being smart due to the heavy taxing on such accounts.