This week’s Bank of Canada interest rate cut brings the return on the many places for investors to park cash down into the low-4-per-cent range at best.
That’s still darn good, right? We are talking here about virtually risk-free money that comfortably beats the most recent inflation rate of 2.7 per cent. Now for the downside of cash: Returns will likely shrink in the next 18 months. At some point, you’ll want to move cash into other assets offering a better blend of returns and risk.
The Bank of Canada has twice lowered its benchmark overnight rate by a minimal one-quarter of a percentage point – this week and on June 5. Expect more of the same in coming months unless the bottom falls out of the economy, necessitating bigger rate cuts. There are three more opportunities for the central bank to lower rates this year, and economists generally think they will produce a cumulative rate reduction of 0.5 of a percentage point.
That would bring us to between 3.5 per cent and 3.75 per cent for cash equivalents like exchange-traded funds that hold assets in savings accounts or money market instruments, as well as investment savings accounts. ISAs are savings products for investors that are bought and sold like mutual funds.
By the end of next year, economists anticipate the central bank will have cut by 1.25 to 1.75 percentage points beyond where they stand today. That would theoretically mean returns in the low-2 per-cent zone for cash-equivalent investments.
Now is the time to think about your cash pain point: At what level of return would you feel unsatisfied? One way to think about this is to use your real rate of return. Maybe you decide that your cash must earn the inflation rate plus one percentage point or thereabouts. You might also consider a nominal threshold at which cash no longer appeals – maybe 3 per cent.
Try and resist the temptation to be a market-timer with your cash. A stock market correction would be a good time to move cash into equities, but there are risks in waiting. One is that you forego strong near-term returns from stocks, while another is that you stay too long on the sidelines when stocks do tank and miss the best part of the rebound.
There’s no immediate rush to ease out of cash because the remaining 2024 Bank of Canada rate-setting dates are not until Sept. 4, Oct. 23 and Dec. 11. But cash returns are coming down. You don’t need to ride them all the way to the bottom.