The next financial trap you have to worry about is the savings bubble.
Way, way too much money is sitting around in savings and chequing accounts as well as money market funds. This money isn't at risk, but the people squirrelling it away are hurting themselves financially. They're missing a chance to participate in the stock market recovery and they're wasting opportunities to pay down debt.
The most recent report from the mutual fund industry shows there's almost $65-billion sitting in money market funds. Wastage alert: Annualized returns from the biggest five money market funds available to everyday investors average 0.12 per cent right now. A joke, in other words.
What's not as widely known is that there's another $60-billion or so that Canadians have sheltered in bank accounts. Add it all up and you get a rough, estimated total of $125-billion in what can accurately be called fear money. That's money that could be doing other things, but isn't, because of worries relating to the global financial crisis and recession.
"People are paralyzed now," said Benjamin Tal, senior economist at CIBC World Markets. "They have to start making decisions."
Money market fund holdings have grown over the past year as a result of people getting out of their equity mutual funds. The growth in bank account holdings is a bit trickier to understand.
David McVay, a financial industry consultant, said there's usually an annual increase in savings and chequing account balances of something in the area of 3 to 4 per cent. In the past year, though, the amount of money in bank deposits surged 22.4 per cent or $71-billion to about $390-billion. Subtract normal growth of $11-billion from this and you're left with about $60-billion in extra savings.
Don't mistake this surge for a shift in the amount that Canadians are actually putting aside from their paycheques. "I believe it's more driven by standing on the sidelines waiting for the investment markets to recover than it is by an increasing savings rate," Mr. McVay said. "An increase in the savings rate tends not to have short-term dramatic impacts like we're seeing."
In fact, Mr. Tal said the savings rate at midyear was 4.5 per cent, which is to say that people were spending $95.50 of every $100 they brought home and had $4.50 left over. A year ago, the savings rate was 3.4 per cent. Note: Contributions to registered savings plans of all types are considered spending, so the savings rate is more of an indicator of how people are managing their family cash flow.
The U.S. savings rate has risen to more than 4 per cent as well, but from lower levels than in Canada. Still, in terms of how much fear money Canadians have stashed away, Mr. Tal said we're about three times ahead of Americans if adjustments are made for the differences between the size of their stock market and ours.
Money market funds are paying virtually nothing now, while savings accounts will get you 1 to 2 per cent at very best. One way to better use this money would be to pay down debts, which in virtually all cases carry higher interest rates of as much as 19.9 per cent for credit cards.
Still, debt may not be a big issue with the fear money people. Mr. Tal estimates that about 90 per cent of this money is held by people who are 55 or older, a group that doesn't owe much.
This brings us back to those treacherous stock markets, which, in the past 15 months or so, lost half their value and then sprang ahead 50 per cent. That's too much drama for many people in the 55-plus group, which explains why they're still on the sidelines instead of in the market.
What to do? Mr. Tal suggests getting into the market in a conservative way with blue-chip dividend stocks. His reasoning: If even a portion of the money on the sidelines goes into the market, much of it will flow into these stocks and support their prices.
If even a portion of the money on the sidelines goes into the market, it's these stocks that are going to benefit the most.
Here's a final word for anyone who's waiting for interest rates to rise so they can move out of bank accounts and money market funds into guaranteed investment certificates and bonds. At CIBC World Markets, they don't see rates rising for another six to eight months, and even then only modestly.
When used to describe something in the financial world, the term bubble implies a messy, explosive end. The savings bubble isn't like that. It won't pop like stock markets did, but it can still hurt you.