ING Direct RRSP GIC – The price of liquidity

I was looking with curiosity at ING Direct’s RRSP GIC page to get an idea of what the retail risk-free rate would be. They had the following term and rate schedule:

1 Year 1.75%
1 ½ Year 2.50%
2 Year 2.20%
3 Year 2.25%
4 Year 2.30%
5 Year 2.75%

The “blip” in this schedule is the 1.5 year term, yielding 2.5%. The basic short-term ING account offers 1.5% on cash. If you break the 1.5 year GIC, you receive a rate of 0.5% instead.

So what a GIC investor would do is ask themselves about liquidity – how much are they paying to sacrifice liquidity? The quick answer everybody would give is 1%, but this is not correct. The actual answer is that liquidity becomes much more expensive as the term approaches maturity.

For example, if you assume the baseline cash rate is 1.5% throughout the 1.5 year term, if you invested in the GIC and then canceled the next day, your liquidity cost is very minute. In the next month, your cost is still fairly minute – you are paying $16.67 per $10,000 to access your funds.

However, if you canceled 17 months into your term, the cost of liquidity would be much, much higher. Giving a numerical example, at month 17 of the GIC, your accrued GIC interest would be $354.17 on a $10,000 investment. However, if you had to break the GIC to borrow the money (for one month as you would ordinarily be able to access your funds on maturity one month later), you have suddenly paid $283.33 in implicit interest for a one month term. This is approximately an interest rate of 33.7% to access your own funds.

So a rational investor that is considering locked products with penalty for withdraw has to strongly consider any liquidity considerations closer to maturity otherwise they could be paying a very expensive liquidity bill.

Most people willingly give up liquidity for a low cost – don’t.

ING Direct gets into the chequing market

In an interesting corporate strategy shift, ING Direct is now getting into the chequing and bill payment market. The salient details are similar to the local credit union that I deal with, mainly no transaction charges and a nominal fee for other basic services (ordering cheques, writing bank drafts, etc.).

ING Direct used to start off as a basic business model where you can save your money at a high rate of return – ING Direct would then use this as collateral to write mortgages, and then make the money off the spread between the mortgage rates and the savings interest paid. As their deposit base grew, they eventually morphed from giving their clients the best rates available to just giving slightly above average rates for savings. They are now out-competed by Ally and other providers.

As there is nothing preventing competition for funds, the only barrier for customers to switch banks is simply to fill in an application form. Since the interest spread between ING Direct and Ally is 0.5% on short-term savings at present, it is a $50 difference on a $10,000 deposit for a year. While this is not a gigantic amount of money, it is likely worth it for those that can spend the 20 minutes applying and getting an account.

As for the chequing account, I was assuming that the funds you leave on deposit would be earning ING Direct’s typical interest rate on savings, but it is not – apparently the first $50,000 will earn 0.25%, and the remainder will be earning more. This is far below the 1.5% that ING Direct offers.

So what is the point of opening an account? Typically the convenience of opening such a chequing account would be that it works completely in synergy with your main ING Direct account, and offering the high rate while you keep your cash idle in the account. Instead, you still have to go through the same procedure to transfer over your money from the high rate account to the lower rate chequing account, and then make the cheque or bill payment.

I don’t think this is going to attract the type of clients that ING Direct wants, mainly those that keep large amounts of deposits in the account.

It is also interesting how most banks probably take a loss processing these accounts – the big money maker on the retail end are for mortgages, loans and credit card interest debt.

TFSA teaser rate dropped at ING Direct

ING Direct offered a 3% interest rate on TFSA accounts in early January; this was presumably done to capture people’s money in the account. They dropped the rate to 2% at the beginning of the month of May, which is more reflective of the market rate.

Ally continues to be the best option for short term savings accounts, offering 2%. They also offer 4% on a 5-year GIC, which is currently the best rate available.

As Garth Turner points out, GIC products have problems concerning liquidity (in the case of the 5-year GIC you will relinquish 1.5% interest), and also taxability (as ordinary income is fully taxable). He is suggesting the world of preferred shares or corporate debt, two fixed-income products which have different characteristics than GICs.

James Hymas has an excellent document which explains the differences between preferred shares and GICs.

If your goal is to preserve income (note: not capital) then preferred shares generally are a better option than GICs for a multitude of reasons. The only problem for most people, however, is that you’ve got to be doing your homework. If this is done correctly, you will be able to obtain a tax-preferred advantage of likely 200 basis points, if not more, than the prevailing rates offered by GICs. Judging from most of the comments seen in an average post on Turner’s site, it seems that most want to be spoon-fed ticker symbols to purchase.

Replacing ING Direct

The place where I normally park cash is in ING Direct, which has been a mainstay financial institution for myself for a very long time. When they first opened, they were by far and away the best place to park cash. Now they are a mediocre offering of the many online products that are available out there. I am guessing that they achieved their desired level of deposits and have achieved their desired debt-to-equity ratio with their residential mortgage offerings.

ING Direct hasn’t contaminated their customer experience by spamming their customer base with too many useless services, but this encroachment to simplicity has been eroding at a faster pace as of late – see my post about RSP loans, for example. It is simplicity that has caused me to stick around with ING Direct instead of shopping for other services. However, that time has now come.

So today I sent in a cheque to Ally, which used to be known as GMAC. Obviously since GM tarnished their brand with their bankruptcy filing and investing money in an institution that shares the same name with a bankrupt entity doesn’t inspire much confidence, they changed their name in 2009. In Canada, they are run by a firm called ResMor Trust Company, which otherwise does mortgages. In any event, they are CDIC insured and this means that the taxpayers of Canada will be picking up the guarantee for deposits up to $100,000.

Since I will not be depositing more than $100,000 in Ally, the safety issue of the institution is more or less mitigated.

Their peak offering is a savings account which delivers 2% interest (which is subject to change at anytime), but since this is significantly higher than ING Direct’s offering at 1.2%, it is a trivial process to click a few mouse buttons and transfer the money. Every dollar counts.

As interest rates rise, it will be interesting to see the spread between these two institutions since they are competing for the same bucket of capital from Joe Saver.

ING Direct trying to trap capital in TFSA accounts

I noticed at the start of the year that ING Direct was offering a 3% 90-day GIC for RRSP accounts (no transfers required) and also 3% for a TFSA account, but with the rate subject to change at any time.

Anybody with an RRSP in ING Direct would do well to lock in the 90-day rate as soon as they can; even though they stated they will offer it until March 1st, they could revoke it. The difference between a 3% rate and a 1.25% rate (which is more representative of the current market rate for a 1-year GIC) is $43.15 on a $10,000 investment. It is not huge money, but it is more money nonetheless.

The 3% TFSA offer is quite a lure, but it is designed to trap as much money before they reset the rate back to a lower rate. The trick with the TFSA is that once customers have deposited their money into the TFSA, it is a lot of unnecessary paperwork to get their money out of the TFSA account once the rate resets to something lower. If customers decide to withdrawal the TFSA once the rate goes lower, then they lose the contribution room into their TFSA until January 1, 2011.

For those people that want to keep their money in a risk-free instrument (e.g. a GIC), use the ING Direct TFSA at your own peril. As a matter of financial planning, the TFSA should not be used as a risk-free account anyhow, but some people will want to use it to park idle cash.

ING Direct used to be the undisupted best place to save money, but over the past few years they have become just “normal”. They are still excellent with respect to having a no-fee operation and this works to their benefit – if money is easy to get out of them, then I feel much safer keeping money with them. For matters such as RRSP and TFSA transfers, however, there is a real bureaucratic cost associated with these and it is not worth it to capture an extra 0.5% elsewhere for the dollar amounts in question that people typically deal with.

If ING Direct wanted to raise a lot of longer duration capital, they’d do fairly well if they offered a 5% 5-year GIC.