Imagine this: You’ve been working hard, saving diligently, and keeping a solid cushion of cash in your savings account. It feels good to have that financial security, right? But here’s the catch—while your money is sitting safely, it’s also quietly losing value.
Inflation is working against you, slowly chipping away at your purchasing power. That $10,000 you saved today might not stretch as far five or ten years down the road. So, while keeping liquid assets is essential for financial stability, relying solely on them for financial growth is like trying to fill a bathtub with the drain open—it’s never quite enough. So, how do you balance security with smart investing? Let’s break it down.
Understanding liquid assets – What is their purpose?
Liquid assets are the financial cushion that helps you navigate life’s unexpected twists, whether it’s a surprise medical bill, or any other unforeseen event.
Liquid assets have one job: to be accessible when you need cash, particularly for emergencies. There could often be moments in life when one would require cash on hand right away. For instance, imagine your car breaks down unexpectedly, or you need to pay for a last-minute flight due to a family emergency. Or maybe you’ve been let go from work, and you need money to cover the bills while you search for a new job. While we hope for the best, it’s best to be prepared for the worst while remaining optimistic about the future – so you can balance your financial security with a healthy growth potential.
In Canada, common liquid assets that are easily accessible include:
- Cash on hand: The most immediate form of liquidity, though it offers no potential for growth.
- Chequing and savings accounts: Provide quick access to funds, though the interest rates tend to be nil to very low.
Good to know: : To put things in perspective, consider this— in 2023, Canada’s inflation rate peaked at 6.8%—meaning that savings accounts with a 2% interest rate were actually losing value in real terms.
For up-to-date information on inflation trends, visit the Government of Canada's Consumer Price Index (CPI) portal (external link) .
How much cash should you keep on hand?
The ideal amount of cash on hand depends on your financial situation. Financial experts typically recommend keeping an emergency fund that can cover three to six months of expenses, which should be able to cover all your unexpected costs, or short-term projects.
Recommended cash reserves:
- At home: $200–$500 in small bills for immediate emergencies.
- In a chequing account: Enough cash for daily transactions and bill payments, with an additional buffer of one to two months' living expenses
- In a savings account: At least three to six months' worth of expenses for financial security.
So how do you balance financial security with growth potential, ensuring you have enough cash available for emergencies while preventing the extra money in your accounts from losing value?
You might have heard some people say, “Just save your money, and you’ll be fine.” But in today’s economy, that advice no longer holds. Any money beyond your emergency cash reserve and three to six months' worth of expenses should be invested strategically to generate returns and keep pace with inflation, and give you back your purchasing power.
→ Explore the 3-box theory in our Investing Guide to gain insights on structuring your assets affectively and managing risk to reach your long-term financial goals.
The silent risk: Inflation and the cost of doing nothing
John, a cautious saver, decides to deposit $60,000 of his excess cash into a savings account that earns 1.5% interest per year. Meanwhile, inflation is averaging 3% annually.
After five years, John’s balance grows to $64,550, thanks to the interest. However, the cost of goods and services has risen significantly, meaning that his $64,550 is only equivalent to $56,002 in today’s dollars due to inflation.
While John’s savings technically grew on paper, his purchasing power actually decreased.
Why diversification matters to build long-term wealth
To build long-term financial security, investing is key. Diversifying your investments across various asset classes like stocks, bonds, and mutual funds helps manage risk and increase your potential for steady returns. A smart investment strategy is all about spreading your money across different assets to reduce risk, while letting your savings grow steadily over time, even as the market changes, so your wealth continues to grow steadily in the background.
Learn more
Explore the following articles for a deeper understanding of investments.
→ Investment
ideas: 5 ways to invest $1,000
→ How
to make your money grow in Canada
→ RRSP
vs. TFSA: Which to Choose?
→ What
are mutual funds?
To showcase the benefits of diversification versus keeping cash in a bank account, let’s compare the two approaches of James and Sarah.
James decided to keep $40,000 of his excess cash in a savings account earning 1.5% interest annually, while Sarah invests the same amount in a diversified portfolio with an average annual return of 7%. While James preferred the safety and stability of a savings account, Sarah took on more risk by investing, but she allowed her money to grow over time through diversification. Let’s take a look at how their choices impacted their investments over the years:
| Years of Saving | James (Savings account @ 1.5%) |
Sarah (Investing @ 7%) |
|---|---|---|
| Day 1 | $40,000 | $40,000 |
| 10 Years | $46, 421.63 | $78,686.05 |
| 20 Years | $53,874.20 | $154,787.38 |
| 30 Years | $65,523.21 | $304,490.20 |
After 30 years, Sarah has more than triple what James has, all because she allowed a diversified portfolio to work in her favour.
The takeaway? When invested wisely, the excess liquid cash sitting in your low-interest savings account can generate significant long-term returns.
Maximizing the potential of your excess cash
After setting aside your recommended cash reserves in liquid assets for emergencies, what do you do with the rest of your excess cash? Here are some investment opportunities to consider, each suited to a different financial goal for life’s milestones:
- Tax-Free Savings Account (TFSA): Ideal for those looking to save for major life events, like a vacation or home renovations, with tax-free growth and withdrawals.
- First Home Savings Account (FHSA): If you’re planning to buy your first home, this account offers a combination of tax benefits and savings specifically for that purpose.
- Registered Education Savings Plan (RESP): Designed to help you save for a child’s post-secondary education, with government grants and bonds that enhance contributions.
- Registered Retirement Savings Plan (RRSP): Perfect for long-term goals, especially for retirement, as it provides tax-deferred growth and can help reduce your taxable income.
→ Discover registered plans designed to meet your needs, and find out how to grow your money in Canada to make your investments work for you.
Good to know: : Over time, a well-diversified portfolio that combines stocks, bonds, and other assets has consistently outperformed holding cash alone, as it balances risk and opportunity for growth.
The Consumer Trends Report by Innovation, Science and Economic Development Canada highlights the benefits of mutual funds (external link), for instance in RRSPs, that offer diversity and can help protect against market fluctuations.
Not sure where to put your extra cash? Speak with an advisor to see if the Cash Advantage Solution is right for you. This option lets you securely park your funds in the short run while benefiting from rising interest rates – giving you the flexibility to invest in a diversified portfolio when the time is right for long-term gains.
Get started on your investing journey
Some people may avoid investing because it seems complicated or risky, but the truth is, getting started is easier than you think. Here’s how to take the first step:
- Define your goals: Are you saving for a home, retirement or travel? Your goals will determine how much liquidity you need and how much you can afford to invest.
- Make a budget: A personal budget is a powerful tool that can help you track your income and expenses, providing a clear picture of your financial situation and allowing you to make informed decisions to achieve your financial goals.
- Build your emergency fund: Before investing, make sure you have three to six months of expenses in an easily accessible savings account.
- Choose the right investment accounts: Start with a flexible plan, then consider one for long-term growth. If you have additional funds, explore strategies that balance liquidity with returns.
- Work with a financial advisor: If you’re unsure where to start, a financial advisor can help you formulate a plan that aligns with your financial situation.
Want to find out more? Our Savings and Investments page is full of other useful tips and tools.
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