The First Home Savings Account (FHSA) is arguably the most powerful tax-sheltered account in Canada. Offering a tax break on contributions as well as tax-free withdrawals, it is the best of the Registered Retirement Savings Plan (RRSP) and the Tax-Free Savings Account (TFSA) all in one! The only downside is that, with an FHSA, you have to spend the money on a home purchase eventually. Furthermore, the home that you purchase with your FHSA money has to be your first home.
Assuming that you are eligible to open an FHSA, and plan to do so, you need to ask yourself what you’re going to invest the account in. The options include bonds, Guaranteed Investment Certificates (GICs), stocks, and funds. If you’re a long-time Fool reader, you probably think I’m about to say that you should invest your FHSA in stocks — but think again!
Generally speaking, stocks and stock funds are best suited to long-term saving (i.e., retirement saving). When you are saving up money to finance a purchase on a specific date, you’re actually better off having the money in low-risk assets. In this article, I will explore the types of assets that meet the “low-risk” criterion and share some ideas for where you should invest in stocks.
GICs are best for the FHSA
Because the FHSA is designed to facilitate saving up for a specific purchase, money held in one ought to be invested in low-risk securities. Below, I’ve listed some examples of low-risk securities and assets, as well as the reasons why they are considered low risk:
- Cash held at banks (insured by the government up to $100,000).
- Canadian treasuries (backed by government taxing power and the Bank of Canada’s monetary instruments).
- GICs (insured up to $100,000, just like cash).
There are some distinctions to be made between the asset classes above.
Cash held in regular chequing and savings accounts pays almost no interest. However, if you are purchasing a home less than one month from today, then you should hold your FHSA in cash, as short-term GICs usually take at least a month to mature, while treasuries can be volatile.
As for GICs and treasuries, it is good to hold them for periods between one month and 10 years. Currently, Canadian treasuries and GICs offer similar yields. However, treasuries can be sold on the open market, while GICs can’t. So, treasuries are more liquid. Either one would be worth holding in an FHSA in principle. Canada bonds have a minimum order size of $5,000, so that might be a limiting factor if you have less to invest.
Where to invest in stocks
Although GICs and bonds are ideal for the FHSA, stocks and stock funds are ideal for RRSPs. With the RRSP, you’re free to hold money in the account long term — potentially until you reach 71 years of age.
One stock that many Canadians hold in their RRSPs is Royal Bank of Canada (TSX:RY). As a stable, mature, blue-chip banking stock, it has many of the characteristics that investors seek in defensive portfolios.
Royal Bank is a dividend stock with a 3.8% yield. If you hold $100,000 worth of RY stock in an RRSP, you get $3,800 per year in dividend income (assuming the dividend doesn’t change). Historically, RY’s dividend has tended to rise slightly each year. If the future looks anything like the recent past, then investors will see rising income from their RY shares.
It’s this characteristic that makes Royal Bank a good RRSP holding. Stocks that pay dividends make the most of the RRSP’s tax-deferred characteristic. You can avoid taxes on non-dividend stocks by simply not selling. With dividend stocks in taxable accounts, a certain amount of tax is due each year. So, dividend stocks like RY benefit significantly from the RRSP’s tax treatment.
As for your FHSA, it is best to keep that invested in cash and bonds. You never know when market volatility will impact your stock portfolio, and you don’t want your future home purchase to be delayed by stock market volatility.
