Investments 101

Investing is all about making your money grow and work for you. You’ve worked hard for your money, so you need to get your money working hard for you. But which way is best; what should you invest in? Well, there is no quick answer to that question, it depends on an array of different things, not the least of which is your risk tolerance. I’m not going to try and sell you a “get rich quick scheme”: they don’t exist. What I will give you is honest, independent financial advice based on your risk tolerance and investment objectives.

I offer Guaranteed Investment Certificates, Mutual Funds and Segregated Funds which I find are suitable for most clients. However I wouldn’t be telling you the truth if I tried to tell you that those were the only things around to invest in. Many folks have done well investing in real estate or their own business or even directly in stocks or bonds. It depends on your objectives, risk tolerance, and time available to manage your own investments.

How Much Will You Need When You Retire?

Likely more than you realize: you need to know your future income requirements, account for inflation, projected rates of return and projected life expectancy, plus build in a reasonable buffer to account for the uncertainties that exist.

The primary purpose of many individual investors is building up the assets they’ll need to retire with. The question of how much you’ll need depends on your answers to a few more questions. At what age do you want to retire? How kind of income do you want in retirement? How soon are you going to start investing? Unlike our parents’ generation, pensions are rare, and we’re going to have to all build up the assets we need so that we won’t have to be working until we’re 75. You’ll forgive me for being a little pessimistic about planning for retirement, but look around at the business landscape, business are cutting back retirement benefits, government too have already started to cut back and post-pone retirement benefits. This trend is unlikely to reverse.

Retirement may seem like a long way off, but trust me; once you’ve seen the math, you’ll realize you need to be thinking about retirement now if you haven’t already. It may be 25-35 years away, but chances are the earlier you start the better position you’ll be in to retire when you plan to. Planning for retirement doesn’t just involve investments though. If you own a home, your mortgage may be a key factor in your retirement planning. Go look through the mortgage section, for some tips to get rid of your mortgage as quickly as possible.  Stop flushing money on debt payments and start investing it for your future.

Economics 101 – Market Forces – Why do investment prices go up and down?

Simple answer:  Demand and the available supply. Stocks and market funds prices go up and down like most things based on what the demand for them is and the available supply.

We could easily fill a library with books on investing and the stock market. But at the end of the day, the question of who sets stock prices and why do they move up and down comes down to supply and demand. Stock prices go up as more and more people want to buy a particular stock as to own part of the underlying company. The reverse is also true, if people are trying to sell a stock the price drops as fewer and fewer individuals want to own a piece of the company.  As companies give out good reports of earnings, prices usually go up as investors expect the company to be worth more in future, equally if a company has bad news or poor media coverage, investors believe the company to be worth less and the price investors are willing to pay drops. This is true of individual companies, as well as sectors or even entire countries’ economies.  A market crash happens when a large proportion of investors want to sell at the same time, there just aren’t enough buyers and prices drop rapidly.  Likewise prices rise when a large proportion of investors all want to buy at the same time, price are pushed higher and higher as the underlying investment is bought up.

Mutual Fund’s and Segregated Fund’s prices move up and down as the stocks and bonds in their portfolio moves up and down. Funds however generally have less volatility than the underlying stocks and bonds they hold, as the funds provide diversification which helps to temper some of the fluctuations. Some stocks may drop, while other rise on the any particular day.

Trying to predict stock prices is both an art and a science. Professional investment managers (like those who manage Mutual or Seg funds) relay on both statistical and economic data and years of experience and instinct when trying to predict what will happen. They typically have both complex computer system to help them manage their trading as well as a team of analysts searching the market for valuable companies.

What Is My Role Regarding Investments?

I’m committed to helping you build a solid and secure financial plan. Investments are certainly an important part of that plan. It has been my experience that most clients are interested in growing their investments, yet want to have a manageable risk level. Though every client is different, I generally recommend putting funds in either guaranteed investments, or pooled investments like mutual funds or segregated funds. Mutual and Segregated funds benefit from professional management and diversification allowing investors acceptable returns with less risk than investing directly in the market via stocks, bonds or derivatives.

How Do I Choose?

Investments choices always need to be done in the context of a larger financial plan. Investments objectives must also be established, are you investing for retirement? a college fund? a first home purchase? An inheritance or an expected liability? Are you concerned primarily with Safety, Income or Growth of Capital? Next you’ll want to consider how much risk you’re willing to accept, we’d all like to maximums our returns, but most of us also want to be able to sleep at night. Before you invest I’ll talk with you to understand your unique situation and objectives so that I can recommend the best choices for you. I’ll also ask you to meet with me annually to review you investment portfolio and insure it is still meeting your needs. You’ll get independent financial advice and I’m able to present you with a variety of options often from competing companies.

Contact me today and I’d be happy to talk to you about your investment objectives, and other aspects of your financial plan.

GIC’s Guaranteed Investment Funds

Guaranteed Investment Funds (GIC’s), are low risk investments. Returns and term are known at time of purchase. Both the initial deposit (principle) and return are guaranteed, both by the company offering the GIC with a further guarantee from the Canada Deposit Insurance Corporation (CDIC)

Returns are typically less than what you’d expect with other investment products, but that is the trade of for the guaranteed nature of GIC’s. GIC’s are typically offered by Banks and Trust companies and they very in term length typically from 1-5 years. GIC’s can be used in an RRSP or a TFSA. Most GIC contracts offer the ability to cash if needed during the term, but there is usually a penalty for doing this.

GIC’s are typically idea for:

  • Client who do not want market risk in their portfolio
  • Clients in or approaching retirement, (who no longer can afford risk in their portfolio)
  • Persons who depend on investments for income and need guaranteed income.

Pros:

  • Very low risk
  • Returns are known in advance
  • Principle and interest are fully guaranteed by bank, trust company  or credit union that issues GIC
  • Further protected by Canada Deposit Insurance Corporation (CDIC) (for Banks) or the provincial equivalent for credit unions, up to $100,000 per company per account should the issuing bank,  trust company or credit union default on their guarantee.

Cons:

  • Interest is fully taxable (if not within an RRSP or TFSA)
  • Returns are typically lower than other investment options
  • Subject to probate upon death
  • No beneficiary designation

Life Insurance Company GIC’s

Life Insurance GIC’s have some unique advantages, including more favourable tax status particularly at time of death as well as the ability to lock in a rate for longer period of time.

Life Insurance companies also offer guaranteed investment contracts very similar to conventional GIC’s. The benefit of getting a GIC from a life insurance company is that you can designate a beneficiary. Should you pass away; proceeds will be paid directly to your beneficiary avoiding being probated on within your estate. Payments from a Life Insurance GIC product may also have beneficial tax treatment, and protection from your creditors depending on your situation.  Life Insurance GIC’s typically have a slightly lower return on similar term options as compared to Banks, Trust or Credit Union GIC’s, however Life Insurance Companies offer considerably longer term contracts typically ranging from 5-30 years.

Additional Pros (compared to GIC):

  • Ability to by-pass probate
  • Preferential tax treatment (in some circumstances)
  • Protection from creditors (in some circumstances)
  • Very Long term options available (5-30 years)

Additional Cons (compared to GIC):

  • Slightly lower returns than conventional GIC’s

 

Mutual Funds

Mutual funds are a pooled investments, that benefit from diversification and professional management.

Mutual funds work by pooling the money of a number of investors and investing it in a variety of different investments such as stocks or bonds. The investor benefits from the professional management and the diversification of having their funds invested in a number of different underlying options.  If the investments within the mutual fund do well, the fund increases in value, like wise if the investments in the mutual fund do poorly the fund will lose value.

Mutual funds typically have a slightly higher return than Segregated funds, but do not have any guarantee attached. There are a huge number of companies that offer mutual funds, and many companies have a huge variety of funds to choose from. It’s nearly unimaginable the number of available mutual funds though an independent advisor.

Because of the huge range of different  kinds of mutual funds available, it is difficult to generalize about mutual funds. Some funds are lower risk with very conservative mandates and are appropriate for investors with a low risk tolerance, other mutual funds are very high risk with very high potential returns (and losses). Funds can have an array of different focuses, including regional, industrial sector, large cap (Big companies) or small cap (small companies).

Mutual Funds can be used within an RRSP or TFSA, but even if not tax shelter they have preferred tax status as they produce capital gains or dividends income vs interest income (which is taxed more heavily)

Mutual Funds however are subject to probate upon death, and all non-realized capital gains become taxable in the year of death.

Pros:

  • Huge variety of funds for nearly any type of investor
  • High returns are possible
  • Favourable tax treatment
  • Benefits From Professional management
  • Diversification

Cons:

  • Principle and return are not guaranteed
  • Subject to probate on death
  • No beneficiary designation
  • No protection from creditors

Segregated Funds

Segregated Funds, are also pooled investments that benefit from diversification and professional management as well as having an element of insurance protection.

Similar to mutual funds in many respects is a segregated fund. These funds are deposited with an insurance company, who in turn invests the money in a diversified portfolio of investments with professional management depending on the objective of the particular fund. Seg funds (like mutual funds) can provide great diversification for an investor. Like mutual funds they provide a variety of options for investors. However unlike mutual funds, Seg funds provide a principle guarantee. The deposit is insured by the insurance company and upon maturity (or death) 75% or 100% (depending on the contract) is guaranteed.  Seg funds generally carrying slightly higher fees than comparable mutual funds due to the insurance on the principle. Seg funds also have an array of estate planning benefits that can drastically decrease taxes owing upon death.

Pros:

  • Guarantee of principle;  either 75% or 100% of the principle upon maturity or upon death.
  • Beneficiary designation
  • Estate taxes and probate are avoided
  • Possible creditor protection.
  • Privacy. Beneficiary information is not made public upon death

Cons

  • Return is not guaranteed
  • Slightly higher fees than comparable mutual funds.
  • As part of our estate planning process, we encourage investors to seriously consider the benefits of Seg Funds, particularly if they are considering leaving something to the next generation. Money is available today for use as needed, but also guaranteed for the beneficiary. Many second generation clients appreciate the benefits Seg funds offered their parents, as they saved thousands of dollars on their inheritances by avoiding the probate and executor fees using Seg funds. Should markets be down significantly upon someone passing, Seg funds may be topped up by the insurance company as per the guarantee attached.

RRSP RESP and TSFA

The Government of Canada of Canada has a vested interested in encouraging people to save. They have setup a number of programs to give Canadians financial incentive to save money for the future whether it’s for retirement, education or a first home there are programs for you.

Registered Retirement Savings Plans (RRSPs)

RRSPs are a tax shelter that work by deferring taxes for years if not decades. They are designed to help you grow your investments without having to pay taxes on the gains while they stay within the RRSP. This enhances the power of compounding, as every dollar earned can be reinvested without having to pay tax (yet) on it. Over a period of 40 years the full effect of compounding without having to pay any tax can greatly increase the size of the investment.

Contributions to an RRSP are a tax deduction, meaning they reduce your income in the year you contribute. The effect of this, is that you get back all the tax you would have paid on the money you invest in an RRSP. Individuals who actively use their RRSP frequently get a nice surprise every April as the government refunds them the tax they had collected on money they have now invested in an RRSP.

Later in life RRSPs must be converted into a Registered Retirement Income Fund, which still has the same tax sheltering and deferral properties except that you can no longer contribute new money into the RRIF and that you must begin to take funds out of the RRIF. All money taken out of a RRIF is taxable as income. But the paying of the tax has been delayed for a long time, and chances are that when you begin talking money out of the RRIF you’re retired and in a lower tax bracket than when you put it in. It’s very important that clients understand that withdrawals from RRIF’s are taxable. I’ve had the unfortunate experience of seeing clients with investments elsewhere get hit with a massive tax bill because their advisor or bank teller didn’t explain to them how much tax they’ll owe on their withdrawal.

Many forms of investments are eligible for using within an RRSP. Including many Mutual Funds, Segregated Funds and GICs.

The amount of money you can invest in your RRSP depends on the amount of income you make. The government tells you on your notice of assessment after you file your taxes how much you can contribute. It is important to note however that once you add money to your RRSP, should you take it out you don’t get the RRSP room back. RRSP are not ideal for short term investment objectives as you’ll consume your RRSP room should you remove your investments from an RRSP.

RRSP’s aren’t appropriate for everyone. Someone who is self-employed may not find using an RRSP as advantageous as someone who is paid a wage or a salary.

Registered Educational Savings Plan (RESP)

RESP is another tax shelter (and deferral) program where the government allows tax-deferred growth for the funds within the program. Perhaps the best thing about the RESP is the potential for government grants. The government will contribute into an RESP to increase the funds available for education under a specific set of rules. RESPs do not however create a tax deduction like a RRSP.

Tax Free Savings Account (TSFA)

The Tax Free Savings Account is a more recent tax sheltering creation by the government of Canada. The primary advantage of a TSFA is investments within a TSFA can grow tax free! In addition (unlike RRSP) withdrawals from a TSFA are not taxable! Finally you contribution room is not comsumed if you remove funds from your TSFA. You eventually (the next calendar year) get your TSFA contribution room back!

This is ideal for clients who are saving for something more short term than retirement, the TSFA is available when needed, and can include investments such as Mutual Funds, Seg Funds or GIC’s.