Here are some basics to help build a long-term plan for your financial future.
Have you ever wondered what investing really means? It can be defined as “the action or process of investing money for profit or material result.” If you’ve ever driven a new car off the lot, tried to sell a used Jet Ski or traded in a used golf club for a new one, you’ll quickly understand that these actions are the opposite of investing, since they involve an expectation of decreased, not increased, value down the road.
Keeping the expectation of material reward in mind, it’s worth learning some basic terms and principles that can help you understand the main types of investments. The (asset) class is now in session.
Investments break down into three main asset classes: equities, fixed income and cash. Each class can be considered in terms of its level of risk and reward.
Equities: Companies issue shares that you can purchase, giving you fractional ownership interest in the business. Investing in equities is affected by the rise and fall of stock market values (volatility) and risk. But with that risk of potential losses comes the potential for more reward.
Fixed income: Generally a more conservative asset class, bonds usually deliver a more modest return than equities. The issuer of a bond, which could be a company or a government, borrows money for a fixed period of time and makes regular interest payments along the way. At the end of the investment term, the issuer returns the principal amount that the bond holder initially invested. While bonds are considered less risky than equities, there are a few things to be aware of with fixed income. Some bonds have higher risk profiles due to an issuer’s lower credit rating, and certain individual bonds may only be available through a financial institution. Most investors access the fixed income market through mutual funds, exchange-traded funds (ETFs) or similar products.
Cash and cash equivalents: Cash may earn interest, depending on the type of account in which the money is held, but generally doesn’t provide any meaningful return for investors. However, having easy access to cash in your portfolio can help to cover unexpected expenses or a planned purchase in the very near future.
If you’re saving for a short-term goal, it may be wise to keep cash in a money market fund or a short-term GIC (guaranteed investment certificate). These products will protect your cash investment while generating a small return. In the case of a GIC, the longer you can commit the cash (say, three to five years), the larger the return will be. However, pulling money out of a GIC before the maturity date can result in a financial penalty.
Now that the three main asset classes are outlined, it’s time to decide how much equity, fixed income and cash to include in an investment portfolio. This is known as asset allocation, and depends in part on your tolerance for risk. A conservative investor with low-risk preferences may have a higher allocation to fixed income in their portfolio. A balanced investor might have a little more appetite for risk, leading to a portfolio containing equal parts equity (including blue-chip stocks) and fixed income (including low-risk bonds). An aggressive investor is very comfortable with risk and is willing to take on more for the prospect of greater returns – this type of portfolio may include a variety of higher-risk stocks and bonds.
Time in the market
In addition to your risk tolerance, another important factor to consider is your time horizon (the amount of time you can commit to holding and growing your investments). Your time horizon can help you calculate how much risk you’re willing to take. Think about what you need the money for. Is it so you can buy a house in five years, or is it for your retirement in 35 years? If it’s the former, you may want to be conservative with your savings since you’ve defined a relatively short time horizon. If your money was invested entirely in equities and the markets dropped, you might need the money before they had time to recover, in which case you might have to sell the investments at a loss.
On the other hand, being too conservative with long term investment goals can mean you forgo some of the benefits of owning more volatile investments. An investor with a long-term time horizon may want to consider a portfolio with more equity exposure to allow for more growth and compounding over the period.
As your time horizon shrinks and you begin to think about retirement, it’s worth talking to your advisor about altering your portfolio to plan for this stage of life.
Choosing the right path
An investor can gain active exposure to mainstream markets through various products.
A collection of stocks or fixed income assets bundled into one fund issued by and purchased from a mutual fund company.
Why it’s good: Mutual funds can offer diversification and convenience. A prospectus gives you lots of information about a fund, including its investment objectives, management approach and risks. Your advisor can help you select a fund that aligns with your goals.
Things to consider: Like all products, mutual funds have associated fees that go toward portfolio management expenses.
Exchange-traded fund (ETF)
Unlike a mutual fund, an ETF is purchased or sold on a stock exchange the same way as a regular stock. Typically, ETFs track a particular stock index, sector, commodity or other asset, and these passive ETFs have a lower management fee because they are not actively managed.
Why it’s good: ETFs can be a great way of buying stocks in a certain sector without the guesswork of figuring out which ones to buy.
Things to consider: Buying the whole index or sector through an ETF means that you get the good and the bad. You may be more susceptible to systematic risk, such as a recession or supply chain issues.
A segregated fund usually has the same investment goals as a mutual fund but it comes with some additional features including a death benefit guarantee and a maturity guarantee. This makes Segregated funds a useful tool for estate planning. Typically, segregated funds are issued by insurance companies, they can hold a mix of equity and fixed income depending on the fund’s goal.
Why it’s good: Unlike mutual funds or ETFs, a segregated fund contract comes with certain guarantees. The death benefit guarantee means that up to 100 per cent of the principal, plus any returns, will be available upon the death of the contract holder. And because a beneficiary can be named on the contract, the proceeds may bypass probate and other estate administration fees and can be paid directly. This makes segregated fund contracts a powerful estate planning and retirement tool. There’s also a maturity guarantee which means that, depending on the contract, at least 75 per cent of the principal, less any withdrawals, will be available on the maturity date.
Things to consider: Segregated fund contracts tend to have higher fees than traditional mutual funds or ETFs because of the cost of the product’s guarantees. Speak to your advisor to see if they fit into your overall plan.
Saving in registered and non-registered accounts
The asset allocation has been decided. The funds have been chosen. Now all that’s left is to invest your savings. But what kind of an account should you use: an RRSP, TFSA, non-registered account – or maybe all three? Consider a few key differences.
RRSP (Registered Retirement Savings Plan): An RRSP allows you to make financial contributions towards your retirement fund (up to a maximum annual amount). This can be an ideal savings vehicle because it allows for some tax benefits; for instance, your contributions are deductible and can be used to reduce your income tax. RRSP withdrawals are taxed, but after you’ve retired you will potentially be in a lower tax bracket than during your earning years.
TFSA (Tax Free Savings Account): While contributions to a TFSA aren’t tax deductible like those to an RRSP, any investment growth inside the account can be withdrawn tax-free, without affecting your Old Age Security (OAS) calculation in retirement. There are annual contribution limits to be aware of.
Non-registered account: This type of account receives no special tax treatment. It’s funded with your after-tax income and all capital gains, interest income and other forms of income are taxed at the prescribed rates in the year you realize them. Speak to your advisor or tax expert for more details.
Company-sponsored pension plan: If your employer offers a pension plan, you may want to take advantage of it. The plan may offer a choice of investments and make matching contributions up to a certain amount. Be aware, though, that money invested in a pension plan typically isn’t accessible should you need to make an emergency withdrawal or a large purchase, unlike some other accounts.
More information about various types of investments and savings products is available here.
Putting it together
During times of market volatility, it’s important to stay committed to your financial plan and goals. As markets expand and contract, the best course is to stay invested and continue making regular contributions. Your advisor can help you understand your investment options, as well as a suitable asset allocation and realistic time horizons.
 The probate process and fees do not apply in Quebec. There is a verification process for non-notarial wills but not for notarial wills.