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What's the Goal?


The type of investment you use should reflect your end goal with the money, your time horizon, and your risk tolerance. Money for short-term goals, like buying a house in the near future, should be put in a low-risk investment, like a High-Interest Savings Account. Long-term goals such as financial independence, or retirement should be invested in a diverse portfolio of securities according to your situation, and risk tolerance.  

Time is a major factor in reducing the risk of investing. Markets go up and down. Longer investment time horizons are historically associated with reduced volatility. If you are flexible with when you need to take your money out of the market, you can choose to sell at a high point.

Owning shares in a single company may increase your risk. Diversification means spreading your investment out across several different asset classes, regions, and market sectors reduces your risk of being exposed to a single company. Don't put all your eggs in one basket. Make a decision, and hold on through market peaks and valleys, rather than trying to predict market fluctuations.

As your investments fluctuate, it's important to rebalance your portfolio. Maintaining your desired exposure to each market sector is an excellent way to continuously buy low and sell high. Like a teeter-totter, when one sector is down, it is naturally under-represented in your portfolio, so you rebalance it to your desired level. This act can also be described as buying low. If that sector improves and becomes overweighted in your portfolio, sell back to your desired allocation. This is selling high. Continuously rebalancing your portfolio is an excellent way to respond to market shifts, without trying to predict the future. 


Types of Investments



This is meant to be a simple overview of a few common investment options to help you understand what is available. It isn't meant as a complete guide or an endorsement of any specific investments.



Savings Account

Your savings account is a safe place to put money for short-term needs such as your emergency fund, saving a down payment for an upcoming home purchase, or saving up for other major purchases in the near future. Generally, interest rates in a savings account won't beat inflation, so over time, your money is losing purchasing power as the cost of goods increases. This makes it a sub-optimal investment strategy for long-term growth. It may feel safe to hold money in savings, but you are slowly losing value.

GICs

Guaranteed Investment Certificates can offer slightly better returns, than a savings account, in a very safe investment. Your funds are usually locked in until the end of the term, so you lose some flexibility. They are a useful tool if you are expecting to need your money at a certain time in the near future, and can't take on market risks in your short time frame.

Bonds

Bonds are a low-risk investment tool.  Purchasing a bond means you are lending money to a government or company. The term length and interest rate of the bond are usually fixed and guaranteed, but there are risks associated with bonds as well. The bond issuer could default, declaring bankruptcy. Or interest rates could rise, meaning your bond loses some value.

Stocks

Simply put, buying stocks means you are buying a small piece of (equity) a business. As the business increases earnings, it becomes more attractive for other investors to want ownership in the business, so the value of your equity increases. The risk with stocks is that the opposite is also true. If a company doesn't meet expectations, its stock price can fall, and investors lose value. There are several ways to mitigate the risks associated with investing in the stock market. 


Mutual Funds

Mutual Funds are investments that pool money from a large group of investors with a similar outlook. The funds are managed by a professional manager, according to the objectives of the fund. They usually invest in stocks and bonds, but some invest in real estate or commodities as well. Mutual funds attempt to reduce risk by spreading investments across a broad section of the market. Each fund has its own prospectus, telling investors how they plan to invest their money. The downside of mutual funds is that they usually carry high management fees. This might be worthwhile, if it means that investors don't have to worry about managing their own portfolio.

Seg Funds

Segregated funds are investments that offer certain guarantees, depending on the fund. They are usually a mutual fund that you purchase through an insurance company. The insurance company protects you from some of the downside risk but allows you exposure to unlimited upside risk. These professionally managed funds have slightly higher fees than mutual funds, but if market volatility is a source of stress, it could be worthwhile to protect your assets.

ETFs

Exchange Traded Funds are a low-fee way to access broad market exposure. They are generally passive funds, meaning your money isn't moving around much in the market. They usually have a certain sector they focus on, and hold several companies from that sector. Like stocks or mutual funds, ETFs can lose value. It is important to hold your position through market fluctuations, rebalancing as you go. ETFs are a good way to take a hands-on approach to investing, but reduce some of the risks associated with buying individual stocks. 



Tax


Investment gains are taxed in a few different ways. In Canada, in order to encourage long-term investing, we have a few options to reduce our investment tax burden. 

TFSA

Tax-Free Savings Accounts allow your investment to grow tax-free. You can put many types of investments in your TFSA. Stocks, bonds, GICs, mutual funds, seg funds, ETFs. The growth is never taxed. You can take money out, and put it back in later.

RRSP

Registered Retirement Savings Plan contributions are tax deductible. This means that if your marginal income tax rate is 30%, and you deposit $1000 into an RRSP, your income tax for that year will be reduced by $300. RRSPs are most effective when used in higher income earning years. The tax savings is your marginal tax rate, and the funds are taxed as regular income when they are withdrawn.

Choosing Between RRSP and TFSA


Your RRSP and TFSA contribution room can be carried forward from year to year, so using choosing account types according to your current income is usually advantageous. On a low-income year when your marginal tax rate is lower than your expected marginal tax rate in retirement, it's best to use TFSA. On a higher income earning year when your marginal tax rate is greater than your expected marginal tax rate in retirement, RRSPs are usually the best option.

When purchasing your first home, you can borrow up to $25,000 from your RRSP to make a down payment or $20,000 to pay for education. These types of withdrawals can be made tax-free but must be paid back within a certain time frame.

Series T Funds

When your RRSP and TFSA accounts are optimized, Series T funds can be an attractive option depending on your situation. Dividends and Interest are re-invested, offsetting your cost basis and deferring tax until disposition. 

In English, you pay less tax and pay it later. 


RESP

Registered Education Savings Plan offers you tax-free growth, and grants to fund education.


LIRA

A locked-in Retirement Account is used to transfer funds from a pension plan into a plan that you can control.

Life Insurance

If your tax-advantaged accounts are optimized, life insurance can offer additional tax-free growth. If you own a participating whole life policy through a mutual insurance company, you become an owner of the company, meaning you participate in the profits of the company. Investors can enjoy close to 5% growth with very low risk in certain policies, depending on their underwriting. Learn more here.



Before You Get Started


There are risks associated with investing. Understanding your risk, and being prepared for unexpected events is essential. Carrying debt while investing can be a leveraging tool, which can magnify your gains and losses. Paying off consumer debt before taking on market risks is recommended. After all your high-interest debt is paid off, you should set aside an emergency fund of 3-6 months worth of expenses. That way, if markets drop and you simultaneously have unexpected expenses, you aren't selling undervalued assets in order to get through. In addition to being debt free and having an emergency fund, a complete financial plan should include having proper personal insurance in place. Whether through a workplace group plan, or an individual plan, every adult should have long-term disability protection in place, and if you have somebody who depends on you as their breadwinner, life insurance is necessary. A halfway funded retirement account won't be adequate if a sudden unfortunate turn of events leaves you unable to work, or worse. 

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