INVESTMENT ACCOUNTS
Meet Jeff
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Jeff needs your help. Follow him along on a financial journey, as he makes mistakes, fixes them, and learns his lesson.
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Click-through time: ~7 minutes.
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Test your knowledge with a quiz and our game: "Talk Like a Banker"!
"Jeff’s heart is pounding as he bolts down the busy sidewalk – the secret service is after him..."
Saving vs. Investing
Keep enough in your savings account for unexpected expenses that can’t wait - like a broken tooth, or a broken bike. Or maybe when you lose your job and it takes time to find a new one. It’s your rainy-day fund.
The money you are saving for a bigger purchase in the future, and for retirement, needs to be invested so that you can beat inflation.
Inflation is a fancy name for the fact that most of the time prices for stuff go up a little bit every year.
Usually it’s 2% - which means that if today you spend $10,000 on a bunch of things you normally buy, the same bunch will cost $102 next year. It does not seem like a lot, but it compounds. After 10 years, the same things will cost $130.
In some periods, like recently, inflation can be much higher than 2%. In 2022, it was almost 7%.
Not all prices go up the same. For example, gas prices may increase more than food. Rents may increase more than salaries. House prices in popular cities may go up more than in rural areas.
Some people assume 2% inflation when they plan for the future. Others are more cautious (in finance the fancy names for that are ‘conservative’ or even ‘risk-averse’ and assume 3%.
Investing Starter Kit
There are many different ways to invest. Your choice will depend on how much you are willing to learn about investing. And also on how lazy you are - you can hire a money manager and pay a fee, or you can do it yourself and save some money.
Before you decide, go through the FinStart Investing Starter Kit and ask yourself four questions:
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Where will you put the money? As in ‘what kind of investment account’?
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What will you invest in?
• As in ‘what kinds of financial products will you have in your investment account?’
• And how do you make money?
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How much of each financial product will your portfolio have?
That depends on:
• When you’ll need the money
• How you feel about investment risk.
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Which financial institution will you open your investment account with? And what exactly will you buy in your account? Just like with savings accounts (and credit cards and other products), knowing the key features will help with making this choice.
There is no ‘single best answer’ to these questions because the answers depend on who you are and what your situation is. We give it a try below to show how to think about investing and how to make decisions.
Let's Take a Closer Look
Josh has $1,500 to invest. He made a budget and knows that every month he will save $150.
He turns 18 this year and wants to open a TFSA account.
What about his annual TFSA contribution room? Check - his $1,500 is well within the $7,000 limit. Saving $150 per month means he’ll using another $1,800 of his contribution room this year (and keeps the rest for the future).
1. Where will you put the money?
Which account will you use to store your hard-earned money?
Start with the TFSA - Tax Free Savings Account. It’s a registered account - a fancy name for an account that has some income tax benefits.
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Starting at age 18, every Canadian gets an annual TFSA contribution room. In 2024, it’s $7000. If you don’t use the room, you don’t lose it - it accumulates for the future.
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You don’t have to pay tax on the investment income in your TFSA account.
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You can withdraw the money any time you want. You can contribute that amount again as soon as in the following year. You don’t lose your past contribution room when you withdraw.
Registered Accounts: RESP, TFSA, RRSP, FHSA
You may already have another registered account - a RESP (Registered Education Savings Plan).
It can be opened for a child by a parent, a guardian, another family member or even a friend.
RESP Tip #1
Ask your family / primary caregiver if you have a RESP.
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If you don't and are <15, you may be able to receive a portion of the government grant - even if your family hasn't contributed.
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If you're 16 or 17 and have a RESP that has not been fully utilized, you may still be time to catch - contribute and receive the grant.
Do your research. Start asking questions - for example, in your local bank.
RESP Tip #2
If you have a RESP, make sure you withdraw the money responsibly.
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When you withdraw money while enrolled in post-secondary education, you get to keep the grant and pay low tax on your investment income because you likely have low income as a student
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If you don’t do post-secondary or drop out, by age 35 your RESP will close - you have to return the grant and pay income tax at the time at whatever your tax rate is
There are 2 other registered accounts that may be of interest to you later:
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FHSA (First Home Savings Account)
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RRSP (Registered Retirement Savings Plan).
They have different tax benefits than the TFSA and different rules for withdrawing the money. You get all their tax benefits only when you withdraw the money for the specific things they are for - buying your first home or and retirement.
All registered accounts have maximum contribution room. After you use it up and still have money to invest, you can open a regular, non-registered account.
When Can You Start?
Age 18.
Tax Deduction on Contributions?
No.
Losing Your Unused Contribution Room?
Never.
Are There Government Grants?
No.
Tax on Investment Income?
This account is non-taxable. Withdrawals can be redeposited the following calendar year without taking up additional contribution room.
Investing Tip
If you have a job and your employer offers a retirement investment plan as a benefit, consider opting in.
If you do, your employer will match your contribution to their plan (usually up to 4% of your annual pay). It's like you’re getting a raise. But the contributions will take up your RRSP contribution room.
Investing Tip Cont.
In a retirement investment plan, you will earn investment income and can withdraw the money once you retire.
This is called a defined contribution plan. Don’t confuse it with a defined benefit pension plan - once you retire, those pay a monthly pension until you die.
2. What will you invest in?
As in ‘what kinds of financial products will you have in your investment accounts’?
And how do you make money?
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We invest in assets. It’s a fancy word for ‘things of value’).
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Financial assets are products you can buy from financial institutions.
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People also invest in other types of assets: like buildings for rent, art, or cryptocurrencies.
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Investment return is a fancy word for the money you make from investing. How exactly this happens depends on the asset you invest in.
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Investment portfolio is another fancy word that means all the assets you’ve invested in, no matter in which specific accounts you hold these assets.
Let's Take a Closer Look
Recall that he has $1,500 to invest and that every month he plans to save $150. And he wants to open a TFSA account.
Josh will consider both fixed income and equities for his investment portfolio.
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Josh will need about $1000 in 3 years - he’ll place that in fixed income.
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The remaining $500 will go to equities. The $150 he saves each month will also go to equities.
Consider two main financial assets: fixed income and equities.
Think of fixed income like a mirror image of a loan. Except that you will be ‘lending’ money to a bank or a corporation. They will pay you interest and return the principal at the agreed time (called ‘maturity’).
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You make money from fixed income assets mainly because they pay interest. What really matters is how much you make after tax - interest from investments is taxed every year as you earn it at the same rate as your employment income.
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A simple fixed income product is a GIC (Guaranteed Investment Certificate). When you buy a GIC from a bank (called the ‘GIC issuer’), you deposit money in your GIC account. At maturity, the issuer will return to your account the amount you deposited, plus the interest you earned.
Think of equities as of buying a small piece of a business someone else runs for you. The smallest piece investors can buy is called a ‘share’.
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You make money from equity assets in two ways.
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The first one is called capital gain: it’s the difference in price between when you bought and sold your investment. Capital gains are taxed only in the year when you sell your investment. They are taxed at a lower rate than interest or employment income.
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When a company you own generates profit, management may decide to make a small payment on each share of the company, called a ‘dividend’. It’s optional, unlike interest on fixed income products that must be paid as promised. Dividends from Canadian companies are taxed at a lower rate than employment income, and from non-Canadian companies as employment income.
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You wouldn’t want to own just one company. What if that business goes bankrupt and you lose all your investment? Or it just doesn’t do as well as other companies and its price declines or just sits there while other companies go up? A fancy word for how to solve this problem is ‘diversification’ or don’t put all your eggs in one basket.
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There are many ways to diversify. A simple product that does the job is an ETF (exchange-traded fund). ETFs are like baskets of shares of all companies that are in a given market - like Canada, or the US, or the whole world. Instead of buying many, many shares of different companies, you buy only one - a share of the ETF you have chosen. ETFs that represent entire markets are called ‘passive’ ETFs.
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Let's Take a Closer Look
Josh calculates his asset allocation today.
$1000 in fixed income and $500 in equity means a 67% allocation to fixed income (1000/1500) and 33% to equity (500/1500 or 100%-67%). He looks like a conservative investor but that’s because he will need a big chunk of today’s savings soon, in three years.
Over the next three years Josh will add $5,400 to his equity investments (150 per month times 36 months).
In three years, his asset allocation will be 15% fixed income and 85% equity - that’s quite aggressive, but Josh is comfortable with risk because he has lots of time before he’ll need to use the money he is investing in equities. And he knows that to beat inflation he should own equities.
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His fixed income will be worth a bit more because he will be earning interest - let’s say $1,118).
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If financial markets do well, his equity investment should also be worth more - let’s say $6,600.
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He expects to have $7,718 in his investment account (1118 + 6600).
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His asset allocation in 3 years should be 15% to fixed income (1118/7718) and 85% to equity.
3. How Much Fixed Income and Equity will your portfolio have?
A fancy name for this is asset allocation. This question does not have a ‘one size fits all’ answer. The answer depends on two things.
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When you’ll need the money (a fancy name is ‘investment horizon’). Most experts would say this with confidence:
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How much investment risk you are comfortable with. It’s called your risk appetite. If your risk appetite is low (which means you don’t like risk), you are considered a conservative investor. If your risk appetite is high (you are comfortable with risk), you are considered an aggressive investor. Most experts would agree on this:
What's Your Risk Appetite?
How do you discover your investment risk appetite?
You don’t have to wait until you open an investment account. Google ‘risk appetite questionnaire’ and answer the questions. Do you get the same result every time?
You can also measure your risk appetite yourself. If you are curious how, click here.
4. Which financial institution? What will you buy in your account?
What fixed income and equity products will you buy in your investment account? And which financial institution will you open your investment account with?
First you need to decide which investing style suits you better.
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Ready-Made - once you open an account, the financial institution will do most of the work for you, for a fee. A well known example is robo-advisors, like WealthSimple.
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Do-It-Yourself - you have to do your own purchases and sales of fixed income and equity products. This means your costs will be lower. DYI investment accounts can be opened at major banks (their discount brokerage divisions, also known as self-directed investing) and independents (a well known one is Questrade).
Second, realize that there are many ways to implement your chosen investment strategy. Let’s look at how Josh did it.
Key features of GICs
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Interest rate they pay (the higher the interest rate, the better).
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Maturity (also called term) - how long your money will be invested (from 1 month to several years).
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Minimum amount of money needed to make an investment - the smaller, the better because you can put your money to work sooner.
Let's Take a Closer Look
Josh uses a simple DYI approach.
His fixed income investment is in GICs, Guaranteed Investment Certificates. With the $1000 he’ll need in three years Josh buys a 3-year GIC. On www.ratehub.ca he discovers that EQ Bank (CDIC insured) offers a high rate (3.45%) in registered accounts, with a minimum $100 purchase.
Ratehub directs him to the EQ Bank website and he follows instructions to buy a 3-year GIC for $1000 as his TFSA investment.
What is a GIC?
GICs (guaranteed investment certificates) are similar to savings accounts, except you can't withdraw your money whenever you want.
Instead, your GIC ‘matures’ on a certain date. That's when you get your money back, along with any interest you earned.
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Redeemable GICs are special - they can be sold back to the bank before they mature. In exchange, they usually offer lower interest rates.
Interest on GICs is relatively low but should be higher than on savings accounts (because you give up the flexibility of being able to withdraw at any time).
The GIC interest rate is a percentage - divide the interest you receive by the amount you invest. It's usually expressed as an annual rate.
Key Features Tip - GICs
The cheapest and easiest way to buy GICs is directly from the provider - both Big 5 and smaller banks sell GICs.
When you do your research, you can compare GIC interest rates on websites like www.ratehub.ca
What if your GIC provider goes bankrupt?
If your GIC bank goes out of business, a government agency called the Canada Deposit Insurance Corporation (CDIC) or its provincial equivalent automatically insures GICs from each GIC issuing bank up to $100,000.
What is an ETF?
ETFs (exchange-traded funds) are baskets filled with equity and / or fixed income securities.
Some ETFs are called index ETFs. 'Index' means the ETF represents the entire market for a particular fixed income / equity security (like all Canadian bonds or US equities).
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You can't buy an index - it's just a list of securities.
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Buying individual securities is risky. Buying a basket of them through ETFs reduces investment risk. Index ETFs reduce risk even more because they hold every security in their market. This is diversification.
Key Features of ETFs
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What exactly is in it
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ETFs are like baskets of eggs. Equity ETFs hold shares of various companies in various countries and markets
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Annual MER (management expense ratio), measured as a percentage of your account balance
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It’s automatically withdrawn annually from your holdings. The lower the MER, the faster you money grows.
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Liquidity - large / popular ETFs that mimic large markets and have a lot of transactions every day are more liquid.
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This means you can sell them more easily, without incurring additional costs.
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Let's Take a Closer Look
Josh’s equity investment is in ETFs, which stands for Exchange-traded Funds. He wants to buy one diversified passive equity ETF that represents a large market, like the US or even the entire world.
He researched ETFs and learnt that well established providers of ETFs are BMO, BlackRock, and Vanguard. He settled on an ETF with the ticker symbol XSP. This ETF represents the entire US equity market but can be bought in Canada in Canadian dollars. It’s is very large and very liquid, with many transactions done each day. It’s management fee is low at 0.09 percent.
Now he needs a self-directed investment account in which he can buy this ETF. He found an independent provider that does not charge any account fees for TFSA accounts nor a trading commission on buying XSP (only on selling, and the commission is low). But it has a $1,000 minimum and Josh only has $500 to put into equities. He saves $150 each month, so four months from now he’ll have an additional $600. Meanwhile, he’ll start the process of opening the account because it may take a few weeks.
What Makes an ETF Liquid?
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High daily trading volume.
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Small bid/ask spread – the difference between the price at which you would buy (ask) the ETF and immediately sell it (bid).
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High market capitalization (number of shares times share price) or net assets.
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Trade at prices close to the fund's net asset value (value of securities in the ETF divided by number of shares.
ETF Fees Tip
When you buy ETFs, you pay 2 annual fees:
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MER (management expense ratio) covers licensing fees for the index that the ETF is tracking, and the ETFs operating and administrative costs.
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TER (trading expense ratio) covers the ETF’s trading costs. It should be really small for index ETFs as they should not trade much.
They are expressed as a percentage of the amount you have invested.
Key Features of Investment Accounts
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Cost to you - account fees and buy/sell commissions (higher fees will eat into your investment returns)
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Usually quoted per trade as a fixed dollar value, regardless how much you're investing.
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Can be reduced or entirely avoided. Some brokers waive commission when you buy / sell certain ETFs.
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Lower commission is better.
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Minimum initial investment and minimum account balance
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Many providers require more than $10,000 to start, but there are some where you can start with $1,000.
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How easy it is to open the account, buy and sell the investment products (‘trade’), and view your monthly statements.
Investment account tip
Research providers of self-directed investment accounts by searching the Globe and Mail newspaper’s website for its annual review of these providers.
You will need a subscription or access to a library that has one.
What if your investment account provider goes bankrupt?
If you are opening an account with an independent online broker, confirm they are a member of the Canadian Investor Protection Fund. They insure your account should your broker go out of business.
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The CIPF website has a list of member brokers. Make sure you know your broker's full name. Your broker will likely advertise they're a member (look for the CIPF logo on your broker's website).
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Big-5 online brokers are always insured.