Do you think saving and investing looks something like the laptop screen in the picture above? I can safely say it does not – not even close.
Nowadays, platforms are super easy to use from Tangerine Banking to Questrade (Credit Unions and the Big Banks also have pretty intuitive sites from what I hear, but I personally use Tangerine and Questrade, hence I can vouch for their ease of use).
“Okay that’s great, but even if I sign up, I don’t know what I’m doing! What are my options?”
This is an excellent question that applies to many Canadians. Fortunately there are many personal finance blogs out there like this one to help you get started!
You have boosted your income, you have looked at your expenses through a microscope and eliminated waste, and have paid off any outstanding high interest credit card debts & loans. Now what?
An important part for anyone looking to grow their retirement nest egg is the vehicle they put their money into.
“What is this vehicle you speak of FN?!”
Not the kind of vehicle you have shunned in favour of biking or walking because they’re insanely expensive (unless you get a beater), but a savings/investment vehicle! Simply put, this is an account where you would place your hard earned money. As I’ve said before, saving is a huge piece of the FI puzzle, but you need to couple that with compound growth. You’ve earned those loonies & toonies, don’t be afraid to make them work for you eh!
So what do Canadians have available to them? Let’s dive into the major categories to give you an idea. I’ll try not to be boring about it but no promises! We’ll see how I do:
- Savings Account
- Where do I get one? Any bank or credit union would allow you to open one of these bad boys.
- The down low: Basic account that doesn’t really give you sh#t. They generate very low interest and cause a loss of buying power. For example, if the interest offered is 0.5% while inflation runs at 2%, you have lost buying power at a rate of -1.5% per year! Ouch!
- What are they good for? Savings accounts are good to keep minimal cash on hand to pay off monthly credit card balances, mortgage/rent, and paying for small emergencies.
- Many financial advisors advocate holding an emergency fund of 3-6 months of expenses that I disagree with. I’d rather have that capital invested earning 5% a year, coupled with a Line of Credit, or LOC. (Something any bank would be HAPPY to give you in hopes that you’ll spend money you don’t have. Of course you won’t because you’re a FI trooper.) This LOC is in case of a massive emergency requiring half a year’s expenses (Think about that for a second). An emergency of that magnitude is likely a 1-in-5 year event (if not longer odds).
- So you can choose between carrying that emergency fund in your savings account earning 0.5% interest while losing out on 2% inflation and 5% equity returns, -6.5% per year, or -28.5% over 5 years.
- Or, earn 5% a year for 4 years followed by an emergency requiring you to use the LOC and maybe paying half a month’s interest while you liquidate the required cash from your investments, owing maybe -0.2% in interest, or +21.3% over 5 years.
- Is holding that emergency fund really worth losing 50% over 5 years?
- Chequing Account
- Where do I get one? Bank / Credit Union
- The down low: Fairly similar to the Savings Account. The only difference is you can write cheques and maybe the interest rate varies slightly.
- What are they good for? Same as savings accounts + writing cheques (That your body can’t cash…Top Gun anyone?). Nowadays, cheques are not as prominent due to e-transfers, so you don’t really need both a savings and chequing unless you’d like to split funds for another reason. Admittedly Mrs FN and I have a savings and chequing, so who am I to judge! Do your thang.
- Guaranteed Investment Certificate (GIC)
- Where do I get one? Offered by any financial institution like your bank or credit union. Just check out their sites or walk up to a teller if you prefer the human experience!
- The down low:
- These are low yield, low risk endeavours. As the name suggests, your investment is guaranteed by the financial institution, as they insure your investment through the Canadian Deposit Insurance Corp (CDIC).
- But this peace of mind doesn’t come free as the yield from GICs is very low, and they will have fixed time horizons that you are invested for (such as 3-, 5-, and 10-year terms).
- Within GICs, you can obtain cashable and non-cashable.
- Cashable means you may recall the investment before maturity, but having such flexibility usually means lower returns, since the bank holds the liquidity risk if you recall your investment.
- Non-cashable means you cannot withdraw your investment before the term is over (some banks will allow you, but will charge you a penalty or keep all accrued interest). This is a reversal from cashable, as the investor now holds the liquidity risk! To compensate you, you receive a higher return (No such thing as a free lunch, Ama-rite?).
- What are they good for? Some folks prefer less risk*. GICs are certainly low risk since there’s no volatility. As I mention above, with low risk is low reward (according to RateHub, the best 3-year offers for a non-cashable GIC today are 3.25%, or about 1.25% net of 2% inflation).
- Government Savings Bonds (GSBs)
- Where do I get one? Once again, any sort of financial institution (A pattern is forming…you can setup any of these vehicles at a financial institution. I should’ve stated that from the get-go instead of repeating, but I’ve come too far with this format! AGH!).
- The down low: Similar to GICs, these vehicles are guaranteed but by the government from which you have purchased (You can check out provincial Ontario Savings Bonds, or federal Canada Savings Bonds and their yields by following the links above. Note these bonds are typically only offered at specific times of the year).
- What are they good for?
- Same ballpark as GICs – low yield, low risk.
- Using the Ontario Savings Bond link above, a fixed 3-year offers 2.10% per year, barely keeping pace with inflation.
- The yield is typically somewhere between a cashable and non-cashable GIC. Why? Because you can typically recall your investment and only need to forego the interest from the period you will not be invested in. So for the institution, it’s riskiness is somewhere between the cashable and non-cashable GIC. Simple as that.
- Registered Retirement Savings Plans (RRSPs)
- Where do I get one? RRSPs are NUMBER ONE and your Chesterfield rifle on the battlefield of life fighting off consumer zombies on your way to freedom. You can set one of these bad boys up with any financial institution directly (bank or small brokers like Questrade) or through your employer where they will be labelled a Group RRSP.
- The down low:
- These puppies allow you to dump before tax earnings into investments, and allow you access to numerous asset classes (equities, bonds, REITs, etc.).
- When you invest before tax earnings it creates what is known as a Tax Shield**. The tax shield is your marginal tax rate since the tax you’re saving is being skimmed off the top – this is good as your marginal tax rate will be equal or higher to your average tax rate depending on your income.
- So for example if you’re in Ontario making $50k, your combined Ontario and Federal marginal tax rate is 29.65%! That means for every $0.70 cents you would’ve received, you receive $1 by directing it to your RRSPs, an instant improvement of +43%.
- From here you can invest in all sorts of Exchange Traded Funds, Real Estate, Bonds, etc.
- What’s nice is these contributions come off your paycheque immediately, so they are a forced savings, a Godsend for those who lack discipline (Best said by Arnie in Kindergarten Cop).
- Finally, note that there are limits to each year, currently it’s the minimum of 18% of previous year’s earnings or $26k of pre-tax dollars that you can put away per person. If you don’t maximize this or can’t right away, don’t worry, any unused space rolls over into the following year and so on. But try to max this out early on as you’ll have more dough compounding those gains you need for financial independence! Time in the market is your friend!
- What are they good for? These should be your first retirement account. As I already said, the tax shield and forced savings aspects are such wonderful benefits that many people seemingly do not take advantage of to the fullest.
- Defines Contribution Pension Plans (DCPPs)
- What are they? These are EQUALLY AS IMPORTANT AS RRSPs if you have them. They are essentially the same and any amount contributed to a DCPP counts towards your RRSP annual limit. A DCPP is specifically offered by an employer, while an RRSP can be setup individually or through your employer.
- The down low:
- One difference here is that your employer will typically provide a match to the dollars you put in. For example if you put in 7% of your salary, your employer may put in 7% – $1 for $1 matching! This is an instant 100% gain! Take advantage – don’t leave money on the table.
- Note even the employer matching counts towards your RRSP maximum.
- So imagine for a second that the $0.70 of after tax dollars is now being put into a tax deferred dollar matching DCPP? You have turned that $0.70 into $2! THINK ABOUT THE MONEY YOU LEAVE ON THE TABLE BY NOT MAXIMIZING THIS.
- What’s it good for? Saving for retirement! Creating automatic tax deferred deductions are incredible and should be utilized to their fullest potential.
- Tax Free Savings Accounts (TFSAs)
- Where do I get one? TFSAs are after tax accounts where you can sock away after tax dollars for investing. They are available through any financial institution. Mrs FN and I hold both our TFSAs through Questrade due to their low trading fees (ETF buying fees are scaled to the volume you are buying and are fractions of a penny per unit, while other products can be $4.95 per transaction…still much cheaper than a bank which charge $9.95+ per transaction).
- The down low:
- A TFSA allows one to continue putting away money in a tax advantaged way after you have maximized your before tax (RRSP/DCPP) accounts.
- What exactly is tax advantaged if it is after tax dollars? A TFSA will not ding you with capital gains tax*** / income tax upon taking those funds out. This is contrary to an RRSP where you are initially able to avoid paying income tax, and while you are subject to capital gains tax, it does not apply until you withdraw from your RRSP.
- Similar to an RRSP, you can invest in pretty much anything here (Equities, Bonds, REITs, etc.)
- What’s it good for? For retirement purposes, this account comes right after maxing out your RRSP / DCPP. For purposes such as putting together a down payment for a home, this is the best place to accumulate (If you’ve heard of the Home Buyer’s Plan, I’d suggest avoiding it…more on that in another post).
- Non-registered Accounts (NRA)
- What are they? These are typically for excess amounts of savings (if you’re here, congratulations! You’re doing better than 99% of the Canadian population).
- The down low:
- Non-registered accounts are typically for leftover savings. So imagine you take advantage of the full room allotted to you in your RRSP / DCPP as well as TFSAs…where do you go next? Non-registered.
- There are NO MAXIMUMS. Contribute whatever you can if this is your jam (Personal Finance rhymes are the best).
- Any gains you have will be subject to capital gains taxes***. While an RRSP defers capital gains to when the amount is withdrawn, NRAs require you to file the capital gain in the year of occurrence, so it is a bit more of a hassle come tax season while you’re still in your growth & accumulation phase.
- What are they good for? Great for continuing to contribute after you’ve maxed out your RRSP/DCPP and TFSA. The more you save and invest, the bigger and faster that snowball of money gets.
That should get you started! I will surely be referencing these accounts throughout a number of subsequent articles as I talk about my own preferences. So we can all freshen up on the material from time to time!
Happy Weekend Y’all
*When we talk about investment “risk”, we are talking about volatility (how much the value goes up and down). With volatility, comes highs and lows, creating more opportunity for big losses if you cash out at the wrong time, or huge gains. In general, more risk should equal more reward.
**A tax shield is great as long as the taxes you’re avoiding now are higher than your marginal tax rate in retirement. For example if your marginal tax rate is hypothetically the same at, say 25%, and you…
- Invest $10,000 into your RRSP for 15 years at 5%, you end up with $10,000 x (1.05) ^ 15 = $20,789. If you withdraw this paying 25% to the tax man, you end up with $15,592.
- Take the $10,000 immediately for $7,500 after tax and put it into your TFSA at 5% interest, you end up with $7,500 x (1.05) ^ 15 = $15,592! Same amount!
- Most people though will have lower taxes in retirement, so take advantage of the RRSPs, especially those of you with higher than average incomes. It also automatically puts your money to work rather than creating a temptation to spend that money now and never see it again.
***Capital Gains tax is a fancy way of saying whatever has been the increase in value while invested, you will be taxed at 1/2 your marginal tax rate. So say Your marginal tax rate is 25% and you had invested $10,000 that grew to $15,000. So the increase of $5,000 is subject to 1/2 x 25% = 12.5%.