Money School – Savings Options
The basic idea behind any investment is to take your principal and earn interest over time. This can be done in a variety of ways, with little or no risk, or with a high degree of potential loss. How comfortable you are with different levels of risk is something individual to every investor, but it can also be affected by the savings goal you may have.
For instance, if you are saving for a down payment on a house, you will not want to risk the principal in a volatile investment vehicle. However, if you are investing today for your retirement in 40-plus years, you may want to capitalize on the length of time involved which may mean you will be able to absorb more risk. Many investors want to have money earning interest for short-term goals, and also money working to achieve goals for their far future. This is what is known as a diversified portfolio, meaning that various types of investment products are being used all at the same time.
What kinds of investments can you choose?
Savings Accounts – Little risk. Money is not locked in; interest earned is low to very low.
Tax-Free Savings Accounts (TFSA) – Little risk, but you can choose different types of investments within a TFSA. Canadians over the age of 18 can have this account and currently may contribute up to $5,000 per year. No earnings on that investment are taxed and contributions are not tax deductible (as they are with an RRSP). Unused contribution room can carry over to following years.
Term Deposits or Guaranteed Investment Certificates (GIC) – Little risk. Invest money for a set number of months or years for a guaranteed earned interest rate. If you remove your money prior to the end of the term you will forfeit some or all of the interest. Cashable Term Deposits are available but usually pay a slightly lower rate of interest.
Money Market Accounts – Little risk. The issuer of the account invests your money in government vehicles and securities, which may provide a larger return than regular savings accounts. Often requires a larger balance to be maintained, and usually restricts the number of withdrawals that can be made.
Bonds – Little to moderate risk, depending on the bond. Usually, a bond is issued to the bondholder with a set interest or gain amount. You might consider it a loan to the company or entity giving you the bond. If the bond is kept for the term specified (usually a long term) it will earn a specific amount. Governments issue bonds frequently.
Mutual Funds – Moderate to high risk. Your investment is pooled with others to create a larger investment amount and is then invested in various securities. Each fund usually has a fund manager and clearly stated goals for the fund. It may reward long term investors much more than short term ones. Often fund managers will charge a fee for their services.
Stocks – High to extremely high risk. Stocks are traded on the stock market. If you have stock in a company, you own so many shares of that company. The stock market can be very volatile, and stock prices can rise and fall significantly within just one day. The theory is always to buy low and sell high, meaning buy the shares when the price is low and hope that the company you have invested in becomes popular so the share price will rise. When you judge that the price is as high as it may go, you then sell the shares and take the profit. Most investors use a stock brokerage to manage the buying and selling of their shares, and will pay fees to the brokerage for the service. Most financial institutions offer an online brokerage for individuals to trade their own funds.
Annuities – Moderate to low risk. It is like an insurance policy in reverse. You invest a lump sum now, and then at a designated point in the future you begin to receive a small monthly amount. Interest rates and the stability of the company offering the annuity all contribute to the growth of an annuity and the payout you will receive. You may end up locked in to a payout amount that does not provide enough income in your retirement years, or it may end on your death without giving any benefit to your estate. You cannot change it once it is purchased, so this type of investment requires a lot of research.
Registered Education Savings Plan (RESP) – Risk varies depending on type of investment. It can be started for you when you are young, or by you for your own children up to the age of 15 to assist in saving for post-secondary education. It is locked in, but earnings are not taxed. You may choose from all types of investments to work for you within the plan. Based on your annual income and contributions to the plan, the government will add to an RESP. If the child does not pursue post-secondary education, the government portion is returned, and earnings are subject to tax.
Registered Retirement Savings Plan (RRSP) – Risk varies depending on type of investment. You can start an RRSP at any age, as long as you have employment income. All investments and earnings are locked in, and sheltered from tax until you withdraw it from the RRSP. The theory is that you will pay much less in tax on small withdrawals during your retirement than you will now on the full amount. You may choose from all types of investments to work for you within the plan.
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