Saving for the Future

Savings and Investment Accounts

Savings and investing accounts include bank chequing/saving accounts, guaranteed investment certificates or term deposits, investment accounts (e.g., a stock/etf trading account), and last but not least, registered plans.

Registered plans for Canadians include Registered Retirement Savings Plan (RRSP), Tax Free Savings Account (TFSA), and Registered Education Savings Plan (RESP). Registered plans for Americans include Individual Retirement Account (IRA) and 401k account.

Types of Investments in your Accounts

There are so many different types of investments and investment products available today. The main investment types to be familiar with are interest accounts, bonds, mutual funds, exchange traded funds (ETFs), and stocks.

Interest Accounts include savings accounts and guaranteed investment certificates (GICs) obtained generally at regular banks but also at online banks which pay higher interest. You put your money in the account and you are paid interest on it.

Bonds are issued by companies and governments and are available from bond dealers such as banks and brokers. When you buy a bond you are lending your money to the company or government for a fixed period of time and for a fixed return.

Stocks are offered by companies and are traded on the stock markets. They are available from brokerages (e.g., online discount brokerage). When you buy stocks you are buying an actual part of the company and as such you own a part of the company and all the associated risks and rewards.

Mutual Funds consist of a selection of stocks managed by a fund manager. When you purchase a mutual fund you are indirectly purchasing a portion of the funds portfolio of stocks. Mutual funds are available from banks and mutual fund companies or brokers.

Exchange Traded Funds (ETFs) are similar to mutual funds except they are traded on the stock exchange and typically have lower management fees because they contain a set index of stocks and therefore are not actively managed.

Low Fee Mutual Funds, a relatively new offering, are index mutual funds which offer low fees and returns comparable to ETFs, but with the convenience of a mutual fund. An example of a low fee mutual fund is the TD e-series mutual funds.

Investment Return and Risk

Generally investments with greater potential returns will have greater potential risk associated with them. The risk however is reduced for investments are held for a long time. That is why short term investments should be held in low risk accounts while investments intended to be held for a long time can/should be considered for higher risk and return holdings. The following shows how different types of investments compare from a risk and return perspective over a period of at least 5 years. What is right for you depends on your time frame and your ability to stomach risk.

Diversify to Lower Your Risk

Investment risk can be reduced through diversification. You can diversify by investing in different types of investments, across different geographies (countries) and over different points in time. Diversification can also, to some degree, reduce the overall risk of investing in higher return investments.

Risk can be reduced by spreading the investment over different types of investments that respond differently to different events. For example, when interest rates rise, bond values tend to go down. When there is a bull market (people with greed charging forward with investing) equity mutual funds rise while bond mutual funds go down. When there is a bear market (people with fear retreating with investing) speculative stocks will fall further than dividend utility stocks. You may choose, for example, to target having 25% in the safety of interest, 25% in bond mutual funds, 40% in dividend stocks and 10% in growth stocks.

Risk can be reduced by investing across different geographies. That is because the markets around the world do not move up or down together. As an example a Canadian may invest 50% in Canada, 35% in US and 15% in International. An American may invest 70% in US and 30% in International.

Risk can also be reduced by spreading your investment and withdrawals over different points in time, perhaps 2 or 3 times per year if you are doing it manually. Or set up an automatic monthly purchase or withdrawal plan.

Whatever types of investments you choose, diversify as much as you can while keeping your portfolio of investments as simple and manageable as possible.