Finance - Savings and Investing

Fact There are two kinds of money problems. Which one do you want? 1. Not enough money? 2. Too much money?

Saving Advantages  Money is protected against loss  Interest is paid by the financial institution Disadvantages  Money loses purchasing power over time due to inflation.  If the current inflation rate is 2.5% and the financial institution is paying you 2%, your money is losing purchasing power. Saving involves safely putting money aside for future use. For example, depositing money into a savings account which pays interest of 1.5%.

Savings Plans 1. Savings Accounts 2. Term Deposits 3. Guaranteed Investment Certificate (GICs) 4. Registered Retirement Savings Plan (RRSPs) 5. Registered Education Savings Plan (RESPs) (RESPs) 6. Tax Free Savings Account (TFSA)

Investing Advantages  Investments often pay a higher rate of return. (higher interest)  Investments can grow at or exceed the rate of inflation Disadvantages  The rate of return is not guaranteed  There is some risk of losing part or all of the money. Investing is using your savings to earn extra income that will grow over time.

Investing Plans 1. Investment in stocks/shares 2. Mutual Funds 3. Bonds 4. Index Funds 5. Collectibles

 Smart investors have a combination of savings plans and investments  An individual’s short and long-term goals and plans impact how savings and investments are distributed.

The Need For a Savings Plan Savings Plan  Systematic or regular habit of putting money aside to reach a financial goal. Why? 1. Emergency needs 2. Short and long-term goals 3. Security 4. Future needs Decisions you need to make:  How much to save  What you save  Where you save

Emergency Needs Loss of family income due to death, injury, or illness Life and health insurance does not always cover all the costs Unexpected hardships such as getting fired or laid off from a job Wanting to quit a job for ethical or personal reasons

How much savings do I need? Ideally, people would be wise to have months salary in savings. Ideally, people would be wise to have months salary in savings. If a job is lost, one’s savings would provide until a new job is likely found. If a job is lost, one’s savings would provide until a new job is likely found.

Short and Long-term Goals Short Term Goals  Purchase of relatively inexpensive items within a short period of time Examples include:  Concert tickets, bicycle, television Long-Term Goals  Purchase of more expensive items in more than a year’s time. Examples include:  Car, house, post- secondary school, retirement

Security and Future Needs   Many people who plan financially for their future are happier because they spend less time worrying about their financial future.   David Chilton’s best selling book, The Wealthy Barber, states people should pay themselves first – take 10% of your earnings as soon as you get it and put it aside in savings or an investment plan.   If you get into the habit of doing this, you never get used to having the money to spend in the first place.

Selecting a Savings Plan  When trying to select which savings plan(s) to use, consider the following: 1. Rate of return (interest rate) and how interest is calculated 2. Safety 2. Safety 3. Liquidity 3. Liquidity

Interest / Rate of Return/ Yield  Interest is money received over time for letting others borrow money  Consumers borrow money from banks and pay interest in addition to paying the initial amount borrowed, which is called the principal.  Banks pay interest to consumers who deposit money into banks, who then use it to lend to others at a higher interest rate.

Interest  Interest is expressed as a percentage of the original investment (i.e. 2% of $)  This is called a rate of return or yield.  Interest rates are based on a one-year time period. (1 year = 12 months = 52 weeks = 365 days) Example:  A savings account yields an annual return of 3%.  The rate of return on the savings account is 3%.

Savings Accounts and Interest  Actual earnings on savings accounts depends on when the bank calculates and pays the interest: 1. daily 2. weekly 2. weekly 3. monthly 4. annually  And how the bank calculates interest and may vary from bank to bank from type of savings accounts. Interest may be calculated in one of two ways: 1. Simple Interest 2. Compound Interest

Calculating Simple Interest   Simple Interest is calculated on the amount deposited by the consumer – also called the principal amount) Simple Interest Calculation Interest = Principal x Rate x Time I = P x R x T a. a. Simple Interest calculated annually at 2% = 2/100 = 0.02   Balance of $2000 in my bank account I = 2000 x.02 x 12/12 = $40 b. Simple interest calculated monthly at 2% = 2/100 = 0.02   Balance of $1400 at the end of the month I = 1400 x.02 x 1/12 = $2.33 c. c. Simple interest calculated weekly at 2% = 2/100 = 0.02   Balance of $1400 at the end of the week I = 1400 x.02 x 1/52 = 0.53 cents

Calculating Compound Interest  Interest is calculated on the principal amount plus any interest already earned.  You earn more interest in each payment period because you are earning interest on interest as well as your principal.  The more often the interest payment is made (i.e. monthly vs. annually, or weekly vs. monthly, or daily vs. weekly), the more your money will grow because interest is being paid on top of interest more often

Calculating Compound Interest If you deposit $1000 in a savings plan and leave it there for 5 years at 5% interest compounded annually, interest is compounded as follows: Balance at the beginning of the Year During the YearBalance at the end of the year Year 1 $ % of $1000 = ? +.05 x $1000 = $50.00 = $ Year 2$ % of $1050 = ? +.05 x $1050 = $52.50 = $ Year 3$ % of $ = ? +.05 x $ = $55.13 = $ Year 4$ % of $ = ? +.05 x $ = $57.88 = $ Year 5$ % of $ = ? +.05 x $ = $60.78 = $

Calculating Compound Interest If you deposit $1000 in a savings plan and leave it there for 5 years at 5% interest compounded monthly, interest is compounded as follows: Balance at the beginning of the Month During the MonthBalance at the end of the month Month 1 $ % of $1000 = ? +.05 x $1000 x 1/12 = $4.166 = $ Month 2$ % of $ = ? +.05 x $1050 x 1/12 = $ = $ Month 3$ % of $ = ? +.05 x $ x 1/12 = $ = $ Month 4$ % of $ = ? +.05 x $ x 1/12 = $ = $ Month 5$ % of $ = ? +.05 x $ x 1/12 = $ = $

Compound Interest Formula   If the interest is compounded once a year: A = P(1 + r)n Where: P is the principal (the money you start with, your first deposit); r is the annual rate of interest as a decimal (5% means r = 0.05); n is the number of years you leave it on deposit – exponent n; A is how much money you've accumulated after n years, including interest.   If the interest is compounded q times a year:   A = P(1 + r/q)nq Electronic Compound Interest/Future Value Calculator:   Note: Compound Interest is also referred to as Future Value.

Selecting the Savings Plan Note:  Compare different financial institutions savings plans in order to find the one with the best rates for you.  Some savings accounts require you to have a minimum balance in order to receive a higher rate of interest on your account. (i.e. $4000 vs. $1000)  Some savings plans require you to leave your money with the financial institution for a minimum number of years. The greater the principal and the longer you leave it with the institution, the higher interest they will pay you.

Safety  Most savings plan deposits in banks, trust companies, and loan companies are protected by the Canada Deposit Insurance Corporation (CDIC) – an agency of the federal government.  The financial institution pays for the insurance - not you.

Safety  Depending on the province, the CDIC will insure your deposits at individual institutions up to a maximum amount. Examples:  The Nova Scotia Credit Union Deposit Insurance Corporation insures deposits up to $250,000.  The Deposit Insurance Corporation of Ontario insures deposits to $ and an additional $ for each registered savings plan.  Depending on how much you have in savings, you may want to make deposits in several institutions.

Liquidity  Liquidity refers to how easily you can convert an item into cold hard cash quickly and without notice  A house for example is not very liquid as it would take time to sell, whereas a chequing account is liquid because you can withdraw the money immediately.

Liquidity  Should there be an emergency, it is important for investors to try to keep some of their savings as liquid as possible.  Some savings plans are locked in for a certain amount of years and/or charge a penalty fee for early withdrawal of money.

Savings Plans 1. Savings Accounts 2. Term Deposits 3. Guaranteed Investment Certificate (GICs) 4. Registered Retirement Savings Plan (RRSPs) 5. Registered Education Savings Plan (RESPs) (RESPs)

Common Savings Plans Savings Account  Interest may be calculated daily and paid at the end of each month, or  Paid on the average account balance during a specific time period; or  Paid on the minimum balance, and deposited in your account semi-annually on April 30 th and October 31 st.  Interest rates vary from institution to institution  Accounts may require a minimum balance in your account at the end of each month (i.e. $5000)  Online banks often have better interest rates

Term Deposits and Guaranteed Investment Certificates (GICs)   Both are savings plans where you deposit a fixed sum of money for a specific length of time (term), at a fixed rate of interest.   Terms may range from 30 days to 5years.   Usually, the shorter the term, the greater the deposit required and the lower the interest rate.   The greater the deposit and the longer the term, the higher the interest rate may be.   Some GICs are locked which means you can not access the money early.   GICs that are not locked will pay a lower interest rate and may have conditions upon when you may cash in your deposit. $4 000 for 5 years at 5% interest GIC $3 000 for 3 years at 3% interest GIC

Registered Retirement Savings Plan (RRSPs)   Introduced by the federal government in 1957 to encourage people to save for their retirement   Think of an RRSP as a money box. You can chose to invest your money in a number of things that will fit into your RRSP box.   Your RRSP may be made up of mutual funds, GICs, stocks, bonds, and index funds. GICs Stocks Bonds RRSP Other

RRSP’s  Helps you save money by allowing you to invest a portion of your annual income without having to pay income tax on it. Example:  Let’s say you pay 35% income tax on your income  If you decide to contribute $5000 to an RRSP over the course of a year, you will receive from the government 35% of that $5000 on your income tax return for that year. (5000 x 0.35 = $1750)  The government has refunded you for the tax you paid on the $

RRSP  The sooner you begin investing money into an RRSP, the longer time it has to grow until your retirement.  Interest or rate of return is earned on your deposits over time.  Actual earnings depend on what type of investments make up your RRSP.  The government limits how much money you can contribute to your RRSP each year.  If you already contribute to a company pension plan, you will not be able to put away as much into your RRSP.  Currently, you can invest 18% of your income up to a maximum of $ a year.

Withdrawing Money from Your RRSP  When you withdraw money on your RRSP, you must pay tax on it.  You may withdraw money before retirement, but if you are working, your annual income will likely be large enough that you may have to pay taxes in a higher income tax bracket resulting in paying more taxes.  Since your income after retirement is usually lower than your income before your retirement, you may fall into a lower income tax bracket.

2009 Federal Income Tax Brackets $10,320 $0 $ $ $ Nil 15% 22% 26% 29%

2009 Federal Income Tax Brackets Taxable Income Tax on this income $0 - $10,320 Nil Nil $ $ % 15% $ $ % 22% $ $ % 26% Over $ % 29% Canadian Revenue Agency. “What Are Income Tax Rates For Canada 2009.” 24 August February 2010

Registered Education Savings Plan RESP   Anyone who wants to contribute to a child’s RESP can.   The contributor does not get a tax benefit like with an RRSP.   Child is the beneficiary because s/he will benefit from using the money for his/her future education costs.   The beneficiary must be a resident of Canada. GICs Stocks Bonds Family Plan RESP Group Plan RESP Individual Plan RESP Other GICs Stocks Bonds Other GICs Stocks Bonds Other

RESP   Income earned from these investments is tax-free until the beneficiary begins to use it to pay for his/her future education.   Students do pay taxes on the income withdrawn from the RESP, but because students usually make minimal income while in school, the tax actually paid is minimal to none.

RESP Main steps in opening an RESP: Get a Social Insurance Number (SIN) for yourself and for anyone you name in your RESP.Social Insurance Number (SIN) Apply to the Canada Revenue Agency for the Canada Child Tax Benefit if your family net income is $74,357 or less. This form is generally provided at the hospital where your child was born.Canada Child Tax Benefit Choose the RESP provider that best meets your needs. RESP providers include most financial institutions, such as banks or credit unions, as well as group plan dealers or financial services providers.RESP provider Decide on the type of RESP you want to open. (Individual, Group, or Family Plan) Decide on the type of investment that will make your money grow. 6. Put some money into your RESP. Sources:  

RESP Rules Current Rules on Contributions to RESP 1. There is no annual limit on what one may contribute except that: 2. The lifetime contribution limit is $ The government will also contribute up to $500 a year to a lifetime maximum of $ The annual limit may go up to $1000 if there is unused grant from previous years. Note: The government’s contribution to an RESP is called the Canada Education Savings Grant, (CESG).The actual grant will depend on a number of factors. See the following site for more detail:

RESP Rules Current Rules on Accessing RESP funds: The students can access up to $2,500 of their income and grants for each 13-week semester of study. Payments are referred to as Educational Assistance Payments (EAPs) Usually, a qualifying educational program is a course of study that lasts at least three weeks in a row, with at least 10 hours of instruction or work each week. A program at a foreign educational institution must last at least 13 weeks Qualifying educational programs include apprenticeships, and programs offered by a trade school, CEGEP, college or university RESP funds can be used for full or part-time study in a qualifying program. 5. To find out more about qualifying educational programs contact the Canada Revenue Agency toll-free at

RESP Rules   What if the child beneficiary chooses not to attend post- secondary education? Since an RESP can stay open for up to 36 years, the money can be used if your child decides to attend school later Use the money for a brother or sister who does continue education after high school 3. Transfer the money into a Registered Retirement Savings Plan (RRSP) to help you save for your retirement. 4. Withdraw your personal savings, tax-free. The unused government portion returns to the government.

Costs of Post-Secondary Education Student Living at Home Years until Child Attends a Post-secondary Four- year College or Institution Estimated Cost of University Program Monthly Savings Needed 2$36 000$1350 4$40 000$681 6$44 000$449 8$49 000$337 10$54 000$266 12$60 000$221 14$66 000$186 16$73 000$161 18$80 000$144 Calculations assume a 5% annual increase in education costs including inflation and four years of education. It also assumes an 8% rate of return on investment savings, and the maximum amount invested to receive the total government grant under the CESG program

Student Living AWAY from Home Years until Child Attends a Post-secondary Four- year College or Institution Estimated Cost of University Program Monthly Savings Needed 2$66 000$2519 4$73 000$1270 6$80000$844 8$88 000$632 10$97 000$505 12$ $420 14$ $359 16$ $311 18$ $274 Calculations assume a 5% annual increase in education costs including inflation and four years of education. It also assumes an 8% rate of return on investment savings, and the maximum amount invested to receive the total government grant under the CESG program. Estimate includes tuition and books.

Tax Free Savings Account (TFSA)  Introduced by the federal government in 2008  Allows individuals to invest and save money and not have to pay tax on any returns (i.e. interest) made.  Money can be withdrawn at any time  Deposit limit of $5000 each year.  TFSA may include a savings account, GICs, stocks, bonds, and mutual funds. TFSA GICsStocks Bonds Savings Account Mutual funds

Common Forms of Investments Canada Savings Bonds and Canada Premium Bonds Corporate Bonds Stocks Mutual funds Real estate Collectibles Note:   Each type of investment has a different level of risk and expected rate of return.   Level of risk varies from guaranteed to get it all your money back plus interest to losing everything)   The safer the investment, the lower the return   The more riskier the investment, the possibility for a larger rate of return exists.

Investing  Good investors diversify their investments Investing in many different types of investments to spread out the risk. Investing in many different types of investments to spread out the risk. If one investment is performing poorly, it may be balanced out by one that is doing well If one investment is performing poorly, it may be balanced out by one that is doing well Don’t put all your eggs in one basket !

Canada Savings Bonds (CSB) CSB  A loan you give to the government  The government will repay you the value of the bond plus interest.  The maturity date printed on the bond is the date when the bond becomes due and is paid back to you.

Canada Savings Bond (CSB)  Provincial and municipal bonds are also available, but less popular  CSB’s can be purchased at all major financial institutions, including banks and credit unions.

CSB Advantages  Guaranteed payment by the government  Can be cashed at any time (very liquid)  No interest will be paid if it is cashed out within the first three months of purchase  Face value of the bond is the initial amount you loaned to the government.  Can be purchased through automatic payroll deductions arranged with your employer  Can be purchased for as little as $100

Canadian Premium Bond Advantages  Offers the same security as a CSB  Offers a higher interest rate but can only be cashed on the anniversary of the issue date (when it was purchased) or during the 30 days after that date)

Corporate Bonds

Source  Wilson, Jack et al. The World of Business, 5 th Ed., Nelson Education Ltd., Canada, 2007