A couple of things that are commonly overlooked when dealing with investments is the effects of taxes and inflation your overall purchasing power. Living in Canada, especially, we are taxed a fair bit (some would argue, more then fair!), but that is not the only point to consider when investing. Inflation also adds to the reduction in your purchasing power (i.e. $1 today will not necessarily be able to buy the same things a year from now, as it would today).
As I mentioned in one of my earlier posts, the cost of living has gradually been increasing over time. 10 years ago the gas prices were about 60 cents/litre, groceries were a lot cheaper, houses were a lot cheaper etc... One would assume that the income levels would be increasing at the same rate as cost of living, but that's not the case, which is why we must pay close attention to the effects of inflation and taxes on your investments.
One investment that many people like to get is a GIC. What is a GIC? It is what's called a "Guaranteed Investment Certificate". In English: the company you invest with will guarantee you a certain interest rate for a certain period of time (that is usually locked in). Why do people invest in GICs?
Pros
- principal guaranteed
- rate of return guaranteed
- liquid asset (can be easily converted into cash in case of emergency)
- people see it as a "safe" investment
Why should people be weary of GICs?
Cons
- interest is taxed fully at your marginal tax rate (MTR)
- very little flexibility
- long term returns are minimum
- inflation erodes purchasing power
- if you break the term of a locked-in GIC, you lose all the interest accumulated and just receive your principal back
- the money you invest is the same money the bank is lending back to you for credit cards and mortgages etc... (credit cards usually charging in the 18%/19% range)
People think GICs are "safe", but are they really? Let's take a look at an investor who has $100 to invest and gets 2 rates of return on his GIC.
Example 1:
Client getting 3% interest rate on a 1 year GIC; 31% MTR (Marginal Tax Rate)
*Note: I'm using Inflation at 3.5%. Most people would say inflation over a 15+ year time period should be calculated between 2.5% and 3.5%. I use the higher end of the scale as an example because, based on all the things that are going on in the world today, we might actually be looking at rates at this level or even higher.
Saving: $100.00
At 3% Interest: + 3.00
Pay Tax at 31%: - 0.93
___________
Net After Tax: $102.07
Inflation at 3.5%: - 3.50
Actual Return: $ 98.57
As you can see, you actually end up LOSING money with this rate. Remember, at this point in time, you'd be pretty lucky to get 3.00% from a bank on your GIC.
Example 2:
Client getting 5.25% interest rate on a GIC; 31% MTR (Marginal Tax Rate)
Saving: $100.00
At 5.25% Interest: + 5.25
Pay Tax at 31%: - 1.63
___________
Net After Tax: $103.62
Inflation at 3.5%: - 3.50
Actual Return: $100.12
As you can see, you BARELY break even even at this rate. You must get about 5.25% or more in interest on your GIC to beat taxes and inflation. Also remember, the higher your rate of return, the more you will pay in taxes. At this point in time it is pretty much impossible to get 5.25% interest rate on your GIC. (To view current rates of GICs in all provinces in Canada, you can do a quick search in your browser and find a few different links that will provide you with the rates)
Now, you can answer the question: Is it REALLY a "safe" investment? To me, the only thing 'guaranteed' is that, unless you're getting at least 5.25% in interest, you're going to LOSE MONEY!
Now lets just say 6 months into your term, an emergency comes up, and you need to take out money from you GIC. You call your bank, and let them know something has happened and you need the funds. What do they do? If they funds are in a locked-in GIC, they tell you that any interest you have accumulated up to that point will be lost, and you only get your original amount invested back. Does that seem like something you want to sign up for? Probably not.
Some would say "well, why go into a locked-in term to begin with?". The answer is quite simple; you will not get the best rate unless you lock the money in. Cashable (redeemable i.e. not locked in) GICs give very little return so they're not even worth it most of the time.
I hope this has helped you to understand how the Real rate of return is calculated, and how it affects you. I have sat down with many people and shown them this easy calculation, and they are completely baffled, because they have never been taught such a simple concept like this.
I have tried to hold an un-biased view on this topic, but it's hard to see many positives from this sort of strategy. I hope you've learned something! Please feel free to contact me for more information or any questions you might have!
Showing posts with label Investment Types. Show all posts
Showing posts with label Investment Types. Show all posts
Annuities
In this post I will talk about Annuities, something that many people have heard about, but don't really know how it works. Annuities aren't as popular today as they used to be, because of all the different types of investments we have today, but they can still be used as a key part in someones portfolio.
Annuities are considered an Insurance contract, and therefore can only be offered by Insurance companies - which could be one reason that they are not known or used as often as other products. There are several different types of annuities, and they can have a few different features added to them as well, so I will explain the details of each below. Before I get to that, I will give a brief definition of what an annuity is, in general.
What is an Annuity?
Here's a definition I got from the Manulife website, which I think is simple but gets the point across.
In exchange for a single lump sum investment, an insurer makes guaranteed regular income payments to an investor that contain both interest and a return of principal. Annuity payments can continue for the lifetime(s) of one or two people, or for a chosen period of time.
(Source: Manulife.ca)
Annuity is often used in retirement portfolios, to give the Annuitant a regular and known stream of income. The concept is similar to that of a pension - when you retire, you start to receive a regular income stream, however, it is not always known. With an annuity, you will know exactly how much income you're receiving on a regular basis. You can purchase an annuity with either registered or non-registered funds, and have your tax rate prescribed (where you know exactly how much taxable income you're going to receive every year) or non-prescribed (every year you pay different amount of tax on your income.
First I'll go through the pros and cons of annuities, and then I will go into the main different types of annuities.
Pros
- receive a regular income stream
- income stream is known
- minimizes taxation of income (because it is returned as principal and interest)
- there is no market risk (you continue to receive regular stream of income even if the markets tumble)
- payments can continue to a beneficiary even after death
- can know exactly how much taxes you're paying
- can be indexed for inflation
- can be set up as single or joint
- generally higher returns than other products (i.e. GICs)
Cons
- very little flexibility - once the money is given to the insurance company, usually, you no longer have any access to it
- if you want to add a cashable component to your annuity (where you can take some of your regular principal as a withdrawal), this will reduce your income stream
- adding features (i.e. payments continuing after death, or index inflation) will reduce the amount of income you receive
- income stream is lower for younger clients
- do not take advantage of market gains
As you can see, there are still drawbacks to using this type of product, and it is not seen as something that might fit into every persons portfolio.
Now that you get a general idea of what Annuities are and how they function, I will now go through the main different types of Annuities offered in the industry.
Single Life - This is fairly self-explanatory. The annuity is issued to a one person, and the annuity payments will continue until the annuitant dies, at which point, they will stop.
Single Life with Guarantee - With this, you can set up a guarantee period (usually 20 or 25 years, or up to age 90, whichever comes first), which means, if you die within this guarantee period, the payments will continue to a named beneficiary until the end of the guarantee period. The longer the guarantee period, the less your income stream will be.
Joint-Life - The payments will continue until the death of the surviving spouse. You can add a 'reduction' feature which will reduce the amount of income received by the surviving spouse upon the death of the first spouse (usually reduced to 40% or 50% of current income stream). By adding this feature, you can increase your current income stream until the death of the first spouse.
Joint-Life with Guarantee - Same as above, but can also add a guarantee period (usually 20 or 25 years, or up to age 90, whichever comes first), so the payments can continue to a named beneficiary (or estate) upon death of the second spouse.
Term Certain - This type of annuity will provide you with a guaranteed income stream for a set number of years (to a maximum of 25 years or age 90, whichever comes first). After this period is complete, the payments stop. If you pass away during this period, the payments will continue to a named beneficiary.
As you can see there are several different types of annuities offered, all with certain features and benefits. One or more of these can fit very nicely into a retirement portfolio to provide you with a regular stream of income, which can help you to maintain your current standard of living and lifestyle. That being said, by no means should you put your entire savings into this type of vehicle. This product should make up only a portion of your retirement plan, and should be used together with other strategies/products.
I hope you have learned some good things from this post, and please consult your financial advisor before making any decisions on how this product might fit into your portfolio. If you have any questions or comments, please do not hesitate to contact me!
Index Funds
In this post I'm going to discuss a type of "mutual fund" that is fairly popular with more educated and sophisticated investors. Index funds are something that are being discussed more and more in todays investment world, especially by those who are not very fond of traditional mutual funds. In this post I'll compare index funds with traditional mutual funds, and try to give the main differences between the 2.
What are Index Funds?
Essentially, an Index Fund is just a Mutual Fund that tracks a specific Index, such as the S&P/TSX Composite Index (Toronto Stock Exchange). An index fund will try to emulate the returns of the index as much as possible, by holding the same stocks as the index itself, and holding the same weightings as each of the stocks in the index.
An index fund will invest in the largest, strongest, and the best known companies in the country/region (and sometimes sectors or commodities) they are invested in. This might offer investors some sort of 'security' in their investment, in the sense that investors will feel that larger companies are less likely to get into financial trouble or become bankrupt or the like.
Management Style
Whereas a regular Mutual Fund will have a mutual fund manager who will buy and sell securities and try to beat the index (known as either professional or active management - depending on the type of fund), an Index Fund will take on what is known as 'passive management'. This is because the Index Fund Manager does not have to do much buying/selling, and his/her job is just to mimic the index as best as possible. Therefore, this requires a lot less research; which will also reduce the overall cost of the fund.
Having 'passive management' means generally there will be no advice from advisors as you would get with traditional mutual funds (therefore no trailer fees paid to the advisor -- which keeps their cost lower). This is why generally Index Funds are used by more sophisticated and educated investors.
Many Index Funds will not be able to fully mimic the index because they will have a 'weighted cap'. This means the fund will not be allowed to have more than x% of one company. For example, at one point Nortel made up more than 35% of Toronto's Stock Exchange, but when it crashed, it took the S&P/TSX Composite down with it. So to reduce the market risk, most Index Funds will have a 'cap' on how much % they can have of one company.
Costs
Since the management of an Index Fund requires a lot less in the way of research, buying/selling, management etc..., this will greatly reduce the costs (MERs) associated with the fund. Where a regular mutual fund can range from about 1.5% to 2.5%, an average Index fund can go anywhere between about 0.4% to 1.4% (depending on the company and the index it is following).
Also, Index Funds are generally bought from on online trading platform or a discount brokerage. This means for every transaction (buy or sell), there would be a charge. Depending on how many transactions are done and how much each transaction is for, this could actually negate any savings from the lower MER. In some cases, the fees associated with trading online will be more than an MER on a regular mutual fund, and thus lowering the overall return of the fund, thus
Risk/Returns
Although an Index Fund will hold the strongest, largest and best known companies in the country/region, they still carry risk (as does any other fund). In fact, often, an Index Fund will have more risk than an average Mutual Fund Portfolio. This is because an Index Fund will track only the Index in a specific region, so it will not give as much diversification as many Mutual Fund Portfolios.
Some will say to balance out risk, to just buy several Index Funds from several different Regions/countries, so to reduce the risk, but that availability of Index Funds for other regions is not as much as for regular Mutual Funds. Regular Mutual Fund portfolios generally have the ability to diversify more than an Index Fund Portfolios, so to reduce the risk. Also, as mentioned above, often there will be a small percentage of companies making up a large percentage of the index, and therefore will make up a large percentage of the Index Fund. This will be more risky than most Mutual Funds, who will have more companies with less weighting, so to spread the risk out.
Generally, Index Funds will have higher returns over a longer period of time, as compared to the average Mutual Fund. Having said that, the volatility is still a lot higher than Mutual Fund portfolios. A Mutual Fund manager will try to match, or even beat the index, with using as little risk as possible. So, although the general returns for Index Funds are higher than the average Mutual Fund, this is not considering the risk involved. If we were to look at the "risk-adjusted returns" (the returns calculating the risk being taken) for Index Fund in comparison to average Mutual Funds, we would find the the returns would actually be fairly similar.
As mentioned before, there is no "one-size fits all" investment or strategy for everybody. Index Funds can be a great addition to an investment portfolio, but only if used properly. Please consult your financial advisor before making any decisions on using Index Funds in your portfolio, and also do your own homework.
I hope you have learned something from this post, and please don't hesitate to contact me if you have any questions!
Socially Responsible Investing!
In this post I'm going to touch upon a topic that I've been getting a lot questions and comments about, which is the topic of 'Socially Responsible Investing'. I'm just going to go through some general points about these types of investments, because it is not a different type of vehicle for investing, just another way OF investing.
We are seeing a big shift in todays world in regards to people becoming more socially and ethically responsible, which is something that is very much needed. As we know, there are a lot of companies out there who are doing an excessive amount of pollution, are not complying with human rights, or are just involved in things that we do not agree with. Traditionally, when we invested in things like mutual funds, we weren't really paying attention to the type of companies we invested in; generally, we were just interested in having our funds grow for our future. However, if we really did our research and looked at some of the companies we were investing in and the type of things they were involved in, we might find ourselves feeling a little 'guilty' or 'uncomfortable' with that. So, whats the solution?
Over the last few years, there's been a big push for the creation of Socially Responsible Investment Funds. These are funds that are focused on investing in companies who meet certain guidelines in regards to how they do business, what type of business they're in, how they affect the environment and so on. Whether its because of religion, personal or moral belief, or any other reason, many people do not want to invest in companies that are involved in certain activities, as it goes against their belief system. Thus, a need for something different!
In 'Socially Responsible Funds', there are strict investment guidelines, and they have exclusion lists. For example, they won't invest in tobacco, or alcohol related companies, or companies that have a poor human rights record, or companies that are involved in weapons manufacturing, etc... Most people invest for their future in things like stocks or mutual funds and the like, however, they also might have a certain belief system which they want to adhere to; so, naturally, this would be a great alternative for them.
As most people don't know that they have a choice, I thought I would share some brief information to let you know there are other options for investing in your future. Typically, these funds work in the same way as regular mutual funds (i.e. investing in companies around the world, expecting growth and income, etc...), but work on a different mandate that is in line with peoples moral/ethical/religious beliefs.
One thing to note is that, generally, the returns on these types of funds MIGHT (not in all cases) be a little lower then a traditional mutual fund. The reason for this is because of the companies that the traditional mutual funds invest in. The fact is, tobacco and alcohol companies (and other types of companies that might not be invested in, in a socially responsible fund), generally have good and more stable returns other companies. However, from the performances that I have seen, these Socially Responsible Funds generally have similar average returns as regular mutual funds.
I hope you've learned something from this post, and if you would like to get more information on these type of funds and the choices available, please do not hesitate to contact me.
Exchange Traded Funds (ETFs)
These days there are so many new investments types coming into the market, its hard to keep track of everything. Over the last few years we've seen a huge surge in something called "Exchange Traded Funds" (ETFs). Although they aren't very new to the industry (have been around for more then a decade), it seems like only in the last 4 or 5 years they have started to make a name for themselves. In this post I will go over the basics of this type of investment, the types of ETFs, the pros and cons, and also the type of investor who I feel would benefit most from it.
What is an ETF?
An exchange Traded Fund is like a mixture between a stock and a mutual fund. It works similarly to a stock because you trade on the stock exchange through a broker. And, like a mutual fund, you can purchase a group or basket of stocks (or other investments) rather then purchasing one at a time.
ETFs are designed to mimic the index or a sector. For example, you can own an ETF that mimics the S&P/TSX index. This means it will hold pretty much the same things and same weightings as that index. Because they are just tracking the index or a sector, the fund manager doesn't really have to do the buying/selling or analyzing/researching that a normal mutual fund manager has to do - thus lowering the fees associated with this investment (the MER).
ETFs are bought/sold on the market and can be sold at any time of day, just as a regular stock can be done. However, unlike stocks, you don't really have to watch and track them everyday, since its following the overall index. Just as regular mutual funds, these should be used as a long-term, buy and hold, type strategy. Unlike mutual funds though, you have more flexibility of when/how you buy and sell.
Types of ETFs
There are a few different type of ETFs that can be invested in and here are just the main ones.
- General Index ETFs - Similar to an index mutual fund, these funds track the broad indexes such as the S&P/TSX Composite Index. This will track the largest companies on the index, and will invest over different sectors/industries.
- Sector ETFs - These funds basically just track a specific sector within the Index, such as technologies or financials, but can also go into commodities such as gold or silver.
- International ETFs - These funds can track indexes in other countries, for example USA, and will give you exposure to them. You can also get an 'emerging markets' ETF that will give you access to multiple international markets.
- Fixed Income ETFs - Similarly to a fixed income mutual fund, these funds will invest directly into fixed income investments. However, these ETFs will follow the actual bond index itself.
Pros and Cons of ETFs
Pros:
- Cost: Generally, ETFs will have lower MERs (fees) then regular mutual funds. This is because there much research/analyzing and buying/selling that a regular mutual fund would have, thus less work for the fund manager.
- Flexibility/Liquidity: Since ETFs trade on the stock market, you can buy/sell at any time of the day (as long is there is someone to buy/sell from you). This is in contrast to a mutual fund, where the trade cannot be done until the end of the day, at which point the market could have fluctuated a lot.
- Performance: Rarely do I discuss performance, because that can always come back and bite you in the behind since no 1 fund will always outperform. However, when it is something more consistent, then it should at least be taken into consideration.
- Taxation: Although inevitably you will have to pay taxes on your ETFs, you can often delay the taxation if you buy and hold. With an ETF, you will pay taxes on any annual dividends (whether received in cash or redistributed - same as a mutual fund), but other then that, you will pay taxes on gains only when you sell the ETF. In a mutual fund, capital gains taxes are incurred as the shares within the fund are bought/sold during the lifetime of the investment (since other people who are in the fund will be buying/selling over the time) AND there will be a capital gains tax when the fund is actually sold by you (if sold for more then you purchased for).
- No Minimums: With ETFs, there are no minimums to start investing (are there are with SOME mutual funds). You can start off with a minimum amount (although its not recommended due to brokerage fees), or as large an amount as you want.
- Short Selling: This, in my opinion, is something for more sophisticated investors. ETFs offer the ability to short-sell, or in other words, betting on a decline on the index that the fund is tracking. In a way, this is a little more of a gamble, but if an investor has taken the time and energy to do all the research and highly feels that the market will go one way or another, they can take advantage of an opportunity they feel is coming.
Cons
- Costs: Although one of the pros was lower MER costs then a traditional mutual fund, brokerage fees are something that MAY negate (and then some) the savings in MER if there is a regular contribution (i.e. monthly, weekly, bi-monthly). For example, if a brokerage is charging $15 per transaction (either buy or sell), and there is a monthly contribution, this means the total annual charge in just brokerage fees will be $180 (and then another $15 when you sell) . Note, this does not include the MER.
- Lack of Liquidity: Again, also listed as one of the benefits, this can also be a weak point of ETFs. Since they are traded on the exchange, in order for one ETF to be sold, there must be a buyer. In some cases, there might be a challenge when trying to sell with limited or no buyers on the market.
- Lack of Professional Management: Mutual Funds have become famous because of the professional and active management they offer. Since ETFs mimic the index, there isn't much decisions that fund managers need to make. This can be a downfall where actively managed mutual funds can spot opportunities to buy/sell certain investments where they see fit, thereby in theory, reduce risk and/or enhance potential for higher returns. Essentially, the investor would pretty much have to do the bulk of the research/analysis on each of the ETFs to make sure they are keeping up with all the opportunities within the market. Most
- Spreds: When you conduct a buy/sell order, you have to pay a "spred" - the price at which you can buy is slightly higher then the price at which you can sell. Whoever is executing the trade in the stock market for you is basically just pocketing the difference. Therefore, you are not getting the full benefit from your trade as part of the money is going into someone else's pocket.
- Dividend Re-investment: Many ETFs will offer a dividend component which will give the investor dividends in cash. With Mutual Funds, you can directly invest the dividends back into the fund, however, ETFs do not do that. This might not allow an investor to take full advantage of purchasing additional shares/units of the ETF to maximize growth. Some brokerages are now starting to introduce a DRIP (dividend re=investment program), but not all do. Also, when re-investing the dividend, many brokerages are charging a fee for the transaction. This could further deteriorate/minimize the growth potential in the fund.
- No Guarantees: There are no guarantees in what you will get as a return when you purchase ETFs. For an investor who is risk averse, this might not be the proper type of investment for them. As opposed to something like a Segregated Fund that offers a principal maturity and death guarantee, ETFs do not have any of those type of features, which could make it a more riskier investment for many investors.
- Fund Switching: With ETFs, there cannot be any direct 'switching' from one fund to another, instead, there has to be a sell order of one fund, and then a buy order of another. Any time this is done outside an RRSP or TFSA, there is a chance of taxes (if there are any capital gains), which will hinder the growth of the portfolio, especially if there are several changes done throughout the lifetime of your portfolio. Whereas, with mutual funds, you can have fund switching without causing any taxation (if the fund is structured as corporate class). Over the lifetime of an investment portfolio, this can add up to a LOT of taxes which can drastically reduce the overall return of the portfolio. Also note that any time there is a 'fund switch' there will be buy/sell fees associated from the brokerage.
As stated many times before, there is no ONE strategy that is best for everybody. ETFs can be a great way to get returns and outperform many other mutual funds, but if used, they should be done so in a knowledgeable fashion. I would say, generally, that ETFs are more for sophisticated investors who have the time, patience, and understanding capability of the market and its trends. This would be more stressed if an investor was to invest into things like commodities, since they tend to be more risky. Also, this is not a strategy that should be used with a regular contribution plan (for example monthly contribution) because of the fees associated with brokerages.
If an investor can only do regular contributions, it would be recommended to put those smaller regular contributions into no-fee/no-load mutual fund until it reaches a larger lump sum (i.e. maybe $5,000 or $10,000), and then transfer that larger balance directly into an ETF. This way, the per transaction brokerage fees are avoided, and an investor can take full advantage of the lower MERs.
Although ETFs would be a great addition to an investment portfolio, please consult a knowledgeable financial advisor in regards to how it might fit into yours. Just as mutual funds, there are many different types of ETFs, and each should be analyzed carefully. One thing to also note is that many Mutual Funds do actually use ETFs within their portfolios (usually a small portion) to take advantage of certain opportunities, so as an investor, both can be used to compliment eachother.
I hope you have learned something from this post, and if you have any questions, please do not hesitate to contact me.
Mutual Funds vs Segregated Funds
In an earlier post, I had discussed the main differences between Stocks and Mutual Funds, as well as the pros and cons of each strategy (http://financialhealthblog.blogspot.com/2009/06/stocks-vs-mutual-funds.html). In this post I will discuss another type of investment strategy called Segregated Funds (Seg Funds) and compare that strategy with Mutual Funds.
To restate what my explanation of Mutual Funds is I'll copy and paste what I wrote in my previous post:
When giving an explanation of Seg Funds, I start by giving the explanation of Mutual Funds, and then give the differences. To better illustrate the differences, I usually draw it/write it out on paper so it is easier to understand; something similar to whats below:
(Source: http://www.segfundscanada.ca/seg_funds_comparison.asp)
Another thing to note, Seg Funds have the ability to 'Lock-In' market gains with a feature called "aut0-resets" (some also have Manual Resets). This can be very beneficial to your bottom line and can guarantee you a minimum return of more then what you started with (principal).
Please note, that since there are some added benefits to Segregated funds, they also charge higher fees (MER's) as well; usually about 1% more then a regular mutual fund. So before using the Seg Fund Strategy, you must determine if you really want to pay the extra for some added features.
Each strategy is only suitable for certain investors so there should always be a proper discussion between the advisor and client before one is chosen. As you can see, both strategies have their pros and cons and there must be careful considering before choosing either one.
I hope this has been helpful, and if you have any more questions, please do not hesitate to ask me. Please consult your financial advisor before making any decisions. If you require any more information please do not hesitate to contact me.
To restate what my explanation of Mutual Funds is I'll copy and paste what I wrote in my previous post:
Let's take a step back and examine what a mutual fund really is. Generally, this is how I explain to someone what a mutual fund is:And some of the points about mutual funds:
There are a group of people who all are investing into a pool of money, which is then invested into a company. That company has Professional Money Managers who then go and buy and sell certain investments (stocks, bonds, cash etc..). The sole purpose of these managers is to buy and sell investments and to get the best returns they can; they look over the balance sheets, income statements, research companies, look at executive statements etc... They are managing all the money that is invested with them, and the fund will earn a rate of return (either positive or negative -- hopefully positive). For doing this service, they charge an MER (Management Expense Ratio), which is like the 'service fee' so to speak for doing all that work.
Mutual Funds:Now, I think most people are familiar with, or at least have heard of Mutual Funds. Seg Funds, however, are often foreign to the average investor and have not been explained by some advisors (usually because many advisors are not licensed to deal with them). Some investors, however, are already invested in Seg Funds, but they don't even know it. They think it is just a regular Mutual Funds and don't know the difference. That being said, it can be difficult for the average investor to always distinguish between the two.
- Professionally Managed
- Can get a diversified portfolio
- Can have up to 100+ stocks
- Also may contain some bonds/cash/t-bills etc...
- Lower risk then just stock picking
- Management Fee charged
- Less control then individual stock picking
- If a few of the companies within the mutual fund tank, it will not affect your investments as much as an individual stock portfolio
When giving an explanation of Seg Funds, I start by giving the explanation of Mutual Funds, and then give the differences. To better illustrate the differences, I usually draw it/write it out on paper so it is easier to understand; something similar to whats below:
| Segregated Funds | Mutual Funds |
Overview | Your net premiums are invested in the segregated funds of an insurer which, in turn, invests in securities such as stocks, bonds and money market investments. Segregated Funds are insurance products. | Money is pooled and invested on behalf of unit holders in securities such as stocks, bonds and money market investments. |
Regulated by | Provincial Life Insurance Acts | Securities Legislation |
Capital Growth Potential | Yes | Yes |
Track unit value in the newspaper | Yes | Yes |
Diversify investments | Yes | Yes |
Financial Protection | At death and maturity, premiums minus withdrawals are usually guaranteed, between 75% and 100%. | No guarantees on investment performance. Theoretically, you could lose everything. |
Death Benefit | Beneficiaries receive either the guaranteed death benefit or the market value depending on which is greater. | The estate or beneficiaries 2 will get the market value only – there are no guaranteed minimums. |
Probate Protection | At death, proceeds can be paid directly to a named beneficiary, avoiding the estate administration process, and the cost of probate fees. | At death, proceeds are an asset of the estate and are subject to the estate, administration process and legal fees. It could be some time before the estate can distribute the mutual funds. Proceeds could bypass probe if held in an RRSP and has designated beneficiary. |
Creditor Protection | Designations in favour of a parent, spouse, child or grandchild may result in the insurance money being exempt from seizure. This is sometimes referred to as "creditor protection".
| Potential of creditor protection if in an RRSP. |
RRSP Eligible | Yes | Yes |
RESP Eligible | Yes | Yes |
Taxation Implications for non-registered investments | You are only taxed on the income you actually receive. Taxation is based on how long you own the Segregated Fund units within the income period.
You can use capital losses to offset capital gains from other sources. | You could be taxed on income you never received. Taxation is based on who owns the mutual fund units on a given date at the end of the income period.
Capital losses must be carried forward by the fund and are not allocated to you, the unit holders. |
Under what circumstances might these be more suitable? | Non-registered or registered funds. Business owners who want creditor protection. | Non-registered and registered funds. |
(Source: http://www.segfundscanada.ca/seg_funds_comparison.asp)
Another thing to note, Seg Funds have the ability to 'Lock-In' market gains with a feature called "aut0-resets" (some also have Manual Resets). This can be very beneficial to your bottom line and can guarantee you a minimum return of more then what you started with (principal).
Please note, that since there are some added benefits to Segregated funds, they also charge higher fees (MER's) as well; usually about 1% more then a regular mutual fund. So before using the Seg Fund Strategy, you must determine if you really want to pay the extra for some added features.
Each strategy is only suitable for certain investors so there should always be a proper discussion between the advisor and client before one is chosen. As you can see, both strategies have their pros and cons and there must be careful considering before choosing either one.
I hope this has been helpful, and if you have any more questions, please do not hesitate to ask me. Please consult your financial advisor before making any decisions. If you require any more information please do not hesitate to contact me.
Stocks vs Mutual Funds
This is the age-old question! A lot of people ask me what should they invest in, stocks or mutual funds? That's kind of a difficult question to answer, since most mutual funds are comprised partly (or in some cases fully) of stocks anyways. There is no general right answer for the entire population, so we must look at the differences of investing in 'single stocks' over mutual funds.
Mutual Funds are one of the most talked about and well-known investments available in Canada. We see them on TV, hear about them from our Advisors/Bankers, and also are one of the broadest investments we have access to.
Seems everybody has heard of "Mutual Funds", but not many actually understand what they are or how they work. Let's take a step back and examine what a mutual fund really is. Generally, this is how I explain to someone what a mutual fund is:
In a nutshell, that is my very 'general' explanation of what a Mutual Fund is. Many mutual funds are comprised by a good percentage of stocks; usually ranging from about 20% to about 80% (there are some funds who have less then 20% stocks and some who have 100% stocks). Mutual Funds are designed for all types of investors, ranging from those with absolutely 0 level of market risk, to those who can stand a lot of market risk and go completely aggressive.
Now, both stocks and mutual fund investing CAN be profitable, however, both are risky as well. Let's take a look at some points on both types of investments.
Stocks:
- Investing in one company at a time
- If that company tanks, your investment tanks
- You have to use your time and energy to buy/sell, research etc...
- No Management fees
- Can be very expensive to buy each stock of a company
- Per transaction fees (buying and selling)
- More control over your investments
- More flexibility
- A lot more risk
Mutual Funds:
- Professionally Managed
- Can get a diversified portfolio
- Can have up to 100 (or more) stocks
- Also may contain some bonds/cash/t-bills etc...
- Lower risk
- Management Fee charged
- Less control
- If a few of the companies within the mutual fund tank, it will not affect your investments as much (risk is balanced)
Both of these types of investments have the potential for positive or negative growth, and both have some sort of degree of risk attached to them. Generally, stocks have a higher potential to get higher gains. We've all heard of stock prices doubling or tripling in a short period of time if that specific company has substantial growth or good news coming out of it.
That being said, stocks also have a higher potential for a lot more losses. From my experience, the average investor (not institutional or big money investors) who invests only in stocks, has between 3-5 stocks in their portfolio. Now, if one of those companies goes down the drain, then potentially that can be 20% (or more) of your portfolio (depending on how much was invested in each company).
These days it can be hard to determine which companies will grow and which companies will fall. In recent times we've seen several HUGE companies go belly-up, so stocks require a lot of research and analysis in the market.
Some people try to 'time' the market, but this can be a HUGE challenge because in order to time the market properly you have to be right TWICE: first, when you buy, and second, when you sell. Even the most experienced traders and analysts have trouble timing the markets properly and many of them have lost a LOT of money when trying to do it.
Mutual Funds, in my opinion, are more seen as 'steady growth' over a longer period of time. They can be a better indicator of the performance of the broader market as a whole, rather then just one company. If, for example, a fund had 50 companies in it, and 5 of those went belly-up, that would not have as big an effect as if 1 out of 5 stocks went belly-up. So the risk is often spread out over different companies, sectors, and geographical regions, among other things.
Generally, for mutual funds, it is more of a long term investment. So, usually, you're not trying to 'time the market', because there should be the hope or expectation that in the long run the money will grow and compound anyways. It can be seen mostly as a 'buy and hold' type strategy (keeping in mind you're not in the same mutual fund for the entire period of your investment; I think it is key to be switching every now and again to make sure you're diversifying properly and keeping up with market trends).
It is clear that each strategy has its advantages and drawbacks. I generally suggest that the average person should not invest in stocks, because of the time and energy that is required to be devoted to do it. Most people do not have neither the time, the energy, nor the patience to do stock-picking. Why would you gamble with your future with something you're not able to commit proper time to?
Remember, we are all responsible for our decisions, whether we decide to invest in stocks, mutual funds or any other form of investments. One of the biggest causes of a portfolio going downhill is that we rely on other people for our advice. Some of these outside sources include Magazines, T.V., Radio, Newspapers, our friends, family etc... If you solely rely on these for stock picks, then you really should re-consider going into stocks.
Generally, for an 'average investor' I would recommend that if they are to do stock purchasing, to do so only with money that they are 'able to lose'. Meaning that if they lost that money because of that one company they invested in going out of business, then it wouldn't put them in a tough financial position. Sort of like, 'gambling money'; if you win, great, if not, no sweat off your brow!
Also, whenever making any decision, please consult a financial professional (your financial advisor/planner). If you require any more information, please do not hesitate to contact me. I hope this has been helpful!
Mutual Funds are one of the most talked about and well-known investments available in Canada. We see them on TV, hear about them from our Advisors/Bankers, and also are one of the broadest investments we have access to.
Seems everybody has heard of "Mutual Funds", but not many actually understand what they are or how they work. Let's take a step back and examine what a mutual fund really is. Generally, this is how I explain to someone what a mutual fund is:
There are a group of people who all are investing into a pool of money, which is then invested into a company. That company has Professional Money Managers who then go and buy and sell certain investments (stocks, bonds, cash etc..). The sole purpose of these managers is to buy and sell investments and to get the best returns they can; they look over the balance sheets, income statements, research companies, look at executive statements etc... They are managing all the money that is invested with them, and the fund will earn a rate of return (either positive or negative -- hopefully positive). For doing this service, they charge an MER (Management Expense Ratio), which is like the 'service fee' so to speak for doing all that work.
In a nutshell, that is my very 'general' explanation of what a Mutual Fund is. Many mutual funds are comprised by a good percentage of stocks; usually ranging from about 20% to about 80% (there are some funds who have less then 20% stocks and some who have 100% stocks). Mutual Funds are designed for all types of investors, ranging from those with absolutely 0 level of market risk, to those who can stand a lot of market risk and go completely aggressive.
Now, both stocks and mutual fund investing CAN be profitable, however, both are risky as well. Let's take a look at some points on both types of investments.
Stocks:
- Investing in one company at a time
- If that company tanks, your investment tanks
- You have to use your time and energy to buy/sell, research etc...
- No Management fees
- Can be very expensive to buy each stock of a company
- Per transaction fees (buying and selling)
- More control over your investments
- More flexibility
- A lot more risk
Mutual Funds:
- Professionally Managed
- Can get a diversified portfolio
- Can have up to 100 (or more) stocks
- Also may contain some bonds/cash/t-bills etc...
- Lower risk
- Management Fee charged
- Less control
- If a few of the companies within the mutual fund tank, it will not affect your investments as much (risk is balanced)
Both of these types of investments have the potential for positive or negative growth, and both have some sort of degree of risk attached to them. Generally, stocks have a higher potential to get higher gains. We've all heard of stock prices doubling or tripling in a short period of time if that specific company has substantial growth or good news coming out of it.
That being said, stocks also have a higher potential for a lot more losses. From my experience, the average investor (not institutional or big money investors) who invests only in stocks, has between 3-5 stocks in their portfolio. Now, if one of those companies goes down the drain, then potentially that can be 20% (or more) of your portfolio (depending on how much was invested in each company).
These days it can be hard to determine which companies will grow and which companies will fall. In recent times we've seen several HUGE companies go belly-up, so stocks require a lot of research and analysis in the market.
Some people try to 'time' the market, but this can be a HUGE challenge because in order to time the market properly you have to be right TWICE: first, when you buy, and second, when you sell. Even the most experienced traders and analysts have trouble timing the markets properly and many of them have lost a LOT of money when trying to do it.
Mutual Funds, in my opinion, are more seen as 'steady growth' over a longer period of time. They can be a better indicator of the performance of the broader market as a whole, rather then just one company. If, for example, a fund had 50 companies in it, and 5 of those went belly-up, that would not have as big an effect as if 1 out of 5 stocks went belly-up. So the risk is often spread out over different companies, sectors, and geographical regions, among other things.
Generally, for mutual funds, it is more of a long term investment. So, usually, you're not trying to 'time the market', because there should be the hope or expectation that in the long run the money will grow and compound anyways. It can be seen mostly as a 'buy and hold' type strategy (keeping in mind you're not in the same mutual fund for the entire period of your investment; I think it is key to be switching every now and again to make sure you're diversifying properly and keeping up with market trends).
It is clear that each strategy has its advantages and drawbacks. I generally suggest that the average person should not invest in stocks, because of the time and energy that is required to be devoted to do it. Most people do not have neither the time, the energy, nor the patience to do stock-picking. Why would you gamble with your future with something you're not able to commit proper time to?
Remember, we are all responsible for our decisions, whether we decide to invest in stocks, mutual funds or any other form of investments. One of the biggest causes of a portfolio going downhill is that we rely on other people for our advice. Some of these outside sources include Magazines, T.V., Radio, Newspapers, our friends, family etc... If you solely rely on these for stock picks, then you really should re-consider going into stocks.
Generally, for an 'average investor' I would recommend that if they are to do stock purchasing, to do so only with money that they are 'able to lose'. Meaning that if they lost that money because of that one company they invested in going out of business, then it wouldn't put them in a tough financial position. Sort of like, 'gambling money'; if you win, great, if not, no sweat off your brow!
Also, whenever making any decision, please consult a financial professional (your financial advisor/planner). If you require any more information, please do not hesitate to contact me. I hope this has been helpful!
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