Clear as Mud

The global financial industry is notorious for making up complex structures and products whether they be for investment, tax planning, insurance etc. To make matters even more worrisome for the average person, financial professionals often slap on complicated names and acronyms for products and services which contribute further to the confusion. If you are one of those people that have a tough time making any sense of financial markets, your investments or your financial plan, don't worry because you are far from being alone.

My main purpose in writing these pieces is to help clear this confusion and so I thought that this week it would be a good idea provide you with some definitions and explanations for some of the more common terms and acronyms financial professionals often use. The list of complicated topics, acronyms and terms is huge, so I will attempt to tackle a few items at a time and periodically write a 'Clear as Mud' piece based on some of the questions I am hearing from working with our clients and other people.

As always, my purpose is in helping people to understand how the world of personal finance works and helping you to make the best decisions for yourself. Hopefully this will help to filter some of the mud.

Let's start with the different types of investment accounts you can have in Canada. To be clear, there are literally dozens of different account types depending on your investment dealer, let's focus on the main three.

RRSP – Registered Retirement Savings Plan  

RRSPs are registered investment accounts that provide investors with a 100% income tax deduction for money contributed in. Money can be invested in a broad range of different investments including Mutual funds, ETFs, Stocks, bonds, cash and many more. Investments within RRSP accounts will grow tax deferred, meaning you won't pay tax annually on interest, dividends or capital gains. When you redeem money out of RRSP account you pay income tax on the full amount withdrawn, taxed in the same way your income from employment is taxed.

TFSA – Tax Free Savings Account

TFSAs essentially act as the name suggests, all growth from investments in TFSAs is tax free. You do not pay any tax when money is withdrawn from TFSAs and you do not pay tax year over year on investment growth of any kind or distributions. Unlike RRSPs, you do not receive an income tax deduction for contributions so if you're looking for immediate tax relief this is not the account for you. However, there is a lot to like about TFSAs as every year you can contribute an additional $6000 currently and that contribution room could increase in the coming years.

As an example, annual contribution room in 2018 was $5500. As of 2020, if you haven't contributed at all to your TFSA you can contribute up to $69,500 as long as you were at least 18 years old in 2009. You never lose your unused contribution room, it simply carries over to the following year, and any withdrawals you make from your TFSA will also be added to your available contribution limit in January of the following year.

An often misunderstood fact about TFSAs is that you can invest your money into a broad range of investment options in fact you have the same options available to you in your TFSA as you do in your RRSP, see above for some of those options. So again, if you thought that you would be limited to investing in only savings accounts or GICs in your TFSA, take note, you can take advantage of some much higher earning investments which can be far more lucrative for you.

Non-registered  

These accounts are quite simply taxable investment accounts. Unlike registered accounts like RRSPs or TFSAs, you will pay tax on investment distributions including dividends and interest, annually, and you will also pay capital gains tax on crystallized gains. One nice advantage that you do have in non-registered accounts is that if you have triggered capital losses in your non-registered account from selling an investment that went down in value, you can use that capital loss amount against an equal amount of capital gains and avoid paying taxes on those gains. Even if you had capital gains in previous years, you can carry a capital loss back up to three years and reclaim some tax that you have already paid. Additionally, capital losses can be carried forward indefinitely against future capital gains.  

Now that all sounds great but hopefully you don't have too many losses in your portfolio as that certainly isn't the idea behind investing in the first place. So those are the basics of the three most common investment accounts, now let's look at some of the more common investment types and what they actually are.

Equities (stocks)

Stocks are essentially a share of ownership in a company. For example, if you own 1% of a company's shares then you are entitled to 1% of that company's assets and earnings.  If you own equity in a company then you are quite literally an owner of that company. There are many different classes of stocks available, depending on the company, with many different options available including voting and non-voting shares but to keep this simple just think about stocks as stakes of ownership.

Bonds

Bonds are essentially debt that you own. Think about it like this, if you are buying a bond you are essentially lending a company or a government money. In return, that borrower promises to give you back the money you lent them and also some interest on top of it. To put it another way, when you borrow a loan from a bank, it's almost like they bought a bond from you. Different bonds will have different ratings given to them by rating agencies which relate to how confident the agency is that the bond will be repaid.

For example, Standard and Poor's, a rating agency, will rate bonds from AAA ratings all the way down to D ratings on the low end with many ratings in between, AAA being the highest quality rating they will give.  There are also other rating agencies that do the same and have their own rating scales, including Moody's and Fitch.

Mutual funds  

Mutual funds are made up of a pool of investors' money collected for the purpose of investing in investment securities such as stocks, bonds, cash and many other assets. Different fund types will have different mandates for what they can own. For example, fixed income funds will typically be required to own a high percentage of bonds in their funds versus equity funds which will be required to hold a high percentage of stocks.

When you invest in a mutual fund you don't actually own the underlying investments held in the funds but rather you own units of funds themselves. This structure can be very useful for new investors starting out as it will allow you to buy into a broadly diversified fund through owning units, which would be difficult to do if you were trying to recreate the same diversified portfolio by buying the underlying individual investments until you have more money.

Mutual funds have portfolio managers who are paid to pick the underlying investments. Again there are a broad range of types of funds with different investment strategies so it's important that you choose one that fits your personal investment objective.

ETFs

Exchange traded funds (ETFs) are similar to mutual funds in that they are a pool of money from investors which own underlying investments. Like mutual funds there are many different types of ETF types which own a variety of different underlying assets including stocks, bonds, real estate and more.  Unlike most mutual funds, ETFs are designed to track a certain index and are considered to be more passive investments.

ETFs still have portfolio managers but instead of trying to pick and choose the underlying investments in the pool in an effort to try and outperform some benchmark, the ETF manager is simply there to own the same holdings as the index that they are meant to track. Due to the fact that there is no 'active management' for the ETF, the costs of owning ETFs is generally lower than mutual funds. ETFs are also traded on the stock market and can be traded during regular market hours unlike mutual funds which are only bought and sold at the end of the trading day.

Please note, that although I am commenting on a few different investment account types and a few different types of investments, I am not making a comment about which I feel are better or worse than others. Simply put, there is no one size fits all approach and the investment accounts you use and in turn the types of investments you own needs to be customized to your own individual situation. There are a lot of factors that go into this including your tax situation, the return needed to accomplish your goals as outlined in your financial plan and your comfort levels for volatility.

Knowing what options are available out there will simply help you to understand what you own and make better choices for you and your family. This is certainly not an exhaustive list and so if you have any questions about other financial terms or acronyms please send them my way and I will be happy to clarify things for you. As always, I welcome your questions and comments.

- Grant White, CIM, CFP

Grant White is a Portfolio Manager/Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Grant White who is a Portfolio Manager for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Portfolio Manager can open accounts only in the provinces in which they are registered.