The path towards investing can seem a distant prospect for many, especially when factoring in the challenges of saving after housing and living expenses. Don’t lose heart, there will come a time where savings will accumulate.
In preparation for when that time comes, and as part of Financial Literacy Month, brush up on some of the basic investing terminology that can help get you started down the right path.
Registered investment account: This is a type of investment account (RRSPs or TFSAs, for example) is registered with the federal government. These accounts allow investments to grow tax free and are intended to be used for long-term savings objectives. RRSP contributions are tax deductible but you’re taxed when you make a withdrawal. TFSA contributions are made with after-tax dollars and aren’t subject to taxes upon withdrawal.
Non-registered investment account: This is a type of investment account that allows Canadians to save for either short- or long-term objectives. This is a taxable account so you pay tax on 100% of any interest income you earn. But if you have a capital gain when you sell an investment, you pay tax on just 50% of your gain. There are no contribution limits for these accounts.
High-interest savings account: This is a type of account—available at banks and credit unions—that pays a higher rate of interest than regular savings accounts. High-interest savings accounts can be used to accumulate savings for future investing or for an emergency fund.
Stock: This is a type of security that signifies a tiny piece of ownership in a company. It represents a claim to the firm’s assets and earnings. The better the company performs, the more likely the stock can increase and vice versa. In order to buy an individual stock, you’ll need to get a brokerage account from your financial institution. Stocks can be held in registered or non-registered accounts.
Bond: Also known as a fixed-income security, a bond is an agreement to loan money to a corporate or government entity for a defined period of time (maturity) at a specified interest rate. Companies and governments (federal, provincial, or municipal) use the money to finance various projects or activities. Bondholders usually receive regular interest payments twice a year. When the bond matures, the issuer of the bond will repay the principal. Bonds can be held in both a registered or non-registered account.
Guaranteed investment certificate (GIC): GICs offer a guaranteed rate of return over a fixed period of time. This low-risk investment is typically issued by trust companies or banks. GICs can be held in registered or non-registered accounts.
Mutual fund: A mutual fund pools together money from many investors to buy stocks, bonds, or both. Mutual funds can hold hundreds of stocks or bonds in an effort to diversify and spread the risk. The specific details on the fund’s holdings and any fees involved are contained in a legal document called a prospectus. A money manager decides on what and when to buy in an attempt to outperform a benchmark index. Mutual funds can be held in both registered and non-registered accounts.
Management expense ratio (MER): This is the annual fee associated with managing a mutual fund or exchanged-traded fund, which includes management, administrative, record keeping and advertising costs to maintain the fund’s buying and selling activities. This fee is paid by investors regardless of the fund’s performance, thus a higher expense ratio can negatively impact investment returns. A 2013 Morningstar report found the average expense ratio for equity mutual funds was 2.42%, the highest in the developed world. If you own a mutual fund with an MER of 2.42%, that means you pay $242 annually for every $10,000 invested.
Index funds: The investments in this type of mutual fund are designed to mimic a given index. Indexes (the S&P/TSX Composite Index in Canada or the S&P 500 in the U.S.) are essentially a collection of stocks or bonds that represent a portion of the economy. The return of an index fund is tied directly to the performance of the companies within the index. As the management of index funds doesn’t rely on money managers to make decisions, the management expense ratios can be as low as 0.32%. Index funds can be held in registered and non-registered accounts.
Exchange-traded fund (ETF): This type of security also tracks an index. Unlike a mutual fund, ETFs are bought and sold like stocks. ETF management fees can go as low as 0.06% but can incur charges around $10 to buy and sell. However, there are some discount brokerages (Questrade and Scotia iTrade, for example) that don’t charge for the buying of and selling of a number of ETFs. You can hold ETFs in both registered and non-registered accounts.