Investment Planning For Retirement

By Ivon T Hughes
investment planning

Chequing and Savings Bank Accounts

A chequing account is a transactional account that allows you to withdraw money to pay for expenses, with few restrictions on the amount or timing of these transactions. Most chequing accounts don't offer a high rate of interest regardless of the amount in the account. Their purpose is to keep your cash secure and enable easy access to it.

Chequing accounts charge fees for different services or defaults by account-holders, such as using the ATM card of another bank for cash withdrawals, not carrying the specified minimum balance, or covering overdrafts. If you do several debits, your monthly chequing account fee can range from $10 to $30.

A savings account is an investment vehicle offering a compounded interest rate on a daily, weekly, monthly or yearly basis. The rates may not be high and, consequently, yields may be meagre but they add up to a big sum over many years. A savings account can be a long-term investment that helps preserve your wealth in a volatile stock market by providing a guaranteed interest amount while also funding planned future expenses.

  • A regular savings account typically doesn’t charge a monthly fee. You earn a small interest amount, and you can withdraw cash quickly and easily.
  • A combined chequing and savings account offers a bigger interest than a checking account but a smaller one than a regular savings account. You pay a fee every time you write out a cheque.
  • A high-interest savings account gives you the opportunity to earn a bigger interest amount. It typically requires you to make a minimum deposit.

It is best to maintain a chequing account as well as a savings account. With online and moble banking options, managing both accounts is simple and convenient.

Guaranteed Investment Certificates

A Guaranteed Investment Certificate (GIC) pays a higher interest than a savings account, but you can withdraw your money only after a specific period of time. A GIC term can range from 30 days to five years. The minimum investment you must make is $500 or $1,000.

Most GICs pay a fixed interest for a specific term. Some may pay a variable interest rate tied to the performance of a stock exchange index or other benchmark. If you want to withdraw your money sooner than the set term, a penalty is usually charged if that option is available. There is no fee when you buy a GIC. You can hold GICs in a registered investment account such as an RRSP or RRIF. GICs are ideal if you want to secure extra funds that you don't immediately need and want the safety of guaranteed interest rates.

Stocks

By investing in a stock, you are buying ownership shares or equity shares in a company. There are two ways in which you make money from stocks. One is through dividends issued by the company as a way of sharing some of its earnings with shareholders. You have the option of taking the cash dividend or reinvesting the amount in purchasing more shares of the company. The other is the capital gains that you earn when you sell the shares at a profit.

Suffice to say that the stock market can be volatile, and a strategic investment approach is the only way to address risk, minimize losses, and capitalize on profit potential. The performance of a stock depends on several factors, the most critical ones being the profitability of the company and resultant strong demand for the stock among investors, the overall stock market sentiment, political uncertainty, economic climate and a rise and fall in interest rates. Stocks tend to follow a cyclical pattern of strength and weakness over a period of weeks or months.

Bonds

A bond is a debt instrument. When you purchase a bond, you're lending money to an institution – the government or corporation – over a specific period of time, ranging from one year or less to up to 30 years. In return, you receive interest payments during the term, plus your full principal when the bond reaches its maturity date. The regular interest payments on bonds make them a fixed-income investment. Most bonds have a fixed interest rate, while some have floating rates that fluctuate over time. The interest rate is determined by various factors, including current market rates, the bond's term and the issuer's creditworthiness.

Bond prices increase with the decrease in interest rates. You can use this opportunity to sell your bond before it matures. Bond investors face interest rate, inflation, market and credit risk.

  • If you sell a bond for less than what you paid, before its maturity date, you will incur a loss
  • If the earnings on your bond investment don't increase with the rise in inflation, you can end up with a net loss when your return is adjusted for inflation
  • In the event that the overall bond market falls, the price of your bond investments will also suffer
  • Credit risk arises from the issuer's inability to make interest payments owing to financial instability

Diversification and bond laddering are two risk management strategies you can explore. The former involves selecting a mix of bonds – corporate and government – to spread out risk. The latter addresses interest rate risk. Here, you buy bonds with different maturity dates. With this laddering strategy, you don't have to worry about all your bonds maturing at a time of low interest rates. By freeing up cash, laddering also allows you to take the income or reinvest. The same strategy applies to GIC’s

Exchange Traded Funds (ETFs)

An exchange traded fund (ETF) is an investment pool holding a set of underlying assets. You can buy or sell the shares of an ETF just like the shares of a regular stock. ETFs have become popular for a number of reasons, including :

  • A wide range of investment options, from commodities and fixed income to stocks and real estate
  • Tax efficiencies, with capital gains tax realized only when you sell your entire investment
  • Transparent disclosure of your fund's holdings and weights on a regular basis, enabling you to assess the risk of your portfolio more efficiently.
  • Ease of trading

The risks to consider when trading ETFs are

  1. variance in the trading price of shares
  2. lack of an active market when you decide to sell, as there is no guarantee that investors will buy the shares of an ETF
  3. lack of a benchmark for active ETFs, making it difficult to compare performance.

There are several costs associated with ETFs. Your ETF manager will collect the management expense ratio (MER), which is a percentage of a fund's average net assets paid out annually to cover its daily and fixed management costs; an annual management fee; operating costs and the brokerage commission.

Mutual Funds

A mutual fund is an investment vehicle that pools money from many investors to purchase stocks, bonds and short-term money market instruments. Your money is invested in various asset classes in line with your investment goal. Mutual funds are well diversified to counteract potential losses.

You can earn money from mutual funds in three ways : through dividend payments on stocks and interest on bonds; capital gains distribution from selling a security that has increased in price; an increase in net current value (NAV), the fund's market value per share.

If the securities held by the fund decline in value, you may lose some or all of your invested money. A change in market conditions can also affect your interest or dividend payments.

Consider mutual funds if you seek:

  • Professional investment management, with the fund manager selecting securities and monitoring performance
  • To minimize risk through diversification
  • To redeem your shares for their current NAV at any time

There are certain costs associated with every mutual fund. Besides the MER and shortterm trading fees charged for redeeming shares within a short period such as 30 days, sales commissions must also be factored in. A sales commission or load is a one-time fee compensating a broker or investment adviser for selling a mutual fund to an investor.

  • A no-load fund charges no commission when a fund is redeemed or bought
  • When you buy a front-end load fund, you must pay a sales fee – typically 5% - on the day you buy the mutual fund.
  • A back-end load of up to 6% is charged when you sell your shares

How to manage investment risk

There are four basic investment strategies used to manage risk efficiently:

  • Diversifying your investments
  • Investing with a long-term perspective
  • Investing regularly
  • Spending some time every day analyzing the markets and your portfolio, or engaging the services of a personal investment adviser

Risk management

The proven risk management strategies leveraged by stock market investors are diversification, asset allocation and dollar-cost averaging.

Diversification insures your portfolio against losses in a falling market. Investing in various asset classes – cash, fixed-income, equities and commodities – counterbalances the weak performance of one asset class against a strong performance from other asset class(es). Mutual funds are the simplest way to diversify your investment, with a single fund holding securities from several issuers.

Asset allocation involves dividing your investment across different asset categories such as stocks, cash and bonds. Asset classes have been seen to perform differently from year to year. The idea behind asset allocation is to expose your investment to wellperforming asset classes over a long-term horizon to minimize risk of losses and increase possibilities of a net gain. It is, of course, important to choose a right mix of asset classes. This decision will depend on your investment goals, appetite for risk and investment time-frame. For instance, if you're in your 20s or 30s, an asset allocation comprising a high percentage of equities may make sense. If you're in your retirement years, you may want to focus mostly on fixed income and cash with a smaller percentage of equity (to adjust for inflation).

In dollar-cost averaging, you buy a certain number of shares of a company at regular intervals of time. The idea is to use the fall in price to purchase a higher quantity of shares and fewer during a price rise.

Pensions

The first Registered Retirement Savings Plan (RRSP) was created by the federal government in 1957. Called registered retirement annuity back then, it allowed contributions of up to 10% of income, to a maximum of $2,500. The need to have an RRSP is quite clear. Canada Pension Plan benefits and Old Age Security payments will provide only a small retirement income. RRSP helps makes your post-retirement life more financially comfortable.

What are the benefits?

RRSP contributions are tax-deductible, enabling significant tax savings, and increasing your retirement funds pool to grow without the hassle of having to pay tax on growth each year. You benefit even more if your marginal tax rate at the time of withdrawal is lower than your tax rate at the time of contributions. RRSP’s are therefore, recommended if you want to defer your income and taxes from your working years – when you pay a higher income tax – to retirement – when you expect to have a lower income.

RRIF or annuity?

RRIF or annuity which is better? Annuities offer a guaranteed retirement income. Insurance companies focus on low-risk investments to provide you a steady guaranteed stream of income for your lifetime.

Do you want the peace of mind of a guaranteed monthly payout?

If yes, buy a life annuity to ensure guaranteed income for life. Also consider it if you have no other source of income other than Old Age Security (OAS) and Canadian Pension Plan (CPP).

Do you want the flexibility to withdraw money as and when you wish?

If yes, a RRIF is the way to go, allowing you to withdraw funds as and when you feel such a need.

An annuity fixes monthly benefits permanently. But there are different variations you can make yourself.

Do you want to avoid outliving your retirement savings?

If yes, a life annuity is a risk-free option guaranteeing payments for as long as you live. But with a RRIF you can outlive your funds, depending on the performance of your assets.

Do you want your retirement funds to be transferred to your spouse upon your death?

A RRIF can be transferred to your spouse A joint-life annuity however provides automatic spousal protection.

You can convert a RRIF to an annuity whenever you want.

Ivon T Hughes

About the Author

Ivon T. Hughes

Ivon T Hughes is a leading expert in life annuities in Canada. His website LifeAnnuities.com is a recognized authority on annuities. He's also an established insurance and investment broker, through The Hughes Trustco Group since 1972. Recently, he's been redefining how annuities are sold in Canada.

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