How to Choose the Right Investment Vehicle for Your Goals

Matching the right investment vehicle to your goals is not always that simple. It’s an important topic but one that causes considerable confusion for new and experienced investors alike. Investing can seem only to relate to stocks and bonds. However, it’s more helpful to look at your portfolio and how it reflects your current life objectives. Naturally, your total holdings will include short-term investments including cash equivalents, some for the medium term, and those held to grow for many years, even decades to maximise their potential. 

Separating Short-terms Goals from Long-term Goals

Short-term goals relate to things that you can foresee will be required in the next three years. They can also be capital that you need to retain reasonable access to; however, it still forms part of an investment portfolio planned for the long-term or even to retirement age. 

People sometimes say that, “cash is king” and, in some circumstances, that’s true. When we need it there and then, we either have it to hand, can get our hands on it quickly, or it’ll cost money to do so. Therefore, while the highest investment return from a portfolio may come by excluding cash equivalents, that’s only on paper.

In reality, life has bumps along the road, which is where cash savings can help to restore balance. Having cash equivalents also avoids needing to access longer-term investments that may involve substantial penalties to do so. 

Short Terms Savings That Make Sense

The right investment vehicle for short-term goals and to preserve funds to support long-term ambitions varies depending on your requirements. 

Savings Accounts

Savings accounts are good places to keep small sums for immediate access. It removes the balance from your checking account which avoids any temptation to go shopping with the money. The interest rate return will be unimpressive and likely won’t beat the inflation rate. As such, if used as part of a larger portfolio, then the balance will need periodic topping up to keep it up with inflation to maintain its buying power. 

Short-term Deposits

The short-term deposit accounts are special accounts that lock up your funds for a minimal amount of time. This can be a few weeks, a couple of months, or something else. It all depends. The advantage here is when immediate needs can be handled using the savings account balances, then other near-cash funds can be placed on deposit for a short time. This way, they earn a marginally higher rate of return to get closer to matching inflation but can still be requested when required. By the time the money from the savings accounts is finished, the funds from short-term deposits will have been released to you. At least, that is the idea.

Short-term Guaranteed Investment Certificates

Short-term guaranteed investment certificates (GICs) are a special kind of savings investment. GICs are found at banks and other institutions that offer to take funds and put them on a deposit. These are typically for longer periods such as 12 months, instead of three months. The upside to this investment is that it’s government-backed and supports up to $100,000 in asset value. Also, because the funds are locked up for longer, the interest rate is the best of the lot. 

How Much Risk is Present with a Savings Account and GICs?

While governments may say that savings accounts with banks are protected up to a certain level should a bank failure happen, these protection schemes are rarely as foolproof as people think. Usually, they’re present to reassure savers but are largely untested. Of the different saving options for cash equivalents, GICs offer the best protection, as long as the sum doesn’t exceed $100,000. 

Are Cash Investments Risk-Free in Other Ways?

Investors often mistakenly think that cash is risk-free, bonds are pretty safe, and stocks are the risky ones. Is that true? Yes and no. In terms of capital values and return of capital, cash tends to be safer than bonds, and both are safer than stocks. However, it’s not that simple. 

Any investment must maintain its purchasing power. It must keep up with inflation or it’s losing value. Therefore, if inflation is 3% annually and the savings account returned 2%, you’ve just lost 1% of the cash value. 

By contrast, bonds tend to keep up with inflation or do slightly better. And stocks regularly beat inflation by 1-2% percentage points, plus they provide a generous cash dividend too. Therefore, there’s an inflation risk to holding too much cash because it’s unlikely to beat inflation. Also, there’s a risk to holding too much stock – even with a long-term perspective – because while it’ll likely thrash inflation along the way, it may have years where it’s down 30-50%. 

Registered Investment Accounts for Long-term Investors

There are three main registered investment accounts available to investors. These were created by the Canadian government to provide a structured way to invest for various purposes:

Registered Retirement Savings Plan (RRSP)

Perhaps the best known is the RRSP. These originate from 1957. They were designed to assist Canadians who weren’t being provided with a company pension and needed a way to save efficiently towards their eventual retirement. Up to 18% of last year’s income up to a maximum of $26,500 (as of 2019) can be placed into these accounts. They grow tax-free while inside the RRSP but are taxable after the accumulation phase.

Sums invested in an RRSP will reduce taxable income. As a result, funds are returned that were previously paid for in the last financial year. Conveniently, it’s also possible to use the RRSP from your husband/wife where part of your monies is placed in their RRSP to reduce the tax burden for the family. Furthermore, any unused allowance to invest in an RRSP is brought forward, rather than being lost.

Many qualified investments including savings, GICs, stocks, bonds, and ETFs can be included in an RRSP plan. To reduce investment costs, index funds are best. For greater trading speed, using the best ETFs in Canada provides sufficient liquidity to alter asset allocations sooner. Wealthsimple, with its commission-free trading, is an ideal platform to purchase ETFs and benefit from broad market exposure. Once you reach the age of 71, the RRSP is converted to a registered retirement income fund. It is then accessible. 

Tax-Free Savings Account (TFSA)

The TFSA is an interesting investment vehicle for Canadians. It was originally offered in 2009 as a way to save with some degree of tax efficiency. Contributing from income is not needed for the TSFA, unlike with an RRSP that is typically contributed via a salary. The annual contribution limit updates each year; 2019 was $6,000.  Funds are invested from the net, not gross funds. However, funds grow tax-free inside this investment vehicle. So, once the RRSP is maxed out for a given year, using a TFSA is a good next step. 

While some investors use these accounts purely for tax-free savings, it is possible to invest in GICs, mutual funds, ETFs, bonds, and stocks too. Therefore, it doesn’t need to be seen as only a savings vehicle but can be used long-term too.

Registered Education Savings Plan (RESP)

To help parents with expensive college payments, there is the RESP. The registered education savings plan allows for net funds (similar to the TFSA) to be invested up to a maximum of $2,500 each year. The Canadian government matches 20% of each dollar invested in this college plan to a maximum of $7,200 in benefits.

The RESP also has maximum contributions for a lifetime of $50,000. Additionally, depending on income levels, some government grants may be available. In the event that your child doesn’t go into training or further education, the funds can be used with another son or daughter. Additionally, sums can be transferred to a TFSA or RRSP. Alternatively, the balance can be withdrawn too. Therefore, funds aren’t locked up and then solely used for educational purposes alone, although this is the intended use. 

Deciding on the Correct Investment Vehicle

To obtain the best results for yourself and your family if you have one, it’s necessary to plan things out on paper first. 

RRSPs have the potential to allow you to invest the most. Their annual contribution limits are higher, and monies are invested with some tax back. These are long-term investments and need to be treated this way. Any money that goes into these won’t be seen until retirement. 

TFSAs can be used either for tax-efficient savings of net salary funds, or to invest in ETFs, and other types of investments to substantially grow the investment. For someone looking to maintain a tax-free cash balance to their portfolio, this is one way to do so. Cash isn’t accessible quickly, so it shouldn’t replace savings accounts and fixed deposits though. Also, the RESP has its place for parents who wish to put money away early and steadily add to the balance. These are created individually for each child, as needed.   

In closing, including short-term savings to cover downside risks, some tax-free cash balances, and ETFs for low-cost exposure to stocks and bonds provides a good balance. Take advantage of government-sponsored tax-efficient investment vehicles to maximise lifetime contributions too.

 

 

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