Personal Finance Chapter 10

CHAPTER 10 – FUNDAMENTALS OF INVESTING        Investment Plan Goals/Objectives Risk Tolerance Asset Allocation Assumptions Investment Selections Implementation Steps Ongoing Monitoring         Establishing Investment Goals Financial goals should be SMART Ask yourself.. What will you use the money for & how much will you need? How will you obtain it? How much risk are you willing to assume? Are you willing to sacrifice current consumption to invest? What possible economic & personal conditions could alter your investment goals? What will happen if you don’t reach your goals? Investment Vehicles – Not Investments Registered Retirement Savings Plans RRSP – An Investment Vehicle not an investment Savings Plan then an Income Plan • Savings plan to build wealth for retirement; then transition to a…. • Income plan to provide an income during retirement years • The RRSP was introduced in 1957 to encourage Canadians to save for their retirement • RRSPs allow us to save money on taxes during the years we contribute • RRSP’s allow for tax deferred growth so our investments can grow faster • RRSP contributions are deducted from income • Income is reduced in the highest tax bracket, therefore taxes saving is maximized • A RRSP Contribution of $10,000 reduces the tax bill by $3,600 • Investment growth within the RRSP is tax sheltered until the time of withdrawal • We don’t pay taxes on interest, dividends or capital gains inside our RRSP • The end result is that investing inside an RRSP increases the rate at which the savings compound • RRSP – Savings Plan – 3 Types • Basic – investment provider sets up RRSP • Self Directed – set up to hold investments not available in a Basic RRSP • Group – sponsored by an employer, union or professional association • Contributions: • Current Year RRSP Contribution Limit: Lesser of • 18% of earned income and the RRSP limit • 2015 maximum contribution is $24,930 • Earned Income • Employment income, rental income from property, taxable wage loss benefits, self employment income, royalties • Notice of Assessment • Your tax return receipt from the previous year indicates what you are able to contribute the following year, including your “carry forward” amount • Unused contribution room • This can be “carried forward” indefinitely, allowing you to contribute that amount in future years • Tax deductible contributions • To be deductible the contribution must: • Be made within the prescribed contribution limits • Be made during that calendar year or in the first two months of the following year, or have been made by over-contribution in previous years • Qualified Investments • GIC’s • Bonds • Shares listed on prescribed stock exchange • ETF’s • Mutual Funds • Mortgage secured by real property in Canada • Covered call options • Gold and sliver • RRSP – Income Plan • Withdrawals are taxable as ordinary income • Exceptions • Home Buyers Plan • Life Long Learning Plan • RRSP – Home Buyers Plan • Conditions for participation • First-time buyer • Have not owned a home as your principal residence within last 4 years • If you have a spouse/common-law partner, you did not live in house owned by that person. • Withdraw up to $25,000 tax free • Funds must have been in your RRSP for 90 days • Pay your RRSP back in 15 equal installments • Payments begin the second year following the withdrawal. • If you don’t make a payment the amount is considered income for that year.             TFSAs Basics: investment vehicle not an investment must be 18 to open a TFSA after tax money is contributed to a TFSA withdrawals from a TFSA are tax free you can contribute to your spouse or child's TFSA and not worry about attribution rules o Contributions: started in 2009 contribution limit for 2009 through 2012 was $5,000 contribution limit for 2013 and 2014 is $5,500 unused contributions carry forward indefinitely withdrawals in one year are added back to contribution room in the following year o Withdrawals: withdrawals are tax free withdrawals can be used for any purpose Common Uses: • Save for short to mid-term goals • Save for Retirement • low income individuals get same benefit as RRSP • high income individuals can create tax efficient income in retirement and protect OAS from claw back • Parents who with to assist adult children – best way to transfer wealth tax free • Education savings (beyond amount eligible for CEG’s in a RESP) • Excess income during retirement (especially after age 71)             Open or Non-Registered Basics: No Contribution Limits After tax money is contributed (no tax deductions) Realized losses and gains are declared for income tax purposes Preferred tax treatment for Dividend and Capital Gain income Savings Accounts: Regular and High Interest savings accounts Interest income taxed as ordinary income Used for short-term goals and non-reoccurring expenses Investment Account: Generally used after; maximizing TFSAs Ensuring pensions and RRSPs will meet retirement basic retirement needs Individual or Joint owner accounts Generally no restrictions on investment options      What’s Investing? Investing makes your money grow Investing capitalizes on economic growth Investing involves some level of risk Investing rewards patience Investing outpaces inflation   Value of Long-Term Investing Programs Many people don’t start investing because they only have a small amount to invest but.... Small amounts invested regularly become large amounts over time. Characteristics of an Investment 1. Risk The uncertainty about the rate of return that you’ll earn from an investment 2. Return The money made from an investment, including the income and capital gain 3. Liquidity The ease and ability of selling your investment in the marketplace without losing money 4. Term How long you are planning to hold onto your investment        Investment Planning Goals/Objectives Risk Tolerance Asset Allocation Assumptions Investment Selections Implementation Steps Ongoing Monitoring      Risk Tolerance The degree of uncertainty that an investor can handle in regard to negative change in the value of his/her portfolio. THE SLEEP TEST the amount of psychological pain you’re willing to suffer for your investments How much volatility in your investment can you handle (standard deviation) Impacted by SMART Goal components Usually the shorter the time frame the less tolerance for risk        Factors Affect the Choice of Investments Safety and Risk The potential return on any investment should be directly related to the risk the investor assumes Safety in an investment means minimal risk of loss Potential return on any investment should be directly related to the risk the investor assumes Risk associated with investing; You could lose all or part of your principal The purchasing power of your investment can decrease You may not receive the return you expected Fundamentals of Investing Risk Tolerance – Questionnaire (BMO example on blackboard) • Takes into consideration • Time Horizon • Financial Stability • Investment Choices • Tolerance for volatility  Asset Allocation Diversification Investment Pyramid – Asset Classes Steps in Effective Investment Planning 1. Establish your SMART Goals. 2. Determine the amount of money you need to obtain your goals. 3. Specify the amount of money you currently have available to fund your investments (Cash Flow Analysis). 4. Determine the most appropriate Investment Vehicle for the goal. 5. Determine the most appropriate Asset Allocation based on the goal, time horizon and risk tolerance. See “6 Asset Allocation Strategies That Work “ on Blackboard under Course Materials 6. Determine how much you will have to save each month to achieve your investment goal. a) Rate of return assumption based on asset allocation. Behavioural finance 1. Loss Aversion a. People do weird shit to avoid loss 2. Anchoring a. “Mental price” b. “I’m just gonna hang on until I get my money back”