As we tame our debt loads and start to understand the differences between “needs vs wants”, as defined in part 2 of this on-going series, the following steps should be logical in our post pandemic world:
- Maintain and refine our established budgets.
- Crank up our savings rates.
- Offload high interest debt loads.
- Plan for the next emergency or even another Black Swan event.
One of the recurring questions I keep hearing from many who were swayed by years of low interest rates is this – “When are things going to return to normal?” The real question is, what is normal? When I left school and started working on Bay Street in 1981, I was placing short term money market for pension plans (maturing in less than 365 days) at rates of 20-21%. I witnessed people literally pitching house keys at tellers at our concourse branch of Royal Trust in downtown Toronto because they couldn’t stomach renewing their mortgage rates at 18% plus! It quickly dispels the myth that so-called Boomers had it so easy because wages were significantly lower, and many households were still single incomes.
That said, the solution is NOT a drop in interest rates back to 2% but a wiser choice to break bad habits precipitated by the shift to a consumer-based economy. Lining up for hours to switch out your iPhone 15 when you own a dynamic iPhone 14 or those who rely on a fistful of weekly lottery tickets as a solid retirement plan.
What is Investing?
Investing involves allocating your funds with the expectation of earning a return greater than your initial investment. While there’s a wide array of options for investment, including businesses, real estate, stocks, and various asset classes, none of these avenues guarantee profits. Businesses may falter, markets can fluctuate unpredictably, and the value of stocks may decline. This inherent uncertainty underscores the risks associated with investing.
According to a 2022 study by BMO Financial Group, more than three-quarters (77%) of Canadians have investments, reflecting a widespread engagement in financial markets. One of the most straightforward methods of investing is through a specialized account dedicated solely to managing your assets. These accounts are offered by financial service providers like Exponent.
Saving vs Investing
Saving and investing both serve the purpose of establishing a financial safety net, albeit through different approaches. Saving involves setting aside money in a secure location for future use, typically within the next few years. On the other hand, investing entails purchasing assets with an acceptance of risk, with the aim of potential appreciation in value over time.
For instance, funds deposited into a savings account typically earn a guaranteed interest rate, ensuring growth regardless of market fluctuations. Although savings account interest rates may vary, the growth of deposited funds remains assured, with minimal risk of loss. Conversely, investments seldom come with guarantees, making it uncertain whether a profit will be realized, and there’s a possibility of losing some or all of the invested capital.
So, why consider investments over savings accounts? Well, in 2022, the average rate for high-interest Canadian savings accounts stands at 1.29% (not much better today). In contrast, the S&P/TSX Composite Index, a broad representation of the Canadian stock market, has averaged a total return of 8.68% over the past decade. This 7.39% difference in potential profit highlights the rewards associated with taking investment risks (risk vs reward).
The impact becomes evident when examining how Canadians utilize their tax-free savings accounts (TFSAs). According to BMO’s 2022 annual savings study, a significant portion of TFSAs (56%) primarily hold uninvested cash, with some accounts containing over 75% cash holdings. While cash reserves are essential, TFSAs also have the capacity to hold investments, providing an opportunity for tax-free earnings. However, only about half of Canadians (49%) are aware of this capability, potentially missing out on substantial tax-free growth.
While savings accounts offer guaranteed interest, investing presents the prospect of significantly higher returns. Nonetheless, investing may not be suitable for everyone, and beginners should carefully consider several factors before embarking on their investment journey.
What’s next?
If you prefer to entrust your investments to a professional, engaging a financial advisor could be the ideal option. Investment management services, also known as wealth advisory services, are available through all major financial institutions in Canada. One solid bit of advice is buyer beware. Check credentials, experience and especially pricing as it can often be hidden or not transparent. Cost of investing can take a serious bite out of your “net returns.”
With this approach, a financial advisor takes charge of constructing and overseeing your investment portfolio on your behalf.
This strategy is particularly suited for investors who prefer not to handle their own investments and value the personalized guidance provided by a financial advisor. In a world where change is now a constant, there are other choices such as Robo-Advisors and DIY platforms, but they are fraught with limitations and quickly cost the investor more for greater access and accuracy. Our model comingles families while maintaining Canadian Privacy laws amongst individuals in efforts to effectively educate, secure family legacies and provide a fairer pricing model not found elsewhere. In a more expensive, post pandemic environment, our objective is one that ensures effective intergenerational wealth transition using several integrative financial strategies.
