hisfa shaukat

Personal Financial Planning – Managing your finances to achieve ‘personal economic satisfaction’

– Successful planning allows for: • Better access to financial resources

• Better control of your financial affairs • Improved personal relationships / less personal stress

Six Step Process

· Step 1: Determine Current Financial Situation

– Consider income, expenses, debt, etc.

· Step 2: Develop Financial Goals

– What do you want to achieve with your money • Individualspecific

– Values and attitudes impact your financial goals

· Step 3: Identify Alternative Actions

– Alternatives are important to the decision making process

· Stay the course

· Expand the current situation

· Change the current situation

· Start a new course

· Step 4: Evaluate Alternatives

· – Can be many ways to achieve the same goal

· – However, alternatives have consequences

· • Need to consider opportunity costs of each alternative – Both personal and financial

· » Measure financial opportunity costs using time value of money

• Step 4: Evaluate Alternatives (cont.)

· – Alternatives have risks which need to be identified and evaluated

• Step 5: Create and Implement a Financial Plan

· – Objective is to choose alternatives that allow you to achieve your financial goals

· • Step 6: Re-Evaluate and Revise the Plan

· – Evolving plan that changes as conditions change

· – Would re-evaluate based on a specific event (e.g., loss of job) or at regular intervals (e.g., every year)

· Financial Goals • Influencers of Financial Goals:

· – Timing of goals • Short, intermediate, and long-term

· – Differing financial needs • Consumable, durable, intangible products

· Financial Goals

· • Influencers of Financial Goals: – Life situation

· Financial Goals • Goal Setting Guidelines

· – Goals should: • be realistic

· • be specific and measureable • have a time horizon • guide your financial actions

· – SMART

· Economic Factors & Financial Planning • Market Forces

· – Supply and demand determine prices • Financial Institutions

· – Facilitate the actions of your financial plan • Global Influences

· – Can influence exchange rates, interest rates, prices, etc.

· Economic Factors & Financial Planning • Economic Conditions

· Economic Factors & Financial Planning

· • Economic Conditions – Consumer prices – Consumer spending – Interest rates

· Achieving Financial Goals

Part1: planning your personal finances

Part2: manageing your credit

Part 3: insuring your resources

Part 4: investing your financial resources

Part 5: controlling your financial future

Time Value of Money Review

Present Value (PV)

• Concept – a dollar today is worth more than a dollar in the future

– Why? • Can add and subtract cash flows so long as

they are valued in the same time period

• * Assume for all questions on these slides that the applicable interest rate is 6%, unless otherwise stated

Present Value (PV) • Single Cash Flow

– Determine the PV of a single future cash flow

– Example: You are scheduled to receive a $50,000 bonus from your employer in one year. What is the bonus worth in today’s term?

Present Value (PV) • Multiple Cash Flows

· –  You can add or subtract the PV of multi1

· –  Example: You are scheduled to receive a $35,000 bonus next year followed by a $90,000 bonus three years from today. What is the PV of your future bonus?

Present Value (PV) • Multiple Cash Flows

– If we have cash flows that are of equal value and equally spaced apart, we can simplify the PV

– Example: As part of your inheritance, you are scheduled to receive $25,000 per year, starting one year from today. In total you will receive 15 payments. What is the PV of your inheritance?

Future Value (FV)

• Concept – Rather than looking for a value in today’s terms, with future value we are looking for the value of a cash flow at some point in the future

• As with PV, we can add and subtract the FV of cash flows so long as they are valued in the same future time period

• Simple versus compound interest

Future Value (FV) • Single Cash Flow

· –  Can determine the value at a future date of a current cash flow

· –  Example: You have $5,000 in your bank account. If you make no further deposits nor withdrawals, how much will you have in your account in 12 years?

Future Value (FV) • Multiple Cash Flows

· –  Can add or subtract multiple cash flows so long as we first determine the value of each at a common future date

𝑇 𝑡=1

· –  Example: You have $7,500 in your bank account today. You will deposit $10,000 in one year and $15,000 in two year’s time. How much will you have in your account 10 years from today?

• How much would be in your account in 15 years?

Future Value (FV) • Multiple Cash Flows

– If we have cash flows that are of equal value and equally spaced apart, we can simplify the FV

– Example: To save for retirement, you will deposit $5,000 a year into your bank account for the next 15 years, starting one year from today. How much will you have in your account when you retire in 15 years?

Examples

You will receive payments of $15,000 in years 2, 5 and 8.

1. What is this cash flow stream worth today?

2. What would the cash flow stream be worth in year 10?

You have the option to receive one of the following:

2.

i. ii. iii. •

$1,500 a year for ten years $17,500 in ten years $13,500 today

Which should you pick?

Money Management Strategy

• Money Management: “Day-to-day financial activities necessary to manage current personal economic resources while working toward long-term financial security”

– That is, how you manage your daily spending while still meeting your long-term goals

– Need to consider opportunity costs when managing money

•

Personal Financial Records

Want to maintain accurate records for: – Handling daily affairs – Financial planning – Taxes

– Etc. Usually kept in one of three places:

1. Home files (taxes, employment records, insurance docs, etc.)

2. Safety Deposit Box (mortgage papers, will, etc.)

3. Personal computer (budgets, Excel sheet of transactions, etc.)

Maintain sufficient history

•

•

Personal Financial Statements

• Help with the first step in the financial planning process: Determining current financial situation

• Personal financial statements comprise a personal balance sheet and a cash flow statement

Personal Financial Statements • Personal Balance Sheet

– Aka net worth statement: 𝑊h𝑎𝑡 𝑌𝑜𝑢 𝑂𝑤𝑛 − 𝑊h𝑎𝑡 𝑌𝑜𝑢 𝑂𝑤𝑒 = 𝑁𝑒𝑡 𝑊𝑜𝑟𝑡h

– Net worth is a measure of your current financial position

• It is not necessarily an indicator of financial success/failure

• Why?

Personal Financial Statements • Personal Balance Sheet

– Allows you to: • Measure your progress toward financial goals

• Determine how your assets are distributed • Calculate your current asset allocation • Identify tax efficiencies • Identify assets that may be damaged or stolen • List your indebtedness

Personal Financial Statement • Personal Cash Flow Statement

– While the personal balance sheet is a snapshot in time, the cash flow statement measures the inflow and outflow of cash over a given period

• Would you want to measure personal cash flow over a year?

𝐶𝑎𝑠h 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑 − 𝐶𝑎𝑠h 𝑂𝑢𝑡𝑓𝑙𝑜𝑤𝑠 = 𝐶𝑎𝑠h 𝑆𝑢𝑟𝑝𝑙𝑢𝑠/𝐷𝑒𝑓𝑖𝑐𝑖𝑡

Personal Financial Statement • Personal Cash Flow Statement

– Allows you to: • Highlight your sources of income

• Reveal sources of cash outflow/spending • Identify spending and saving patterns

Budgeting – A specific plan for spending

– Can help: • Live within your income

• Spend wisely • Prioritize and plan for emergencies

• Budget

Budgeting

• A Seven Step Process:

1. Setting financial goals

2. Estimating income

3. Budgeting for emergencies

4. Budgeting fixed expenses

5. Budgeting variable expenses

6. Recording spending amounts

7. Review and revise

Saving

• Common Reasons: – Vacation/larger purchase – Long-term planning – Emergency planning

• Techniques: – Automatic debit – Payroll deduction

Taxes and Financial Planning

• Taxes impact your financial plan/personal financial statements

– How?

• Tax Planning:

· –  Know tax law/regulations

· –  Keep records

· –  Maximizing tax benefits

· –  In context of financial objectives, minimize taxes payable

Taxes and Financial Planning • Category of Taxes

1.

• •

2.

• • • •

Taxes on purchases Think GST/HST Excise tax (e.g., alcohol or gasoline tax)

Taxes on property Property tax to municipal government Based on assessed value of property Kentville: Residential ~ 1.49% / Commercial ~3.54%

Example: If your house in Kentville is assessed at $450,000 how much would you pay in tax each year?

Taxes and Financial Planning • Category of Taxes

3.

• • •

4.

• •

Taxes on wealth Realized capital gains tax Taxed at 50% of the normal tax rate

Example: If your marginal tax rate is 35% and you have a capital gain in the year of $5,000, how much would you be taxed on this?

Taxes on earnings

Income taxes – used by federal and provincial governments for social benefit

Two biggest expenses for governments?

Filing Taxes

• You need to only file one tax return, which covers both federal and provincial requirements (except PQ)

• Who files: – Anyone who lives in Canada for 183 days or more

in a year

• Taxed on worldwide income

• Where you live at year end decides your province of residency

– Need to file for any year you owe money

Income Tax Fundamentals

Income Tax Fundamentals • Calculating your income tax due:

1.

Determine Total Income

1. Employment income

2. Net business income (e.g., income after expenses from partnership)

3. Investment income (e.g., interest, dividends, rental income)

4. Taxable capital gains

– Is net capital gains in the year (i.e., can offset with capital losses in the same year)

e. Other income (e.g., retirement income, CPP/EI payments)

• Some income is not taxable (e.g., lottery winnings, GST/HST rebate, scholarships & bursaries, etc.)

Income Tax Fundamentals

• Calculating your income tax due:

2. Calculating net income

• Total income less applicable deductions

• Deductions:

1. Contributions to RPP and RRSPs

2. Unions and professional dues

3. Child care expenses

4. Disability supports

5. Moving expenses

6. Other (e.g., interest paid on loans which are used to generate taxable investment income, employment expenses, etc.)

Income Tax Fundamentals • Calculating your income tax due:

3.

•

Calculating taxable income

After net income we need to factor in any additional

deductions or losses carried forward from prior years:

· –  Stock option deductions – taxed at half the benefit

· –  Capital gains deductions – limit of $750,000 in capital gains exemption in small business; equal to one-half of the eligible capital gains exemption

· –  Net capital losses from prior years – can be used to offset capital gains in current year

· –  Other deductions – Northern resident or Canadian Forces deductions, etc.

Income Tax Fundamentals

• Calculating your income tax due: 4. Calculating federal tax owing

• Your taxable income from step 3 is that amount to which our tax tables are applied

Income Tax Fundamentals • Calculating your income tax due:

– Can calculate your federal and provincial tax due at the same time once you know your taxable

Income Tax Fundamentals • Calculating your income tax due:

– Aside: Marginal versus average tax rate • What is your marginal and average tax rate from the

5.

•

prior example?

Calculating net federal tax Two types of tax credits:

· –  Non-refundable: Most common / is subtracted from tax owing but can not result in a negative tax owing

· –  Refundable: Tax credits that are refunded to individuals even if they result in a negative tax owing

Income Tax Fundamentals

• Calculating your income tax due: 5. Calculating net federal tax

Income Tax Fundamentals • Making Tax Payments

– Source withholding – employers are required to hold back and remit to the government tax, EI premiums and CPP contributions (where applicable)

• Can lead to a tax refund if your employer withholds too much – is this good or bad?

• Reductions in source withholdings – can reduce these withholdings if you can prove that too much is being remitted on your behalf

• Instalment payments – Need to pay taxes in advance of the deadline

Income Tax Fundamentals • Aside: Additional Source Withholdings

– Employment Insurance

• 1.88% of gross earnings

• Maximum insurable earnings ($49,500) / maximum premium for 2015 $930.60

• Can lead to a tax refund if your employer withholds too much – is this good or bad?

– Canada Pension Plan

– Minimum ($3,500) and maximum ($53,600) annual earnings – 4.95% of pensionable earnings – Maximum annual contribution in 2015 $2,479.95

Income Tax Fundamentals • Deadlines and penalties

– Taxes are due for most people on April 30th of each year

· Or the next business day if the 30th is on a weekend

· Considered filed by postmark date or electronic submission

date

– However, if you have no balance due in a year, you don’t need to file your taxes

• Still recommended you file – Late filing penalties are severe

· 5% of the balance owing immediately (can be avoided simply by filing)

· 1% of the amount owing per month thereafter up to 12% in total

Tax Planning Strategies

• Tax planning strategies

– Tax planning versus tax evasion

– Tax planning: • Choosing payments that are most tax efficient

• Claiming all available deductions and credits • Defer tax payments to a later date • Income splitting • Investment planning

Tax Planning Strategies • Tax planning strategies

– How to receive income:

• Salary versus dividends – Salary leads to RRSP contribution limit – Salary also counts as CPP contributable income

– Tax Free Savings Account (TFSA)

· Can contribute $10,000 annually to a TSFA with unused

contributions carrying forward indefinitely

· Withdrawals create room in future years

· Withdrawals are tax-free and do not impact OAS, GIS and other federal credits

Tax Planning Strategies • Tax planning strategies

– Maximize deductions and credits: • Interest charges on funds invested to earn taxable

income is tax deductible

• Stock options are typically only taxed when exercised

• Capital losses can be used to offset capital gains in a given year

· –  If the net capital gain in a year is negative this net capital loss can be carried back three years to restate capital gains or carried forward indefinitely

· –  Lifetime capital gains exemption on shares of qualifying small businesses and eligible farm property

Tax Planning Strategies • Tax planning strategies

– Maximize deductions and credits:

· Student loan payments made under the Canada

Student Loans Act can be claimed

· Tuition fees – can carry forward a maximum of $5,000 less what you’ve transferred

– Can claim textbook amounts ($20/month and $65/month)

· Medical expenses

· Expenses related to severe and prolonger physical and mental impairment

· Charitable donations – 15%/$200 + 29%/$200+ up to 75% of net income

Tax Planning Strategies • Tax planning strategies

– Tax deferral techniques

• Registered Retirement Savings Plan (RRSP) – invest tax free earnings today but pay taxes when you withdraw

– Why would you do this?

– Contribution in a year plus 60 days into the following year

– Current contribution limit is $24,930 plus any unused contributions from prior years

» Is reduced by pension contributions by you or your employer

– Withdrawal for reasons other than retirement is difficult – LLP or HBP

» Both limited to $20,000

Tax Planning Strategies • Tax planning strategies

– Tax deferral techniques

• Registered Pension Plan (RPP) – Set up by employers for employees

– DCPP versus DBPP – Have a vesting period

• Individual Pension Plan (IPP) – DBPP designed for one individual

• Deferred Profit Sharing Plan (DPSP) – Similar to RPP, employer makes contributions and employees are taxed only when they receive the funds

– Rather than set benefits or contributions, employer contributions are based on company profits

Tax Planning Strategies • Tax planning strategies

– Income splitting techniques

· Marginal tax brackets make it advantageous to spread

income over both spouses in some situations

· Making contributions to spousal RRSP

· Split CPP payments with spouse

· Split pension income with spouse

· High income spouse pays expenses while low income spouse invests

· RESP for children

Tax Planning Strategies • Tax planning strategies

– Income splitting techniques • New in 2015 – ‘Family Tax Credit’:

– Applied to only two-parents families with at least one child under 18

– Allows the higher income spouse to transfer up to $50,000 of taxable income to the lower income spouse

– The amount of tax saved is a non-refundable tax credit that can be claimed by either spouse

– This credit is capped at $2,000

Tax Planning Strategies • Tax planning strategies

– Income splitting techniques • Example:

– The MacNeils are a married couple with two young children. Jim makes $30,000 a year and Vickey make $80,000 a year. If they live in NS how much can they save in taxes under 2015 income splitting legislature?

Tax Planning Strategies • Tax planning strategies

– Ensure your investment portfolio is tax-efficient

• Will not impact which assets you hold but rather in which type of account you hold them

– Example: » Interest paying assets held in RRSP » Dividend held in non-registered accounts » Capital gains held in TFSA

Tax Assistance and Audits

• Tax information sources – Tax guides – KPMG, E&Y, etc. – Internet – cantax.com, taxpayer.com, etc.

• Tax preparation software

– e.g., TurboTax (NETFILE)

– Allow for electronic filing (75% of returns)

• Environmentally friendly, faster refund, much easier than paper forms, not required to send records, etc.

Tax Assistance and Audits • Tax preparation services

– e.g., H&R block, accountants, lawyers • Fees versus ease • Immediate refunds

• Audited returns – Tax audit – Detailed examination of your return

• Desk audit - Request additional information / proof of expense

• Field audit – Visit from an auditing agent

Strategy for Managing Cash • Meeting daily money needs

– •

– •

Managing cash

Ease of payment (cash, credit card, ATM) must be balanced with costs (direct and indirect)

Sources of quick cash

Can liquidate savings (money market account, GIC, TFSA) or borrow (line of credit, overdraft, credit card)

• Types of financial services

i. Savings / time deposits

ii. Payment services (demand deposits)

iii. Borrowing

iv. Other financial services (insurance, real estate purchases, financial planning)

Strategy for Managing Cash • Electronic banking services

– •

•

– •

• •

Direct deposit

Automatic deposits into one’s bank account (e.g., weekly pay, government payments)

Benefits are time, effort and cost

Automatic payments

Bills paid through direct withdrawal (e.g., car loan payments)

Can result in errors but are very uncommon Benefits are the same as with direct deposits

Strategy for Managing Cash • Electronic banking services

– •

•

Automated Teller Machine (ATM)

Very convenient but can be expensive

To reduce fees:

· –  Shop around and find the bank or bank package that best matches your lifestyle

· –  Use your own ATM and avoid third-party ones

· –  Withdraw larger amounts if required

· –  Get cash back when using debit card

· –  Foreign ATMs can be very expensive

Strategy for Managing Cash • Method of payment

1.

• •

2.

•

3.

•

4.

• •

Point-of-Sale (POS) Transactions Using your debit card at a retail store or restaurant Is also applicable to credit cards

Stored value cards Prepaid cards for specific outlets (e.g., prepaid phone card)

Smart Cards

ATM cards with microchip which stores pre-paid amounts, data on account balances, insurance information, medical history, etc.

Software based payment systems e.g., Bitcoin

Can be used to buy physical good and services

Strategy for Managing Cash

•

Types of Financial Institutions: Deposit Taking

Deposit-type institutions

–

– •

•

Take deposits from individuals and corporations and use these deposits to generate loans

Chartered banks Primary function is to take deposits and make loans

– How do they profit from this?

Typically own a full range of financial services including brokerage firm, investment bank, etc.

• •

Types of Financial Institutions:

Deposit Taking Schedule I Banks

– Full-service domestic banks (including the big six)

Schedule II Banks

· –  Subsidiaries of foreign banks

· –  Limits on asset growth and lending activities

· –  Limited presence in retail market

· –  e.g., HSBC Bank Canada

Schedule III Banks

· –  Branches of foreign banks which typical specialize in financing

· –  e.g., Citibank, N.A.

•

•

Types of Financial Institutions: Deposit Taking

Trust companies

· –  Offer services similar to banks in addition to acting as a personal or corporate trustee

· –  Typical owned by banks but also include, for example, Manulife Financial

Credit unions

· –  User-owned, not-for-profit co-operative

· –  Most offer services similar to those provided by banks but at lower fees

•

• •

• •

Types of Financial Institutions:

Non-Deposit Taking Life insurance companies

Investment Companies

· –  AKA mutual funds

· –  e.g., money market fund

Mortgage and loan companies

– Provide real estate mortgages and loans to individuals and small businesses

Finance and leasing companies

– Categorized by the type of loan or sector they operate in

Types of Financial Institutions: Non-Deposit Taking

• Pawnshops – Make loans backed by physical collateral

• Cheque-cashing outlets

· –  e.g., Money Mart

· –  Fees can be as high as 20% of cheque cashed

Online Banking

• Some banks (e.g., Tangerine) operate exclusively online

• Features:

· –  Electronic bill payment

· –  Pre-authorized debits / recurring transfers

· –  Stop-payments

· –  Cheque services

· –  Email Money Transfer (EMT)

· –  Download statements

Online Banking

Types of Savings Plans

•

Types of Savings Plans Categories of savings plans:

– •

– •

•

Regular savings accounts

Generally allows for withdrawals as needed but fees my apply

Term deposits / GICs

Term deposits:

· –  Have a guaranteed interest rate for a specific period of time

· –  Cannot access money / require minimum balance

GIC – Guaranteed Investment Certificate

· –  A term deposit of longer term (up to five years)

· –  Minimum balance likely / rate of return can be fixed, floating or index-linked

•

Types of Savings Plans Categories of savings plans:

– •

– •

•

• •

•

Interest-earning chequing account

Usually pay a very low rate of interest but can be used for saving

Canada Savings Bonds Sold once a year from Oct to April

Have a fixed rate of interest in the first year and rates can be adjusted according to market conditions in subsequent years

Are cashable at face value plus accrued interest Are available as a regular interest bond or a

compound interest bond

A variant is the Canada Premium Bond

Evaluating Savings Plans

• Rate of return

· –  Compounding frequency and EAR

· –  Example: Compare a 6% APR with quarterly versus daily compounding

• Inflation

– As inflation increases, interest rates must

increase to compensate investors • Tax considerations

– Need to consider tax status in relation to saving decisions (e.g., TFSA versus RRSP)

Evaluating Savings Plans • Liquidity

· –  How likely are you to need to access your savings quickly (e.g., in an emergency)

· –  Will your savings vehicle allow for this (e.g., chequing account versus term deposit)

• Safety

· –  Of limited concern in Canada

· –  CDIC insures up to a maximum of $100,000 of eligible deposits per person

• Restrictions and fees

– Transaction fees

•

Selecting Payment Methods Types of chequing accounts

– •

– •

•

Regular chequing accounts

Have monthly fees that can or cannot be waived if you

maintain a minimum balance – This has a cost

Activity accounts

No ‘package’ – charge a fee for each transaction plus a

monthly fee – However, they don’t require a minimum balance

Interest-earning chequing accounts

– Earn interest so long as you maintain a minimum balance / Accrue fees if you don’t

Selecting Payment Methods • Restrictions

• Fees and charges – Nearly all require minimum balance or have a fee

• Interest – Both rate and compounding frequency

•

Special services

– –

•

Online banking, ATM fees, etc.

Overdraft protection – Covers any cheques or withdrawals that exceed the account’s balance

Cost is high fees

•

Selecting Payment Methods

Other payment methods

· –  Personal cheques

· –  Certified cheques – guaranteed payment

· –  Money order

· –  Traveller’s cheques

What is Consumer Credit • First, what is credit?

• Consumer credit

· –  Credit used by individuals and families for

personal needs

· –  Is one of three ways in which consumers can finance purchases

· –  Is largely based on trust

· –  Baby boomers are largest users of credit

· –  Can be valid and invalid reasons to use consumer credit

What is Consumer Credit

• Advantages

· –  Can buy now even if you don’t have the funds

· –  May provide added benefits (e.g., credit cards points, insurance, etc.)

· –  One easy payment for multiple purchases

· –  Security

· –  Requirement for some purchases (e.g., flight reservation)

· –  Grace period (i.e., free loan)

· –  Credit rating history

What is Consumer Credit

• Disadvantages – OVERSPENDING!!! – Consequences for failure to pay – Can result in long-term financial consequences

– Costs • Both direct and indirect

Types of Credit

• Consumer loans – Installment loans - One-time loan which is repaid

according to a pre-specified schedule

– Demand loans – lender can demand full repayment at their discretion

• May be interest only for a specific period of time – Are for a specific purpose and amount

Types of Credit • Revolving credit

– Continuous loan for which you’re billed periodically

– Have a credit limit and interest rate – Credit cards

• Convenience users – use card for convenience but don’t pay interest each month

• Can be co-branded (e.g., WestJet RBC MasterCard) – Offer points, rebates, etc. – Help build loyalty

Types of Credit – Credit cards

• Costs – Late payments / interest

– Exceeding credit limit – Cash advances – Foreign currency transactions – Membership fees

• Benefits – Interest free loan

– Rewards – Insurance – Fraud protection / limited liability – Emergencies

Types of Credit

– Personal line of credit

· Is a revolving line of credit

· Payments may or may not be interest only

· Can be secured by an asset / results in lower interest

charges

· Has a credit limit but funds can be withdrawn at any time so long you remain under your limit

· Home equity line of credit – Can borrow up to 80% of the appraised value of your home less your mortgage balance

– Are pledging the equity in your home as collateral

Types of Credit

• Consumer loans

– Mortgage loans

– Car loans

• Can finance at a bank or dealership

• Can also lease

· –  Closed-end lease – leasing company is responsible for the residual value of the car at the end of the lease / you can purchase and pay all applicable fees or return car to leasing company

· –  Open-end lease – you are responsible for the residual value of the car and any other charges at the end of the lease

• Can pay cash – Least expensive and there are often significant cash incentives

Credit Capacity • Rules of credit capacity

– Debt payments to income ratio • What does the ratio try to measure?

• Excludes mortgage/rent payment

• Should be no more than 20% (max) of after-tax income

• Can sometimes factor in credit card or LoC debt even if not used

Credit Capacity • Gross debt service and net debt service

· Is related to mortgage financing

· GDS - considers your total living expenses including

mortgage payment, heating and taxes

· TDS – mortgage and debt payments

· GDS should be below 32% ; TDS below 40%

• Co-signing – If you co-sign you guarantee the debt, including

fees and penalties • Can go to collection, be sued, etc.

– Often end up paying

Credit Capacity • Building your credit rating

– Credit bureaus

• Third-parties that collect financial and other information on consumers and provide to lenders for a fee

– e.g., Equifax and TransUnion Credit

• Get consumer information from banks, court records, credit card companies, retail stores, etc.

Credit Capacity

• Building your credit rating – Credit bureaus

Credit Capacity • Building your credit rating

– Credit bureaus • Regulations

– Provincial regulations focused on protection of consumer privacy

– Credit reporting legislature – sets out the type of information that can be included in a credit report – consumer information versus personal data

• Access

– You have legal right to your credit report ; should review annually for mistakes and fraudulent accounts – can get it free of charge

• Limits on adverse data

Applying for Credit

• Five Cs

•

1. Character 2. Capacity 3. Capital 4. Collateral 5. Conditions

FICO Score

· –  Fair Isaac Corporation

· –  Rating based on payment history, amounts owing, time with credit, types of credit used, number of recent applications

· –  Ranges from 300 (poor) to 900 (perfect)

Applying for Credit • VantageScore

Avoiding Credit Mistakes

• Billing errors

· –  Your responsibility to determine if there is an error

· –  Start with the creditor but the lending institution will also help

• Identity theft

· –  Contact both credit bureaus immediately and

report the fraud

· –  Contact all creditors that are associated with a fraudulent charge

· –  File a police report

· –  To prevent – be careful with documents!

Sources of Consumer Credit

• Cost should be a factor in your decision a. Inexpensive loans (family) b. Medium-priced loans (financial institutions) c. Expensive loans (retailers, credit cards)

d. Government Student loans

· –  Inexpensive loans offered by GoC or provinces

· –  Deferred interest

· –  Administered by Canada Student Loan Program (Federal) and provinces (NSSL)

· –  Don’t forget about grants (CSGP) as well as bursaries

Cost of Credit

• Annual percentage rate (APR) versus effective annual rate (EAR)

– Example: Your credit card has an APR interest rate of 21%. Interest is compounded monthly. What is your effective annual interest rate?

• What would be the EAR if the compounding period was daily?

Cost of Credit • Term versus interest rate

– Which is best?

Cost of Credit

• Other considerations: – Regular versus final payments – Variable interest rates – Secured loans – Upfront cash – Shorter term loans – Expected inflation – Minimum monthly payments

– Credit insurance • Credit life / credit accident and health / credit property

Calculating Loan Payments

• Fixed rate loans:

– Calculated simply as the PV of an annuity

– Example: You wish to borrow $50,000 from your bank for a trip to Vegas. The bank quotes you an APR of 6%, compounded monthly. If you make monthly payments for 6 years, what is the value of your payments?

• Draw an amortization table for the first three months of this loan.

Calculating Loan Payments • Floating rate loans:

– Example: You wish to borrow $50,000 from your bank for a trip to Vegas. The bank quotes you an interest rate of Prime plus 250 basis points and you will make monthly payments of $500.

· If prime is currently 4%, draw the amortization table for the first two months.

· Assume that on the first day of the third month Prime drops by 100 bps. Draw the amortization table for months three and four.

Managing Your Debts

• Most people can manage their debts without issue ‘under normal circumstances’

– Most likely cause of trouble is an emergency

• Frequent non-emergency ‘traps’ :

i. Emotional problems

ii. Use of money to punish

iii. Expectation of instant comfort

iv. Keeping up with the Joneses

v. Overindulgence

vi. Lack of communication

vii. Finance charges

Managing Your Debts • Consequences of debt

– Vary from relationship issues to bankruptcy • Consumer credit counselling

– Non-profit financial counselling program • e.g., Credit Counselling Services of Atlantic Canada

– Can also be provided by provincial authorities, some employers, etc.

– Focus on 1. preventing or 2. dealing with serious credit problems

Personal Bankruptcy • Prevention

– Consolidation loans: trade-off single interest rate and extended term versus higher interest rate and extended term

• Bankruptcy and insolvency act – OSFI

– Consumer proposal versus assignment – Protected assets – those required to live and earn

• Effects of bankruptcy – Future credit and direct costs

Housing Alternatives • Costs of housing choices:

– Guideline – should spend no more than 25%-30% of take-home pay on housing

• Significant opportunity costs: – Lost investment income on down payment – Commute versus housing costs – Repair versus purchase cost – Time during build / renovations

Renting • Selection:

Renting

– Fewer responsibilities – Lower initial costs

• Disadvantages – Few financial benefits – Restricted lifestyle

• Lease

· –  Each province has a Residential Tenancies Act

· –  Sets out rights and obligations of tenants and landlords

• Advantages: – Mobility

Home-Buying Process • Step 1: Determine Needs

– Benefits:

i. Pride of ownership

ii. Financial benefits (not always a benefit)

iii. Lifestyle flexibility

– Drawbacks

i. Financial uncertainty

ii. Limited mobility

iii. Higher cost of living

iv. Property taxes

Home-Buying Process • Step 1: Determine Needs

– Types of houses:

i. Single-family (detached)

ii. Multi-family (duplex)

iii. Mobile homes

iv. New build

–

Formers of ownership i. Sole ownership ii. Condominiums iii. Co-operative (non-profit and for-profit)

Home-Buying Process • Step 1: Determine Needs

– Down-payment

i. 20% minimum to qualify for a ‘conventional’

mortgage

ii. Can use funds from RRSP

– What can you afford • GDS Ratio and TDS Ratio

Home-Buying Process

• Step 2: Find and Evaluate Property – Selecting a location – Real estate agents and home inspections

• Step 3: Price the Property – Determine fair value price – Negotiate purchase price

Home-Buying Process • Step 4: Obtain Financing

•

– Evaluate different interest and payment options

i. Fixed versus variable rate mortgage

ii. Payment frequency

Step 5: Complete Purchase

– Will come with closing costs • Transfer deed, legal, etc.

Selling Your Home

• Prepare house for showing • Determine selling price / appraisal • Sale by owner versus real estate agent

Calculating Your Mortgage Payment

· Is simply the PV of an annuity

· Example: You wish to buy a house that costs $550,000. You will put a 10% down payment on the house and will make bi-weekly payments. If the bank quotes you an APR rate of 4% and you wish to amortize the mortgage over 25 years, what is the value of your bi- weekly payments?

Calculating Your Mortgage Payment

• Example: You recently saw your dream home for sale at a price of $850,000. You will put a 25% down payment on the house and will amortize the mortgage over 30 years, making monthly payments. If the applicable APR on the mortgage is 6%, what is the value of your monthly payments?

Intro to Insurance and Risk

Management – Protection against financial loss

– Terms: • Insurance company

• Policy • Premium

• Risk – What is a risk? – Peril – cause of loss – Hazard – increases the likelihood of loss

• Insurance

Intro to Insurance and Risk

Management • Types of Risk

– Pure risk – personal, property or liability risks • Insurable

• Accidents or unintentional risks – Speculative risk – comes with a chance of loss or

gain • e.g., starting a business • Legally uninsurable

Intro to Insurance and Risk Management

• Risk Management

– What is risk management?

– Risk avoidance • May not be practice

– Risk reduction

– Risk assumption • Personally assume the loss • e.g., collusion insurance on an old car

– Risk shift • This is what insurance does

Intro to Insurance and Risk

Management • Risk Management

Intro to Insurance and Risk Management

• Personal Insurance Program – Step 1: Set insurance goals – Step 2: Develop a plan – Step 3: Put plan into action

– Step 4: Review

Property and Liability Insurance • Examples: home, automobile, valuables, etc.

– Two types of losses

i. Physical damage

ii. Loss of use (e.g., theft)

– Liability protection • Liability – legal responsibility for someone else’s loss or

injury • Negligence – failure to undertake reasonable care • Strict vs. vicarious liability

Home and Property Insurance

• Homeowner’s insurance – protection of residence and its associated risks (e.g., liability)

– Coverages: • Building and structures

• Additional living expenses • Personal property • Structure replacement • Personal liability

• Specialized coverage (e.g., flooding)

Home and Property Insurance

• Tenants insurance – Essentially homeowner’s insurance for renters

– Coverages:

· Tenant’s personal property is not covered by building

owner’s coverage

· Does not cover replacement of structure

· Includes liability

· Can also provide Tenant’s Legal Liability coverage – e.g., if you cause damage to your apartment

Home and Property Insurance • Home insurance types

– Two types of policies i. Named perils – perils specifically listed in the policy

– e.g., fire, flood, etc. ii. All perils – all events causing loss are covered unless

explicitly excluded • e.g., force majeure, terrorism related loss

Home and Property Insurance Costs • Deductible

– A higher deductible results in a lower premium • Share larger portion of the loss

• Less risky behaviour is insured is paying a larger share • Fewer claims • 3% rule

• Coverage

– Full coverage suggested

– Belongs based on percentage (55% to 75%) of dwelling insurance

– Settlement: Either 1. actual cash value (replacement price adjusted for time of use) or 2. replacement value

Home and Property Insurance Costs

• Factors that affect cost: – Location

– Replacement cost – Electrical configuration – Heating – Pipes – Age of roof – Coverage amount and policy type

Automobile Insurance Coverage

Automobile Insurance Coverage

• Types of Coverages – Bodily injury – Accident benefits – Uninsured motorists – Property damage

– Collision – Comprehensive

Automobile Insurance Costs • Home Much Coverage

· –  Legal concerns (e.g., minimum third-party liability requirements)

· –  Typically in the $1M - $2M range

• Cost factors – Where you live (e.g., urban/rural, province) – Type of car – Use – Rating territory – Driver classification

Life Insurance • Life Insurance

– Makes a lump sum payment to beneficiaries upon the death of the insured

– Endowment policy – pays a lump sum to the insured at the maturity of the plan

– Is applicable to nearly all individuals

Life Insurance

• Purpose of Life Insurance

– Provide financial support to loved ones

– Pay off mortgage, retirement savings for surviving spouse, provide education for children, etc.

Life Insurance

• Principles of Life Insurance – Is a function of probability of death – Depends on age, occupation, gender, etc.

Life Insurance Needs

• If others are financially dependent on you, life insurance may be a good idea

– Single people have less need, but not necessarily no need

– Parents with small children usually have greatest need

• Need to consider what is needed and what is desired from your policy

– Of course you need to balance this against cost

Life Insurance Needs • Life Insurance Requirements

– Income Replacement Method

• Guideline – need 70% of annual income for 7 years

• Example: If your annual income is $80,000 then insurance needs would be $392,000.

Life Insurance Needs – Family Needs Method

• Income replacement method ignores insured’s assets and over sources of income

Types of Life Insurance • Types of Life Insurance

Types of Life Insurance • Types of Life Insurance

1.

•

• • •

•

Term Life Insurance

Life insurance for a pre-specified period of time (e.g., 20 years)

When policy expires you get no financial benefits AKA temporary life insurance

Premiums rise as you get older but can reduce coverage

Options include: renewal options, conversion option, term-to-100, decreasing term insurance

Types of Life Insurance • Types of Life Insurance

2.

• • •

Permanent Life Insurance Purchased to cover lifetime needs

Most policies have level or constant premiums

Has a cash surrender value (or policy reserve) due to the fact that you pay higher premiums in early years than justified by your risk of death

– Can take full or partial withdrawals of cash value

When you die the cash value is paid to beneficiaries

Tend to be relatively expensive and have a higher fee than a simple savings account

• •

Types of Life Insurance • Types of Life Insurance

2.

Permanent Life Insurance

1. Whole Life Insurance

· –  Pay a specified premium so long as you are alive

· –  Insurance companies pays a pre-specified amount when you die

· –  Has a cash surrender value – so provide a death and savings benefit

2. Universal Life Insurance

· –  Uses current interest rates as assumptions, so when rates rise the policy is more valuable

· –  Have a life insurance component and an investment component

· –  Flexible premiums

Types of Life Insurance • Types of Life Insurance

2.

Permanent Life Insurance c. Variable Insurance

– Premiums are guaranteed but cash value is dependent on the performance of an investment fund

» Insured assumes investment risk – Minimum death benefit guaranteed

Types of Life Insurance • Other Types of Life Insurance

– Group Life Insurance • Insurance a group of people under a single policy

• Is a term life insurance policy • Premium is split between employer and employee

– Credit List Insurance

· Similar to group life but is purchased by creditors to

insurance borrowers

· e.g., mortgage insurance

Types of Life Insurance

• Life Insurance Provisions – Beneficiary – Grace Period – Reinstatement

– Incontestability Clause

– Suicide Clause

– Riders to policies • Accidental death benefit

• Critical illness • Joint, last to die

Buying Life Insurance • Where to buy

– Direct/agent/broker/group plan

• Choosing settlement options – Lump-sum payment – Limited instalment payment – Life income option

– Proceeds left with life insurance company

Health Insurance • Health Insurance

– Why do we need health insurance given single payer system in Canada?

– Typically group insurance plan – Coverage varies from plan to plan

• Typical coverage includes private room, nursing care, cosmetic surgery

Disability Insurance

• Disability Insurance

– Provides cash earnings lost by accident or illness

– Disability: • Own occupation

• Regular occupation • Any occupation • Total disability / Partial disability

– Provided by employer/private (insurance companies) or public sources

• Public: EI, CPP, WCB, Welfare – Critical illness insurance

Supplemental Health Insurance

• Supplemental Health Insurance

– Dental and vision

– Health services • Includes prescription drugs, home care, paramedic

services, etc. • Travel insurance

– Long-term case • Day to day assistance if you have an illness of disability

Supplemental Health Insurance

• Provisions in Health Insurance Policy – Eligibility

– Assigned benefits – Internal limits – Co-payment – Benefit limits

– Exclusions – Coordination of benefits – Guaranteed renewable

Supplemental Health Insurance

• Health Insurance Trade-Offs – Reimbursement versus indemnity – Internal limits versus aggregate limits – Deductibles and co-pay – Out-of-pocket limit

Preparing to Invest • Establishing Goals

– Should be specific – something you can measure and strive towards

– Ask yourself: • What will the money be used for? • How much do I need? • How will I obtain this? • How much risk am I willing to take? • What are potential issues • Etc.

Preparing to Invest

• Evaluate Financial Position – Create and balance your budget – Review and obtain insurance

– Start an emergency fund • Including external sources for emergencies if required

Preparing to Invest

• Getting the funds to invest

– Prioritize your goals

i. Pay yourself

ii. Participate in a savings program

iii. Once or twice a year making saving your top priority

iv. Use employer sponsored retirement programs

v. Use gifts/inheritance to invest rather than spend

Preparing to Invest • Long-Term Investment Horizon

– Example: You will retire in 40 years and will make monthly deposits of $250 into a savings account. Your bank quotes you a deposit rate of 4% with quarterly compounding.

1. How much will you have in your account if you start depositing today?

2. How much will you have if you start saving in 20 years?

1.

Safety and Risk

Factors Impacting Investment Choice

– –

•

• •

The expected return should be directly related to the risk of the investment

If you have a high risk aversion, you may prefer more secure investments like Government bonds, GICs, or fixed income securities

Alternatively you may choose more speculative investments like stocks, derivatives, etc.

Is individual specific

Your risk aversion will change throughout your life, in particular as you age

1. 2.

Safety and Risk

– Risk tolerance – is a function of the individual and their investment goals

Components of Risk

Factors Impacting Investment Choice

i. ii.

•

Business risk – risks associated with the underlying firm (e.g., management, products, competition, etc.)

Inflation risk – investment returns should at least keep pace with inflation

What are the consequences if they don’t?

2.

Components of Risk

iii. Interest rate risk – value of all investments, in particular fixed income investments, will decline in value as interest rates rise

iv. Market risk – Systematic risk (e.g., recession)

v. Global investment risk – have the additional risk of currency fluctuations

– Example: You buy stock in a US company worth US$1,000 today and sell it in one year for the same price. Today’s exchange rate is 0.75 CAD/USD and in one year it is 0.90 CAD/USD. What is your return?

Factors Impacting Investment Choice

Factors Impacting Investment Choice • Other Considerations

i.

Investment income – some investments have relatively secure investment income (e.g., fixed income investments) while others do not (e.g., stocks)

Investment growth – capital gains

Greatest growth potential typically provided by common stock

ii.

•

– But not all are the same iii. Liquidity

Investment Alternatives

1. Stocks

2.

· –  Represents ownership in a business

· –  Dividends are source of income but is not guaranteed

· –  Can be common or preferred

Bonds (fixed income)

· –  Gov’t or corporate

· –  Receive (typically) interest plus principle repayment

Investment Alternatives 3. Mutual Funds

· –  Professional managed pool of money that buys stocks , bonds, etc. on investor’s behalf

· –  Can be tailored to different investor needs 4. SegregatedFunds

· –  Combines the components of mutual funds with insurance

· –  Sold by life insurance companies and have a maturity date

· –  Protect investment when markets decline

· –  Get 100% of your contributions back at maturity

Investment Alternatives

5. Real Estate – Can be direct or through a REIT

Reducing Investment Risk • Financial Planner

•

· –  Help you with your planning and implementation of plan

· –  Assess your risk tolerance

· –  Should verify how they are paid

Investor Role

· –  Evaluate and monitor potential investments

· –  Keep records

Reducing Investment Risk • Taxes

· –  Want the most tax efficient portfolio that is legally possible

· –  Interest and rental income is fully taxed

· –  Dividends and capital gains are taxed more

favorably

· –  Use RRSPs and TSFAs

Investment Information

• Internet

• •

· –  Large source of good and bad information

· –  Moneysense.ca is a good general source

· –  Bank sites can give you information on specific products (e.g., GICs)

· –  Company information from google, SEDAR, etc. News media Corporate reports

Common Stocks • Market index

– A portfolio of stocks that represents changes in the ‘overall market’

– S&P/TSX Composite Index • Covers 95% of the Cdn equities market

Common Stocks • Market indices

– Dow Jones Industrial Average (DJIA) • Most widely reported indicator • Tracks 30 industrial stocks

– NYSE Composite Index • All stocks on NYSE

– NASDAQ Composite Index • All stocks on NASDAQ • Heavily technology / internet weighted

– S&P 500 Index • Large-cap index

Common Stocks

• Why issue common stock – Public (IPO) versus private (SEO)

i.

• •

ii.

•

iii.

•

• •

Form of equity Exchange ownership for capital Don’t have to repay shareholders for buying stock

Dividends are not mandatory Whereas interest payments are

Voting rights and control

Is mainly a concession given up in exchange for capital

Proxy voting Pre-emptive rights

Common Stocks • Why buy common stock

i.

• • •

ii.

•

Income from dividends Record date

Cum-dividend and ex-dividend date

Example: The record date for XOM stock is Wednesday, January 14th.

Change in stock value Hope to realize a capital gain

Common Stocks • Why buy common stock

iii.

• • •

Increased value from stock splits Weak argument for increased value

Split and reverse split

Example: You own 1,500 shares of XOM, and each is currently trading at $40. The shares go through a 3- for-1 stock split. How many shares do you own after the split and what is their price?

– What would these values be if the stock went through a 1- for-4 split?

Preferred Stocks

• Preferred stocks – Receive dividends before common stock holders – Dividends are known in advance – Are typically callable – Issued far less often than common stock

Preferred Stocks

• Features i. Cumulative dividends

• Skipped dividends must be made up before common dividends can be paid

ii. Participation

· Excess after preferred and common dividends is paid is split between each

· Is rare iii. Conversion

• Option held by shareholder to exchange the preferred shares for a pre-specified number of common shares

Evaluating Stock Issues • Stock valuation

i.

•

ii.

•

– •

• •

Fundamental analysis

Micro (e.g., management, financials) and macro (e.g., economic conditions) that impact share price

Technical analysis Looking for trends in historical prices

What does the EMH say about each Stocks move randomly (don’t follow a pattern) Current price reflects true value Relationship between risk and return is positive

Evaluating Stock Issues • Classification of stock investments

i.

•

ii.

•

iii.

• •

Blue-chip stock

Relatively safe investment in the strongest companies (e.g., RBC)

Income stock

Stocks paying high, consistent dividends (e.g., utilities)

Growth stock

Potential for high earnings growth

Usually have a smaller dividend payout ratio in early years (e.g., Apple)

Evaluating Stock Issues • Classification of stock investments

•

iv. v.

vi. Bull market versus bear market

• •

Cyclical stocks Follow the overall economic cycle (e.g., Caterpillar)

Defensive stocks

Are not significantly impacted by overall economic cycle (e.g., Kellogg, P&G)

Large-cap vs small-cap

Evaluating Stock Issues • Calculations

– Annual shareholder return 𝐴𝑛𝑛𝑢𝑎𝑙 𝑟𝑒𝑡𝑢𝑟𝑛 = 𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑖𝑣𝑖𝑑𝑒𝑑 + 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐺𝑎𝑖𝑛

𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑃𝑟𝑖𝑐𝑒

– Can be broken into dividend yield and capital gains yield

– Example: You buy HP stock for $35 and hold it for a year. Over that year the firm pays a $4 dividend and the stock price falls to $32. What is your annual return?

Evaluating Stock Issues • Calculations

– Earnings per share (EPS) • Is simply the net income per share • An increase in EPS is a healthy sign for the firm

– Price-Earnings ratio (P/E)

· Divide the stock price by the company’s earnings

· Measures how much investor’s are willing to pay for $1 in earnings

· Can be an indicator of buying or selling opportunities – Beta

• Is a measure of the stock’s risk relative to that of the overall market

Buying and Selling Stocks

• Transactions – Primary versus secondary market – IPO versus SEO

– Full-service versus discount brokerages • Differ in:

i. Cost

ii. Research provided

iii. Assistance with investment decisions

iv. Easy of buying or selling

Buying and Selling Stocks • Types of orders

– Market order • Transact at current market price

– Limit order • Transact at a specified price • e.g., Buy at a price below $20 • e.g., Sell at a price above $30 • Fulfilled behind market orders

Buying and Selling Stocks • Types of orders

– Stop order • Sell a stock once its market price reaches a certain

point • Does not guarantee that it sells at that price • Protect against price declines

– Discretionary order • Lets the account executive decide when to transact

Buying and Selling Stocks • Commission charges

– Fee to make a transaction • Round lot – 100 shares (or multiples of 100) • Odd lot – fewer that 100 shares

Long-Term and Short-Term Strategies

• Long-Term – Investors

– Diversification

– Buy-and-hold

– Dollar cost averaging • Purchase a set dollar amount of the stock each

year • Don’t try to time the market • Average price is considered in selling stock

Long-Term and Short-Term Strategies • Long-Term

– Direct investment • Purchase directly from the firm rather than through a

broker – Dividend reinvestment plan

• Reinvest dividends to purchase stock • No transaction costs

Long-Term and Short-Term Strategies • Short-Term

– Buying on margin

· Essentially borrowing money needed to buy stock

· Financial leverage allows you to magnify gains but also magnifies losses

· Subject to margin calls and interest

– Short-selling

· Borrow a stock, sell it to someone else

· Eventually need to repurchase the stock and return it to its owner

· Why would you short-sell?

Long-Term and Short-Term Strategies • Short-Term

– Trading in options • Right to buy or sell at a predetermined price • Call versus put

Why Mutual Funds • Defined

– An investment in which a number of people contribute (pool) money to buy stocks or other financial assets

• Reasons 1. Professional management 2. Diversification

Why Mutual Funds

Why Mutual Funds • Reasons:

Why Mutual Funds

• Characteristics

– Are run by investment companies

– Closed-end funds

· Is finite in size and shares are issued by the investment

company only when the fund is set up

· Fund neither issues nor redeems shares

– Doesn’t have to maintain cash holdings

· Shares are traded on an exchange, with price determined by supply and demand

– Price may not reflect value of underlying portfolio

Why Mutual Funds • Characteristics

– Open-end funds • Shares are issued and redeemed by the investment

company at the request of the investor

• Shares trade at net asset value (the market value of the underlying investments less liabilities)

𝑁𝐴𝑉 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑀𝑉 𝑜𝑓 𝑃𝑜𝑟𝑡. −𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 # 𝑠h𝑎𝑟𝑒𝑠h𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔

Why Mutual Funds • Characteristics

– Index funds and exchange-traded funds

· Passively tracks an index (e.g., S&P/TSX Composite

Index)

· Main advantage is lower costs

· Also, performance

· ETF have added liquidity (and flexibility) versus index funds

– Also tend to have lower management fees but you need to pay commissions to trade them

Why Mutual Funds • Fees

– Load versus no-load funds

· Load fund – pay commission every time you buy (front)

or sell (back)

· Average is between 3 and 5 percent

– Management fees • Are a fixed percentage of assets • Very very high (avg. 2-3%)

– Management expense ratio

· Total of management fees and direct costs charged to

fund

· Canada has some of the highest MERs in the world

Why Mutual Funds • Fees

– Special fees

• e.g., account set-up, transfer fee, etc.

• Service fees - ongoing commissions paid by mutual fund company

Classification of Mutual Funds • Categories

i.

•

ii.

•

iii.

•

iv.

•

v.

•

Money market funds Short-term

Bond funds Invest in bonds

Dividend funds

Invest in preferred shares and high-quality common share

Ethical funds Invest for moral/ethical reasons

Balanced funds Balance income and growth

Classification of Mutual Funds • Categories

– Family of funds

• One investment company manages multiple funds

• Usually more cost effective to switch within the same family of funds

– Managed asset programs • Designed for those who want to invest in more than

one fund • Is a pool of mutual funds

Investing in Mutual Funds • Prospectus

– Outlines the risk factors, performance, investments, objectives, etc.

• Annual report • Financial publications • The Internet

Trading in Mutual Funds • Return on investment

– Looking for dividends (income) and/or appreciation in value (capital gains)

• Fund will make capital gains distributions • Can also make capital gains from selling your units in

the mutual fund

• Tax issues

i. Distributions that are reinvested are still taxable

ii. Realized capital gains are at the fund’s discretion

iii. Distributions are fully taxed no matter when you buy into the fund

Trading in Mutual Funds

• Purchasingmutualfunds – Closed-end via stock exchange or OTC – Open-end, no-load via investment company – Open-end, load through salesperson – Can also purchase via brokers

• Purchasingopen-endedthroughinvestment company

– Regular account transaction – Voluntary savings plan – Contractual savings plan – Reinvestment plan

Trading in Mutual Funds • Withdrawing from a mutual fund

– Closed-end funds • Can sell on the exchange or OTD market

– Open-end fund • Can be sold back to the investment company on any

day • Redeemed at their NAV (value of portfolio less debt) • Also have options if you have significant holding

i. Fixed dollar amount each period

ii. Fixed number of units each period

iii. Fixed percentage each period

iv. All growth distributed each period

Why Retirement Planning

• Misconceptions – Expenses will drop in retirement – Retirement will only last 15 years – Government will fund my retirement

• Importance of saving early

Conducting Financial Analysis

• Analyze and evaluate your current assets and liabilities

• Review assets

– Housing

• Why is this important enough to single out?

• Canada Home Income Plan (CHIP)

· –  Reserve mortgage – provides tax-free income to the homeowner which they repay (with interest) when they sell their house

· –  Must be 55 and older and does not impact OAS or GIS payments

Conducting Financial Analysis • Review assets

– Housing

• Reverse annuity mortgage (RAM)

– Used to buy life annuity from insurance company

– Provides regular income to homeowner until death

– Upon death or sale of the house, the loan must be repaid

– Life insurance • Cash surrender value

– Other assets • Cottage, savings accounts, etc.

Retirement Living Expenses • Expenses that may decrease when you retire

– Work expenses • Transportation costs, lunches, etc.

– Clothing expenses • Reduced need for dress clothes, etc.

– Housing expenses • If mortgage is paid off when you retire, if you downsize,

etc. – Federal income taxes

• No tax paid on some retirement income (GIS) and you’re typically in a lower marginal tax bracket

Retirement Living Expenses • Expenses that may increase when you retire

– Insurance • Loss of employer’s contribution, higher life insurance

premiums, etc. – Medical expenses

• May not have access to group health insurance, premiums tend to generally increase with age, etc.

– Leisure expenses • Can be significant as you may want to travel more, visit

family more often, etc. – Gifts or donations

• Want to make same gift but now have a lower income

Retirement Living Expenses • Change in expenses

– Need to consider inflation!

Retirement Housing • Types of housing

– e.g., apartment, own home, downsize, etc. • Discussed in chapter 7

– Are resources available if someone wants to remain in their own home

i. Home Adoptions for Senior’s Independence Program

ii. Emergency Repair Program

iii. Residential Rehabilitation Assistance Program

Retirement Income

Retirement Income • Public Pensions

– Canada Pension Plan • Three kinds of benefits: disability benefits, retirement

pension and survivor benefits • Contributions

– Based on salary alone (not investment income)

– Maximum pensionable earnings for 2015 is $53,600 and employer and employee contribution rates are 4.95%

» Maximum contributions in 2015 for each is $2,479.95

Retirement Income • Public Pensions

– Canada Pension Plan • Benefits

· –  Is payable at age 65 regardless of whether you continue to work or not

· –  Amount depends on how long you’ve contributed and the age when you start receiving your retirement benefit

· –  Full benefit is based on 25% of average pensionable earnings

– Benefits are taxable

Retirement Income

• Public Pensions – Canada Pension Plan

Retirement Income • Public Pensions

– Old Age Security (OAS)

· To qualify, you need to be a resident for at least 40

years and over the age of 65 (67 starting in 2023)

· Is taxed and clawed back (at 15%) when your income reaches $64,718

· 2015 maximum monthly amount is $569.95 – Guaranteed Income Supplement (GIS)

· Designed for low-income individuals who are 65 and older.

· Amount received depends on marital status – e.g., $772.83 if single and $512.44 if married

Retirement Income

• Employer Pension Plans – Defined benefit plan – Defined contribution plan

Retirement Income • Personal Retirement Plans

– RRSP • Contribute pre-tax earnings and are taxed on

withdrawals

• Contribution limit for 2015 is 18% of earned income up to a maximum of $24,930

– Also unused prior contribution limits accrue each year

• Are not for everyone

Retirement Income • Personal Retirement Plans

– Deregistering an RRSP • Plan must be deregistered by the end of the year in

which you turn 71.

• Payment options:

i. Full withdrawal – least favourable option

ii. Annuities – pay fixed periodic amount for a specified period of time (fixed-term) or until death (life)

iii. Registered Retirement Income Funds (RRIFs) – you make your own investment choices; need to withdraw a minimum amount each year

Living on Retirement Income • Workingduringretirement

– May result in benefit claw backs • Dippingintoretirementsavings