Personal Finance: Interest, Insurance, Investments, and Retirement

Posted on Dec 17, 2024 in Economy

Simple Interest

Interest on a loan or investment is computed as a percentage of the loan or investment amount, or principal.

Ex. Farah invests $1,000 in a GIC that pays 3 percent simple interest each year. At the end of year one, the bank will credit Farah’s chequing account with $30. I=P x r x t —- $30=$1000´0.03´1

Compound Interest

Farah decides to invest her money into a GIC that pays 3 percent interest compounded annually.

Interest earned will be re-invested back into the GIC and not to her chequing account.

Farah will earn interest on interest (compound interest).

Future Value of a Single Dollar Amount

Present Value of a Single Dollar Amount

Types of Insurance

Property: Covers damages to home/auto and protects against liability.

Health: Covers medical, dental, and vision care.

Disability: Replaces income if you can’t work due to illness/injury.

Critical Illness: Lump sum for major illnesses (e.g., heart attack, cancer).

Long-Term Care: Covers care if you can’t care for yourself due to illness/injury.

Life Insurance: Provides financial support to dependents upon death.

Risk Management

Techniques: Avoid, Reduce, Accept.

Steps: Recognize risks. Decide whether to protect. Determine coverage needed.

Auto Insurance

Third-Party Liability: Covers bodily injury & property damage.

Accident Benefits: Covers medical & income replacement.

Collision/Comprehensive: Covers vehicle damage (optional in some provinces).

No-Fault: Immediate medical benefits, no suing for pain/suffering.

Homeowner’s Insurance

All Perils Coverage: Covers everything except exclusions.

Named Perils: Covers only specified risks.

Cash vs. Replacement Cost: Cash value is depreciation-based; replacement is full cost.

Tenant’s Insurance

Covers personal property, liability, and living expenses if displaced.

Umbrella Liability Policy

Extra liability coverage beyond auto and homeowner’s policies.

Public/Private Plans: Covers drug, dental, medical care.

Disability/Critical Illness: Replaces income or provides a lump sum for major illnesses.

Whole Life: Permanent coverage with fixed premiums and cash value.

Universal Life: Flexible premiums and investment options.

Canada Health Act

Federal criteria for insured health services.

5 Principles: Public administration, comprehensiveness, universality, portability, accessibility.

Provincial/Territorial & Private Health Insurance

Role of Government: Administers health services, offers supplementary benefits.

Private Insurance: Covers additional medical costs (e.g., dental, vision, travel).

Investment Types

Money Market: Low risk, earns interest.

Stocks: Dividends, low to high risk.

Bonds: Interest, low to high risk.

Pooled Funds: Dividends & interest, low to medium risk.

Real Estate: Interest & capital gains, low to high risk.

Stock Markets

Primary Market: Newly issued securities.

Secondary Market: Existing securities traded.

Types of Stocks

Common Stock: Ownership in a firm.

Preferred Stock: Safe, dividend-paying investment.

Stock Price Calculation

  • Price per Share = Market Value ÷ Shares Outstanding. Example: $600,000 ÷ 10,000,000 shares = $60/share.

Bonds

Long-term debt securities; investor “lends” money to issuer. Safe bonds = low risk; high-risk bonds = higher returns.

Pooled Investment Funds

Funds combine money from many investors to invest in stocks, bonds, etc.

Examples: Mutual Funds, Index Funds (track stock market indices).

Risks in Investments

Small Stocks: High growth potential, high risk.

Bonds: Low-risk, lower returns (for reputable firms).

Mutual Funds: Diversified but may have bond defaults.

Real Estate: Volatile market, risk of default.

Investment Decisions

Life Stage: Early investors need easy access to funds.

Risk Tolerance: Long-term investing allows more risk.

Economic Conditions: Monitor stock market and economic trends.

Stock Exchanges

TSX: Senior equities.

TSX Venture: Public venture capital (risky, high-growth firms).

Montreal Exchange: Derivatives (Options).

OTC Market: Non-transparent, electronic market.

Electronic Trading

Bid Price: Buyer’s purchase price.

Ask Price: Seller’s price.

Liquidity: Volume of stocks available.

Market Depth: Number of active traders.

Types of Brokerage Firms

  • Discount Brokerage: Executes trades, no advice.
  • Full-Service Brokerage: Offers advice, executes trades.

Placing Orders

  • Market Order: Buy/sell at market price.
  • Limit Order: Buy/sell at specified price.
  • Stop Orders: Triggered when price hits a certain level (Buy-stop/Sell-stop).

Buying on Margin

  • Margin: Borrowed money to purchase stocks.
  • Margin Call: Request to add more cash if stock value drops.

Ratios & Financial Health

  • Liquidity: Current ratio (assets/liabilities) & Quick ratio (assets – inventory/liabilities).
  • Efficiency: Turnover ratios (accounts receivable, inventory, total assets).
  • Profitability: Net profit margin, return on assets, return on equity.
  • Financial Leverage: Debt-equity ratio, times interest earned.

Economic Indicators

  • GDP: Total value of products/services in the economy.
  • Inflation: Measured by CPI (consumer price index).
  • Interest Rates: Economy moves opposite to interest rate changes.

Bonds: Key Concepts

  • Bonds: Long-term debt securities issued by governments or corporations. Bondholders lend money and earn interest until the bond matures.
  • Par Value: The face value of a bond, which is paid back at maturity. Bonds are quoted as a percentage of par value.
  • Coupon Payments: Regular interest payments, usually semi-annually, based on the bond’s coupon rate.

Types of Bonds

  • Government Bonds: Issued by the Canadian government, no default risk.
  • Provincial Bonds: Issued by provincial governments, with varying default risk.
  • Corporate Bonds: Issued by companies, subject to default risk.
  • Municipal Bonds: Issued by local governments, generally low default risk.
  • High-Yield Bonds: Issued by less stable corporations, higher risk but higher return.

Bond Features

  • Convertible Bonds: Can be converted into stock at a predetermined price.
  • Extendible Bonds: Allows the bondholder to extend maturity.
  • Call Feature: Allows issuers to repurchase the bond before maturity.

Bond Investment Strategies

  • Interest Rate Strategy: Adjust investments based on expected changes in interest rates. If rates are expected to fall, invest in long-term bonds; if they’re expected to rise, invest in short-term bonds.
  • Passive Strategy: Invest in a diversified portfolio of bonds for long-term stable returns.
  • Maturity Matching: Select bonds that align with future expenses, a conservative strategy.

Mutual Funds: Types

  • Mutual Funds: Pooled investment vehicles where many investors combine funds to invest in a diversified portfolio of stocks, bonds, or other securities.
  • Types of Mutual Funds:
    • Equity Mutual Funds: Invest in stocks.
    • Bond Mutual Funds: Invest in bonds.
    • Balanced Funds: A mix of stocks and bonds.
    • Money Market Funds: Invest in short-term, liquid securities.

Mutual Fund Share Classes

  • Series A, B, C: Different mutual fund series with varying fee structures and compensation for the investment advisor.
  • ETFs (Exchange-Traded Funds): Similar to mutual funds but trade on stock exchanges like individual stocks.

Mutual Fund Costs

  • Management Expense Ratio (MER): The percentage of a fund’s net assets that goes toward operating costs (e.g., management fees). A higher MER means lower returns for the same level of performance.
  • Load Fees:
    • Front-End Load: Fee charged at purchase.
    • Back-End Load: Fee charged upon redemption.
    • No-Load Funds: No fee when purchasing or selling.

Key Financial Metrics

  • Net Asset Value (NAV): The total value of a mutual fund’s assets minus its liabilities. NAV per share (NAVPS) is the NAV divided by the number of outstanding shares.
  • Tax Implications: Interest income from bonds is taxed as ordinary income, and capital gains may be taxed when bonds are sold at a profit.

Applying for CPP Benefits

  • Application Required: Must apply to receive CPP benefits.
  • Earliest Age: Apply as early as age 60.
  • Latest Age: Apply by age 70.
  • Early Application Reduction: CPP is reduced by 0.60% per month for each month you apply before age 65.
  • Late Application Increase: CPP is increased by 0.70% per month for each month you delay beyond age 65, up to age 70.

Pension Sharing

  • Eligibility: Married or common-law couples may share CPP retirement pensions.
  • Purpose: To reduce combined income taxes.
  • Age Requirement: Both individuals must be at least 60 years old and receiving CPP pensions.

Surviving Spouse/Common-Law Partner Benefits

  • Benefit Amount: Surviving spouse or common-law partner receives 60% of the deceased’s CPP pension for life.
  • One-Time Payment: A $2,500 lump-sum death benefit is paid to the estate of the deceased.

Canada’s Private Pension System

Canada’s private pension system consists of two main components:

  1. Employer-Sponsored Pension Plans
  2. Individual Retirement Savings Plans (RRSPs)

Four Common Types of Employer-Sponsored Pension Plans

  1. Defined Benefit Pension Plans (DBPPs): Fixed pension amount based on salary and years of service.
  2. Defined Contribution Pension Plans (DCPPs): Pension amount depends on the contributions made and investment performance.
  3. Deferred Profit-Sharing Plans (DPSPs): Employer contributions based on company profits, often invested in RRSP-like accounts.
  4. Group RRSPs: Employer-sponsored RRSPs, where contributions are made through payroll deductions.

Defined Benefit Pension Plan (DBPP) – Example

  • Scenario: Bridgette is retiring after 30 years of employment.
  • Accrual Rate: 2% per year.
  • Formula: Average of her five best consecutive earning years.
  • Earnings Breakdown (Last 5 Years):
    • 2016: $65,000
    • 2017: $75,000
    • 2018: $80,000
    • 2019: $90,000
    • 2020: $100,000
  • Average Salary: ($65,000 + $75,000 + $80,000 + $90,000 + $100,000) ÷ 5 = $82,000
  • Annual Pension: $82,000 × 0.020 × 30 = $49,200 per year.

Individual Retirement Savings Plans (IRSPs)

Types of IRSPs

  1. Registered Retirement Savings Plan (RRSP):
    • Tax-Deductible Contributions: Contributions are tax-deductible and grow tax-deferred.
    • Eligibility: Available to Canadian citizens aged 18-71 with earned income.
  2. Tax-Free Savings Account (TFSA):
    • Contributions are not tax-deductible, but growth and withdrawals are tax-free.
  3. Locked-In Retirement Account (LIRA):
    • For pension funds that are transferred from a pension plan (locked until retirement age).
    • Locked-In RRSP (LRSP) may exist in certain provinces.

RRSP Contribution Limits

  • 2020 Contribution Limit: $27,230 (subject to annual changes).
  • Carry Forward: Unused contribution room can be carried forward to future years.