Understanding the types of Canadian accounts

Before starting investing, it’s important to have a basic understanding of how investing works – different account types, taxation, convenience vs fees, and how to get reliable, truthful information. In Canada, one of the most popular ways to invest in assets within a Registered Retirement Savings Plan (RRSP) and Tax-Free Savings Account (TFSA). These accounts both offer tax benefits helping you save for retirement or other long-term goals. See my blog about the various Canadian account types.

Effectively, money you put into an RRSP reduces your taxable income for the year. You invest this money, and withdraw later when you’re retired. You’ll pay tax on it later (“deferred taxation”) but you’ll be in a lower tax bracket. In other words, all of your investment gets taxed when you withdraw it.

Money put into a TFSA will not be taxed in any way. You put money into a TFSA account, purchase assets, and your withdrawal isn’t taxed at all.

Of course, you can just have a regular account that you can invest with, but all that income will be taxed. It’s common to do this when your RRSP and TFSA has as much as you’re allowed to put into it.

Choosing an investment brokerage

Once you have these basic understandings of investing accounts and types, the next step is to choose an investment brokerage where you’ll open one or more of: RRSP, TFSA, and margin account. Most people just use their bank for this out of convenience. Banks offer mutual funds and other investment options for the money within your account, and this is paid for with fees.

There are many different brokerages to choose from, each with their own fees, investment options, and account minimums. Some popular options in Canada include Questrade, Wealthsimple, TD Direct Investing, and RBC Direct Investing.

When choosing a brokerage, it’s important to consider your investment goals and the types of investments you want to make. You should also pay attention to the fees charged by the brokerage, as these costs reduce your returns over time.

Investing the easy or hard way: Is there a difference?

Using my bank

Let’s say I’m just starting saving for my retirement. I go to my bank and ask to set up an RRSP with my first $10,000. They will help create the RRSP, transfer the money in, and will likely sell you a mutual fund that is appropriate for your level of risk. (More risk = more returns. In the short term it will bounce around up and down, but over the long run, they will be able to show you how it has performed in the past.)

One example of a mutual fund that you may be sold is SEI 60/40 (60% stocks, 40% bonds) which (as of Feb 23, 2023) has a 10-year return of 5.33% per year. That’s not guaranteed in the future, but that’s how well it’s done in the past. Notice, they also have fees in there for 1.78%. So you’re making 5.33% and they took 1.78% to get you the 5.33%.

You leave it in there for 30 years, you’ll have $47,485.67.  Here’s how you calculate this. using P=$10000, R=5.33, n=Annual, t=30

When you withdraw at retirement, you are taxed on the amount you withdraw.

Managing my own investments

I want to save for my retirement. I open an RRSP account with Wealthsimple, and deposit my first $10,000. I decide that I want to have 60% stocks, 40% bonds based on my risk tolerance. I buy an ETF that manages everything for me called VBAL. VBAL has a 5 year return of 4.71% per year (it hasn’t existed for 10 years yet…). The fees for that are 0.24% but it also pays 2.11% interest which you can use to buy more VBAL.

If this continues like this for years, you make 4.71% + 2.11% – 0.24% = 6.58%. You’ll need to either manually buy more VBAL every quarter for 30 years, or you can get something like a DRIP to do it for you. When you retire you’ll have $57,650.57.

So how should I invest my money?

I’m skimming over many aspects here, but effectively you can make investing simple with your bank or financial advisor, OR you can manage your money yourself. Maybe the fees are worth it as you may in the future get better returns. Maybe the complication of managing your own money is worth knowing and potentially saving yourself loads on fees. You’ll need to figure this out yourself.

Diversification of your portfolio

Another basic yet very important concept to understand is asset allocation. This refers to how you divide your investments between different types of assets, such as mutual funds, ETFs (“Exchange traded funds”), stocks, bonds, cash, rental property, and businesses. The right asset allocation will depend on your goals, risk tolerance, and how long you’ll be invested.

It’s truly very important to diversify your portfolio with a mix of different assets to reduce your overall risk. There are a lot of variables here:

• Mixture of cash, bonds, GICs, stocks, mutual funds, ETFs — all without making it too complicated
• With stocks: investment in different sectors of the stock market, like technology, healthcare, and energy.
• With stocks, mutual funds, ETFs: investment in stocks in different countries, like Canada, US, Europe, emerging markets (India, Mexico, Brazil, etc.)

Diversification can help protect your portfolio from market downturns and reduce the impact of any one investment on your overall returns. Yet, it’s very important to remember that diversification does not guarantee any profit or protect you against a loss.

What did we learn?

Investing in Canada can be a great way to grow your wealth over time, but it’s important to take the right first steps by understanding accounts types, asset types, and diversification for managing risk. As always, it’s important to do your own research and certainly consult with a financial advisor before making any investment decisions.

Contact me about a referral to Wealthsimple for a chance to get a reward between $5-$3000.