Investing in Canada
Over the past few decades, many Canadians have turned to investing as a way to grow their savings. In an economic environment where it can be hard to get ahead, an investment plan that has an element of growth can supplement incomes, support special purchases and ease the cost of retirement.
Of course, your investment strategy will depend on you — your age and your stage in life, your goals and your ability to tolerate risk. Although some people choose to handle their own investments, most Canadians seek out a financial Advisor who can bring knowledge and discipline to the investment process. In any case, you will want a diversified portfolio that keeps risk manageable and delivers the return you need. For more on types of investments, see the Investing 101 brochure.
If you choose to work with an Advisor on your investment strategy, there are things you will want to know about Canada's investment environment. For starters, if your Advisor is going to sell you an investment product — such as a mutual fund, bond or stock — he or she will be licenced. In Canada, there are three main types of licencing of Advisors.
An Advisor may be licenced to sell mutual funds only and will work at a mutual fund dealer. These dealers fall under the regulations of the Mutual Fund Dealers Association of Canada. Mutual funds offer diversification and professional management. See the Mutual Fund 101 brochure for more on how mutual funds work.
If you prefer to hold stocks and bonds directly rather than through mutual funds, you will want to work with a securities-licenced Advisor, which gives him or her the ability to sell stocks, bonds and exchange-traded funds. Such an Advisor will be associated with an investment dealer which, in turn, is regulated by the Investment Industry Regulatory Organization of Canada.
Your Advisor can also be licenced to sell insurance and many Advisors are licenced to sell insurance as well as mutual funds or securities. Insurance is often used in estate planning, which is used to eliminate uncertainties over the administration of the disposal of an estate and maximize the value of this estate by reducing taxes and other expenses. Some insurance products have an investment component. For more on insurance see the Insurance section.
Laws governing mutual funds and securities are developed and overseen by provincial securities regulators who are part of an umbrella organization called the Canadian Securities Administrators. For the provincial securities regulators, go to Protecting Investors.
Advisors in Canada may also have "designations" showing that they have studied to attain a higher level of knowledge. There is an alphabet soup of credentials — an Advisor might be a Certified Financial Planner (CFP), for example, or a Chartered Investment Manager (CIM) or a Fellow of the Canadian Securities Institute (FCSI). Some designations, such as the CFP, are international and show the Advisors are qualified by taking courses and passing exams, and adhere to a code of conduct. Other designations may indicate only that a course was completed.
Advisors are paid in a number of ways. You may pay a commission — as is the case when a stock is traded — or you may pay a percentage of the amount invested. Some Advisors charge a straight out hourly fee for the amount of work they do, say, developing your financial plan. Or an Advisor may do some combination or all of the above.
Advisor licencing and compensation, securities markets and regulations are confusing — even to long-time inhabitants of Canada. So, when you meet with your Advisor, you should find out where he or she fits in the investment world. Ask your Advisor the following questions:
When you are satisfied with the answers and feel comfortable with the integrity of your Advisor, you are in a position to develop your investment strategy, one that meets your needs and goals.
How your investments are taxed depends both on the type of investment and the account in which you hold your investments. Interest income, dividend income and capital gains or losses are all taxed differently but with a proper tax strategy you can take advantage of those differences. You will want to work closely with your Advisor to devise a strategy that fits your circumstances.
Tax-sheltered or registered investments
The first thing to note is that investments inside a registered account — such as a Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA) — are treated differently than those held in an unregistered account. Any income earned by investments in your registered accounts grows tax-free; they are tax-sheltered. The difference in tax treatment of investment income disappears. When your investment income is taxed depends on the type of registered account.
If you put your investments into a non-registered — or unsheltered — account, you pay income taxes on the money you earn in the tax year in which the income was realized. The amount of taxes you pay depends on the type of income you have earned.
You can earn interest from many sources — from a bank account, a guaranteed investment certificate, a bond you hold, a mutual fund that holds interest-paying investments. Interest income is fully taxed; $1 of interest is $1 of income (see the Tax System in Canada section). The logic behind the tax treatment of interest is that when a borrower or an issuer of a debt instrument, such as a bond, makes the required interest payment to lenders, the borrower is allowed to take an offsetting tax deduction. The interest income you are receiving, then, has not been taxed; but it will be taxed in your hands.
If you own common or preferred shares in a taxable Canadian corporation, or own units of a mutual fund that invests in such common and preferred shares, you will probably have dividend income, which rates a more favourable tax treatment than interest income.
Dividends are cash payments to shareholders of a corporation made from the corporation's profits. That means the dividend income you receive has already been taxed in the hands of the corporation. In order to avoid paying taxes twice on the same amount of money, dividends are treated to the "gross-up and tax credit" system. So, to simplify a very complicated process, your dividend income is grossed up by a factor of 1.25 and you calculate the taxes you would pay on this amount at your marginal rate. Then you calculate both the federal tax credit (about 25%) and the provincial or territorial tax credit (which varies by jurisdiction) and subtract that from the amount of taxes payable you calculated earlier.
Sound circuitous? It is, but the end effect is that the amount of taxes you pay on dividends is relatively low, making dividend income very attractive. However, dividends from foreign companies are not eligible for this treatment.
Capital gains and losses.
Let's say you bought 100 shares of ABC Corp. for $10 a share. It was a brilliant move. ABC Corp. is now worth $100 a share. You decide to take some profits and sell 50 shares — half your investment. You reap $5,000, realizing a profit of $4,500. That $4,500 is a capital gain.
Let's say you also bought 100 shares of XYZ Co. for $10 a share. That didn't go quite as expected; the company's big product launch was a failure and the shares are now trading at $5 a share. You decide to sell all your shares. You realize $500 on the sale for a $500 capital loss.
What makes a capital gain or loss attractive from a tax point of view is that you bring only 50% of the gain or loss into income. So, in our ABC Corp. example, you would include only $2,250 in your income for that year. It would be taxed at your marginal tax rate.
The other advantage to capital gains or losses: is that no tax is triggered until an asset, such as a share, is sold. For example, you can continue to hold the remaining 50 shares of ABC Corp. until they reach $500 a share and you pay no taxes until you sell the shares. That allows you to defer realizing the gain or loss until a time that is tax-effective for you. You may want to wait, for example, until income is lower and your marginal tax rate comes down; or you may decide to take a loss to offset a gain.
You can realize a capital gain or loss on stocks, bonds, exchange-traded funds (ETFs) and mutual funds. If you invest in a mutual fund, you can have a capital gain when you sell the fund if the unit value of the fund has appreciated, or you may receive capital gains earned by the fund itself.
Understanding the tax consequences of your investments can make a difference to your financial well-being. Talk to your financial advisor; he or she will have more information on the taxation of investments and can suggest strategies to maximize your tax effectiveness.