The five Cs of credit are a basic concept in lending, and I thought it would be helpful to write an article that explains each “C” in greater detail for those that may be unfamiliar with the topic. I think that understanding the five Cs of credit really comes down to putting yourself in the “shoes” of a lender and asking yourself what sorts of things you would look for in a borrower when deciding whether or not to approve a loan.
Character is basically about deciding whether or not it would be prudent to lend to a specific borrower based on their history of making payments to other lenders. If you can demonstrate a track record of paying all of your debts when they are due, you likely have a good credit score, and if you don’t, you will unfortunately have a much lower credit score and find it more difficult to borrow money.
Tax-free savings accounts (TFSAs) are types of accounts in Canada that provide incentives for us to save money. TFSAs first became available in 2009, only allowing a contribution limit of $5,000 initially, but because the contribution limit automatically increases each year, the total TFSA contribution room is now as much as $69,500 for 2020 (it was previously $63,500 for 2019).
Once you understand the key differences between RRSP and TFSA accounts, and also which types of investments are permitted in a TFSA, the next question is typically how to go about calculating your total TFSA contribution room. Annual TFSA room begins to accumulate when a person turns 18, or in the case of someone that moves to Canada from another country, their cumulative TFSA limit begins to increase the year that they arrive in Canada and obtain a social insurance number.
Mutual funds are one of the first types of investments that most investors are likely to encounter when saving for retirement. Mutual funds are a great way to get started with investing, and offer some key benefits, including low barriers to entry, diversification, and professional management of your investments.
I think it is also very important for investors to learn about what is meant by the Management Expense Ratio (MER) fees that are disclosed for a mutual fund that they are considering investing in. MERs are also relevant for other types of investments, such as exchange traded funds (ETFs).
As we will see shortly, MERs have the effect of reducing annual returns (growth rates) for investors, which makes this a very important financial literacy topic!
Imagine a world where literally anyone could sell you an investment without first taking into consideration your specific financial circumstances and determining if an investment is suitable for you. Fortunately, we instead live in a world where investments are heavily regulated, along with the firms that sell them to you and also the individuals working for those firms, in order to protect investors.
Securities regulators such as the SEC in the United States and the multitude of provincial regulators in Canada expect investment dealers to know who they are dealing with, more specifically referred to as an obligation to Know Your Client (also referred to as Know Your Customer), which is abbreviated as KYC. KYC partially consists of collecting basic information about you as a person (name, address, phone number, etc.), as well as your financial circumstances (sources of income, liquid net worth, non-liquid net worth, liabilities, etc.).
When I am asked to explain what self-directed investing is, I often find it helpful to first talk about the opposite of self-directed investing, which is entrusting our money with some form of investment manager.
For many of us our first encounters with investing are often when our bank tries to sell us investments, such as term deposits or mutual funds. Or perhaps our employer offers us a defined contribution retirement savings plan at work, with similar investment options.
Banks and wealth management firms are required to “know your client” (KYC) before selling you investments, and they will typically have a formal process to walk you through the types of investments that they offer. This generally includes a brief crash course on learning about what stocks and bonds are in very broad terms, and also talking a bit about risk.
I was recently asked to explain the difference between investing and trading, and I thought it would be beneficial to also begin to answer this question with a blog article.
What Is Investing?
Investing in my opinion is about taking a long-term approach to the financial markets. That said, time horizons may vary significantly for each investor. For example, a pension fund may have a different time horizon than an individual investor, and each person will have a different time horizon depending on their age and specific goals.
To break this down further, goals might include saving for a down payment to purchase a home, setting aside money for a child’s post-secondary education, or a longer-term goal such as saving for retirement. The time horizon then becomes an important factor when choosing investments.
The specific method of investing will also vary for each investor. For some it will involve entrusting their money with a bank or a wealth management firm, perhaps by investing in mutual funds or exchange traded funds, and for others it may involve choosing to open an account with a discount broker and then making their own investment decisions.
One of the first things that someone new to self-directed investing or trading must learn is the array of order types that are offered by their brokerage, as well as the pros and cons of each order type.
A market order is the simplest type of order to understand. When we use a market order we are instructing our broker to immediately buy at the currently available offer price(s) or to sell at the currently available bid price(s). Note that price may be plural, because we may buy or sell at more than one price based on the liquidity (market depth) that is currently available at the best bid or offer price (we will explain this in greater detail in a future blog post).
Every business should have a business plan, even the smallest of small businesses. Why? In my opinion it is because a good business plan should answer a number of questions that also relate to budgeting and forecasting:
I recognize that business plans can be a very formal document, and that preparing a business plan can be an intimidating process for entrepreneurs. That said, forcing yourself to go through the process of preparing even a basic business plan can really help you to think about the viability of your business.
Having worked in asset-based lending and private equity roles previously, I generally found that businesses were usually able to provide historical financial information fairly easily (particularly for past fiscal years, less so for interim fiscal periods). Where they typically struggled however was when it came to providing forecasts. With that in mind, what specifically does budgeting and forecasting mean for businesses?
According to a recent poll by RBC, 57% of Canadians have TFSA accounts. I think that is a reasonably good start, with room for progress on that front (the number should be closer to 100%), but many Canadians are unfortunately missing out on investment types that offer the highest growth potential for their TFSAs.
The RBC poll stated that the top five holdings in TFSA accounts are:
Let’s think about the impact of this for a minute. Tax-free savings accounts offer us the huge advantage of tax-free growth, because no taxes are payable when funds are withdrawn from TFSAs. If we invest $10,000, and it increases to $15,000 over time, we owe $0 in taxes for the growth of $5,000 (the entire $15,000 can be withdrawn tax-free).
The problem is that savings accounts pay very low interest rates currently, ranging from around 0% to 1%, and the RBC poll tells us that this is the most common type of “investment” in TFSAs. Canadians are basically stuffing their TFSA accounts with investments that are unlikely to grow by very much over time (not even keeping up with inflation), and they are missing out on the significant tax advantages offered by TFSAs. Even non-cashable GICs tend to offer fairly low interest rates of around 2% currently (exact rates vary), which would barely keep up with inflation.
Assets and liabilities are basic accounting terms that would be one of the first topics presented to a student in a bookkeeping or accounting class, and I personally think that it is essential for every small business owner to understand this basic accounting terminology as well.
Assets are items on a company’s balance sheet that provide future economic benefits to a company. Some common examples of assets include:
Johnathan Klimo, CFA