Investing 101 – The Home – The Floor Plan – The Furniture

Managing Your Money

In the financial industry we use many acronyms such as RRSP, RRIF, LIRA and TFSA to name a few. Most people know that these are financial terms, but not everyone knows what exactly they stand for or how they work.  When in a medical environment, I know that MRI, ECG, CT, and CBC are all acronyms that refer to medical tests. But I don’t necessarily know what the acronym stands for, how the tests work or what they test for. But in the financial industry, more that the medical field, I feel as if many people have a self-imposed pressure that they should know more than they do, regardless of their level of knowledge.

If you’re reading this article, and already have a good understanding of how investment accounts work, consider forwarding it to a child or grandchild, or even a parent or friend who may not be well versed in the financial world.

In my practice I often find that there are misunderstandings when it comes to some basic, but very important aspects of investing. I’m going to share the analogy of a home, floor plan, and furniture which I often use with clients to clarify some of these misconceptions.

The home – Account

If we think of a home, there are many different kinds. There are detached homes, semi-detached, townhouses, condos, etc. Now, think of different types of investment accounts – Non-Registered account, RRSP account, TFSA account, etc., as different types of homes – they house your money and investments, as your home houses your furniture. Just as you could have a home with no furniture in it, you could have any one of these accounts with no money or investments in it (though pointless, it is possible). The account is simply a place to hold money or investments. Just as some homes, such as condos, have rules associated with it, so do some of these types of accounts. Others, like a detached family home, have very few rules. And yes, the rules are very important, but that’s a topic for another discussion.

The floor plan – Asset allocation

When we walk into any home we can observe the floor plan to see how the home is laid out. Maybe there’s a big living room and small kitchen, or maybe the opposite. Maybe there are four bedrooms or maybe only one. From an investment perspective we would call this asset allocation – which shows how investments are divided or laid out. Asset allocation is one of the most important aspects of investing, and one of the most important decisions regarding your investments. It will be the main determinant of your investment results.

“I often find that there are misunderstandings when it comes to some basic, but very important aspects of investing”

Just as most homes have standard rooms (kitchen, bedroom, living room), asset allocation is broken down into three main categories – cash, equity (or stocks), fixed income (or bonds). And each of those categories can be sub-divided further. The image below, Periodic Table of Investments by Phil Huber, is a brilliant way of depicting all the different asset categories, with their goals and risks.  A larger version can be found easily online, but the point is to show just how many asset categories there are. And you don’t need to have all of them!  Just like there is no right or wrong floor plan, there is no right or wrong asset allocation. It really comes down to your risk tolerance and goals. When we talk about diversification, this is what we mean – diversifying across these asset categories.

The furniture – Investments

So, once we establish what kind of home we’re in and what the floor plan looks like, it’s time to add the furniture. Just as you could put identical furniture in any home, the same holds true with most investments (with some exceptions). And this is often where there is confusion. You could put the same basic savings account, stock, mutual fund, etc., in any “home” – an RRSP account, a TFSA account, a Non-Registered account, etc., however, just as certain furniture looks better in some types of homes, some investments work better in certain types of accounts. And the reason usually comes down to taxes. Because the rules on some accounts provide tax sheltering, more highly taxable investments are better off in those types of plans. The other factor to consider regarding this is the time frame. Maybe you wouldn’t normally place a savings account in a TFSA, but if you plan to buy a property in six months then it would make sense.

Periodic Table of Investments by Phil Huber, is a brilliant way of
depicting just how many asset categories there are

I realize that some people are not interested in knowing too many details about their investment accounts, and simply put their trust in the person managing it. But just as in a medical situation, being informed and knowledgeable about the basics allows you to ask better questions, such as: why are you putting that investment in this account instead of that account? What is my asset allocation? How did you determine my asset allocation? How many different asset categories am I diversified in? In fact, I think I could write a whole article on great questions to ask about your investments.

The bottom line is, you should never feel embarrassed or shy about your level of knowledge, nor feel hesitant to ask questions in fear of looking unknowledgeable. I don’t know how an ECG differs from a ECHO or exactly how an MRI differs from a CT. I also don’t feel like most medical professionals expect me to know, and therefore I don’t hesitate to ask. However, I also know that if I inform myself, I will be able to ask better questions, and ensure I’m getting the best medical advice. Remember, it’s not only your physical health you want the best advice for; it’s your financial health as well.

Lynn MacNeil, F.PL. Vice President, Investment Advisor, is a Financial Planner with Richardson GMP Limited in Montreal, with over 25 years of experience working with retirees and pre-retirees. For a second opinion, private financial consultation, or more information on this topic or on any other investment or financial matter, please contact Lynn MacNeil at 514.981.5795 or [email protected]. Or visit our website at www.EphtimiosMacNeil.com.

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