What is Not an Investment?
Introduction to Investment Planning – Part 1
People often use the terms savings and investments as though they mean the same thing. This makes sense because generally speaking you cannot invest unless you have money to invest. You cannot have money to invest unless you have savings. However, savings and investments are not quite the same thing, although the lines do blur somewhat.
A chequing account is not an investment
I would argue that money held in an account which has no risk of loss is not an investment. Cash is not an investment. Cash simply sits in a chequing account, or in your wallet, waiting for you to use it for some short-term purpose, like buying groceries or paying a bill.
A savings account is not an investment
A savings account is not an investment either. Savings accounts generally earn interest, so you could argue that you are getting a “return on your investment,” in terms of the monthly interest you receive. However, the interest rate is seldom above the rate of inflation and when you take into account the taxation of the earned interest, you are probably losing money over time. That means that savings accounts are best used for shorter-term purposes where the risk of loss is unacceptable. That short-term time frame is implicit in your ability to withdraw money from a savings account at any time.
A guaranteed investment certificate is (not) an investment
What about Guaranteed Investment Certificates (GICs)? Here is where the line between savings and investment gets blurred. In order to get a decent amount of interest, you must be willing to lock up your money for a period of time, typically between one to five years. There is an element of risk involved because in return for giving up the ability to redeem your GIC, you generally get a higher interest rate. What happens if inflation starts going up dramatically? You are stuck until the GIC matures. If, on the other hand, inflation decreases, you have locked in a higher interest rate until the maturity date, potentially five years down the road. I do not want to make too sharp a distinction, but I will suggest that a GIC that is due in one year or less has characteristics that are more like a deposit in a savings account, while a GIC which has a maturity date greater than one year into the future might be considered more investment-like.
The primary difference between chequing, savings or GIC accounts on the one hand and investments on the other hand is that the former are considered deposit accounts and they are generally considered secure from loss. Subject to certain rules, these accounts held at banks are covered by the Canada Deposit Insurance Corporation (CDIC), which protects your principal and any accrued interest if the financial institution goes bankrupt. Provincially regulated institutions, like credit unions, have their own separate insurance programs. Click here for more information on the insurance provided by CDIC. CDIC also provides a helpful list of the provincial deposit insurers in each province here.
So, what is an investment?
I will elaborate on this question in future posts. Briefly, though, investments operate on the idea that with greater risk there is the potential for greater return. In the deposit accounts discussed above, money is held in an essentially “risk-free” environment. Not so with investments.
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, accounting or legal decisions.