Definitions for Common Personal Finance Terms

Bond

You can help grow your savings by lending your money temporarily to a company or government. To document the agreement, you receive a bond, which is similar to an IOU. A bond is a type of fixed income that pays you a set interest rate over a specific period. A bond is often considered safe if you lend your money to a major government or stable company. In other cases, a bond could be risky if you’re lending your money to a company that already owes a lot of money or isn’t earning any income. The interest rate that you receive depends on how risky the loan is. Bonds with lower risk (e.g., lending to the Government of Canada) offer a lower interest rate.

You can learn more about bonds and other fixed income investments in Chapter 13 of The Snowman’s Guide to Personal Finance.

Canada Pension Plan (CPP)

To help Canadians save for retirement, the Government of Canada created a savings plan that collects payroll tax from you each year and then pays you income in retirement. As of 2019, you’re required to pay 5.1% of your earnings to a maximum tax of $2,748.90. Then in retirement, which can start between ages 60 and 70 the CPP provides income to you each year. The maximum annual payment is roughly $14,000, and the average amount paid is roughly $8,000 as of 2019. The amount you receive depends on the number of years you contribute to the CPP, the amount you contribute and when you choose to start receiving payments.

For those working in Quebec the CPP is replaced by the Quebec Pension Plan (QPP).

You can learn more about the CPP and other government programs in Chapter 17 of The Snowman’s Guide to Personal Finance.

Credit Score

Your credit score is a number that falls somewhere between 300 and 900. It signals to lenders your ability to take on and repay a loan. Your score takes time to build and is based on five main factors. These include your payment history, current credit, credit history, credit applications and forms of credit. When it comes to building and managing your credit score, best practices are:

  • only borrow what you know you can payback.

  • make payments on time.

  • avoid maxing out your borrowing accounts.

  • check your credit history occasionally to ensure there are no errors.

You can learn more about your credit score and managing debt in Chapter 7 of The Snowman’s Guide to Personal Finance.

Dividend

Some companies pay a dividend to the owners of the company (also referred to as shareholders). Companies often pay a dividend when they have more income than they need. If a company earns $1 billion in a year, its management may decide to keep $600 million to invest into new products and to expand their team. The remaining $400 million can be passed to the company’s owners by paying them a dividend. The $400 million is split up among all the owners and paid out.

You can learn more about dividends and stocks in Chapter 12 of The Snowman’s Guide to Personal Finance.

Exchange-Traded Fund (ETF)

When you invest in a single company (e.g., Apple) by purchasing shares, you take on a significant risk. To minimize the risk of investing in one or two companies, a common approach is to buy many different companies—called diversification. Exchange-traded funds (ETFs) bundle many different investments (often 100s or more) into a single investment that you can easily buy and sell. This way you have greater diversification without the need to manually buy all the individual investments yourself. ETFs can invest in a wide range of investments, including stocks, bonds, REITs and more. You buy and sell ETFs similar to how you buy and sell a stock, through a digital exchange called the stock market. To provide the service of buying all the individual investments, the ETF charges you a fee called the Management Expense Ratio (MER).

You can learn more about exchange-traded funds (ETFs) in Chapter 14 of The Snowman’s Guide to Personal Finance.

Guaranteed Investment Certificate (GIC)

Guaranteed investment certificates (GICs) provide a way to lend your money to financial institutions for a fixed period. If you need your money back before the period is over, there can be penalties. Because you agree to lend for a fixed period, the borrower is often willing to pay you a higher interest rate. For instance, the interest on a savings account where you can withdraw any time might be 1.5%. However, if you commit to lending for a year through buying a one-year GIC, you may receive 2% interest. In addition, typically the longer you lend your money, the higher your return. Instead of buying a one-year GIC and earning 2%, you could buy a three-year GIC and receive 2.5% a year. In Canada, some GICs are guaranteed by the Canada Deposit Insurance Corporation (CDIC) up to a maximum of $100,000. You can speak with your financial institution or CDIC to learn more about the coverage, given your situation.

You can learn more about guaranteed income certificates (GICs) and other fixed income investments in Chapter 13 of The Snowman’s Guide to Personal Finance.

Interest

When you lend someone money the expectation is that you’ll be compensated for temporarily giving up the ability to spend. To compensate you, the borrow will pay you interest in addition to giving your money back. For example if you deposit $100 into a high-interest savings account with your bank, you could receive $2 in interest over a year. Therefore you’d have $102 at the end of the that year. Interest is one way to help grow your savings for the future. When you’re borrowing money you’re the one paying interest. If you borrow $25,000 to pay for school, you’ll have to pay back the $25,000 plus roughly $8,000 of interest to compensate the bank.

You can learn more about using interest to grow your savings in Chapter 2 and how paying interest can be damaging to your financial goals in Chapter 6 of The Snowman’s Guide to Personal Finance.

Management Expense Ratio

Mutual funds and exchange-traded funds (ETFs) bundle investments together to make it easier to spread your money across a range of investments. These funds are either actively or passively managed. This difference is important because it often has a large impact on the fees you pay. The management expense ratio (MER) of the fund is one of the most important figures to consider. It’s how much of your money is used on an annual basis to pay for the managing team’s time, resources and expenses. The higher the MER, the more the managers of the fund are costing. Generally, higher MERs—usually greater than 1%—are associated with actively managed funds. These funds do research and regularly buy and sell new investments, experiencing high costs. Less expensive funds—usually with MERs of 0.5% or less—typically follow indexes or broad markets. These funds buy a pre-set list of investments instead of picking and choosing. Therefore, they need less research and trading, thereby lowering their costs.

You can learn more about the management expense ratio (MER) and the impact it can have on your savings in Chapter 14 of The Snowman’s Guide to Personal Finance.

Old Age Security (OAS)

The OAS pension is one of the Government of Canada’s retirement income programs. The government takes a portion of the taxes it collects each year and pays individuals aged 65 and older. To qualify for the pension you must be a Canadian citizen, permanent resident or landed immigrant and have lived in Canada for at least 10 years after turning 18. The amount you receive depends on how long you lived in Canada after turning 18 and your income. The full monthly pension of $607.46 (as of January 2020) is paid if you’ve lived in Canada for 40 years or more since turning 18 and earn less than $79,054. If you’ve lived in Canada for less than 40 years or earn more than $79,054 you may receive a portion of the pension.

You can learn more about the OAS pension from the Government of Canada’s website.

Registered Education Savings Plan (RESP)

An RESP is an account that’s intended to help you save for a loved one’s post-secondary education. The two main benefits of using an RESP instead of a traditional savings account are:

  1. money grows tax-free while it remains in the account.

  2. government grant and incentive programs deposit additional money in the account.

There are some provincial grant programs, but the main two federal programs are:

  1. The Canada Education Savings Grant (CESG), which matches 20% of your deposits to the account in most cases.

  2. The Canada Learning Bond (CLB), which pays up to $2,000 into the account for qualifying individuals, without any need for you to deposit money.

You can learn more about the RESP in Chapter 16 of The Snowman’s Guide to Personal Finance.

Registered Retirement Savings Plan (RRSP)

An RRSP is an account designed to help you save for retirement. The Government of Canada recognizes the importance of retirement savings for a country’s well-being. Therefore, they offer a series of incentives to encourage you to plan and save for the future. The main benefits of an RRSP are:

  1. You don’t pay income tax on money deposited to an RRSP until it’s withdrawn, most often in retirement.

  2. Your money grows tax-free while in the account.

The RRSP also allows you to take money out of the account to purchase a home through the Home Buyers’ Plan (HBP) or to go back to school through the Lifelong Learning Plan (LLP).

You can learn more about the RRSP in Chapter 9 of The Snowman’s Guide to Personal Finance.

Stock / Share

A share, often referred to as a stock, represents your partial ownership of a company. You can grow your savings by purchasing shares of a company and then selling those shares later for more than you paid. As long as you own the shares, you may also receive payments from the company called dividends which also help you grow your savings. In some cases you can buy shares directly from the company, in which case they take the money and invest it in the business. In other cases you may buy the shares from an existing investor in the company. This is done through the stock market where investors buy and sell shares from one another.

You can learn more about stocks in Chapter 12 of The Snowman’s Guide to Personal Finance.

Tax-Free Savings Account (TFSA)

A TFSA is a flexible and fantastic account that can be used when setting aside money for any goal. It can be used for short-term savings toward a car or vacation, medium-term savings for a house or long-term savings for retirement. Any growth on the money held in the account is tax free. This allows for much faster growth of your savings relative to holding them in a traditional savings account. Cash in a TFSA can be invested in fixed income to earn interest or invested in stocks, ETFs, mutual funds or more. There’s a limit to how much you can deposit to a TFSA. If you:

  • were born in 1991 or earlier

  • have resided in Canada

  • haven’t deposited to a TFSA

your limit is $69,500 as of January 1, 2020.

You can learn more about the TFSA in Chapter 10 of The Snowman’s Guide to Personal Finance.