Year after year, studies show that Canadians think they have a good basic understanding of finance, but then they come up against the complexity of the financial world and its vocabulary.
It’s Financial Literacy Month, so here is a handy overview of 10 key concepts in economics and personal finance.
Some general concepts
1. Economic, financial, fiscal
These terms may seem interchangeable, but in fact they refer to very different realities. Economics looks at the overall production, distribution and consumption activities within a given society. Finance designates in particular the management of capital and money – for instance, your investments. And fiscal refers specifically to issues that affect your taxes.
2. Inflation and policy interest rate
The past year has reminded us that inflation is the sometimes abrupt increase in consumer prices. In this country, the Bank of Canada has a mandate to keep inflation within a target range that favours healthy economic activity. The main tool used for this is the “overnight rate target,” also known as the policy interest rate, which applies to the one-day loans financial institutions make amongst themselves. This is not the rate available to the general public, but it influences the interest rates on loans and savings products. In theory, higher interest rates encourage households to curb their spending, which reduces upward pressure on prices. To learn more about the causes of inflation, watch this video.
Your investments
3. Mutual fund, ETF, SEG, MER
A mutual fund1 is one form of investment fund, as is the ETF, or exchange-traded fund. The abbreviation SEG is often used to refer to segregated funds, also known as guaranteed investment funds. All of these terms refer to funds in which you can invest your savings in accordance with various criteria and objectives. They differ in a number of ways, however, notably in terms of how they are managed, what guarantees they offer and their management expense ratios (MERs), i.e., the fees deducted from your assets to cover the cost of management and administration.
4. GIC
A GIC is a guaranteed investment certificate. This is an investment available from your financial institution that guarantees both a specified rate of return and the full return of your principal. A GIC may have a fixed term, usually one to five years, or be redeemable, i.e., cashable on demand. In a context of high interest rates and stock market volatility, this form of investment, considered to be safe, is enjoying a resurgence of popularity.
5. RI, ESG, PRI, CSR
All of these acronyms are related to the global issue of responsible investment and sustainable development. RI simply means “responsible investment” and is used by portfolio managers to indicate their commitment to acting “responsibly” in their investment practices. ESG is a concept that defines the three main areas where this responsible investment must be applied: environment, social and governance. PRI stands for Principles for Responsible Investment, as defined by the United Nations to provide a framework for responsible investment practices. Finally, CSR, for “corporate social responsibility,” is a concept that applies to any company with respect to its relations with stakeholders.
Your insurance
6. Term, whole life, universal life, participating
These are the four main types of life insurance you can buy. Term insurance is a policy that covers you for a set period – 10, 20 or 30 years, for example. When the term is over, your coverage ends unless you renew the policy, generally with higher premiums as you age (you might also have to provide evidence of insurability). Whole life insurance is more expensive, but it provides lifelong coverage and the premiums are fixed and guaranteed. Whole life insurance often includes a cash surrender value, which means that you may receive a cash payment if you terminate your policy. Lastly, universal life insurance and participating life insurance are products that combine an insurance component and an investment component.
7. Cash surrender value and reduced paid-up insurance
The cash surrender value of a life insurance policy, if it has this feature, is the amount that would be paid to you if you cancelled your policy. However, you could also decide to relinquish the cash surrender value to your insurer in exchange for a smaller life insurance policy. In this case, you would not receive any cash, but you would still have lifetime coverage without paying any more premiums. This is known as reduced paid-up insurance.
8. Disability and critical illness
Disability insurance and critical illness insurance are known as “living benefit” policies. They are designed to pay out benefits if you were to become unable to work or if you were diagnosed with a critical illness from a list of covered health conditions. Disability insurance provides a regular income until you are able to go back to work, while critical illness insurance pays out a lump sum.
Your taxes
9. Tax rate
People sometimes confuse the marginal tax rate with the effective tax rate. Because we have a progressive tax system, higher income brackets are taxed at higher rates. Your marginal tax rate is the rate that applies only to your highest income bracket. Your effective tax rate is the average rate you pay on your income as a whole. Generally speaking, your effective rate will be lower than your marginal rate.
10. Tax credit
A tax credit is an amount that the government allows you to claim on your income tax return in order to reduce your taxes. For example, all taxpayers benefit from a basic personal tax credit, i.e., income up to a certain threshold that is not taxed. Tax credits fall into two main categories. “Refundable” credits are those you receive regardless of how much tax you have to pay – even if your tax bill is zero. “Non-refundable” credits only reduce your tax payable: if you don’t owe any taxes, the tax credit won’t give rise to a refund.
This is just a quick overview of some of the most common concepts. Your advisor can provide you with more information about any of these, and cover a broader range of concepts as necessary. Feel free to ask him or her!
1 Only mutual fund representatives associated with Desjardins Financial Security Investments Inc. have access to mutual funds.
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The following sources were used to prepare this article:
Autorité des marchés financiers, “How to access the cash surrender value without cancelling your insurance.”
Bank of Canada, “Understanding our policy interest rate.”
City News, “7 in 10 Canadians consider themselves financially literate: poll.”
Get Smarter About Money, “Mutual funds & segregated funds”; “ETFs”; “GICs.”
Global Sustainability Leadership Institute, “What’s With All the Acronyms?.”
Government of Canada, “Disability insurance”; “Critical illness insurance.”
Ingénierie financière, “Différence entre économie et finance.”
Institut québécois de la planification financière, “Tax situation.”
Intuit TurboImpôt, “Refundable vs. Non-Refundable Tax Credits: What’s the Difference?.”
Investopedia, “Finance vs. Economics: What's the Difference?.”
Investopedia, “What Is a Canadian Guaranteed Investment Certificate (GIC)?.”
Larousse, “Fiscalité.”
Ontario Securities Commission, “Investor research and reports”.
Protégez-vous, “Glossaire des termes d’assurance.”
XpertSource, “Cash Surrender Value of Life Insurance: What You Need to Know.”