Financial literacy is a critical life skill and is just as important in life as any other basic life skill. Being financially literate means, you understand all things money – how it works, how it's generated, how to manage it and how to invest it. It also means having the knowledge and confidence that allows you to make smart, responsible decisions about your money.
A recent poll by Angus Reid Institute shows that Canadians are lacking this confidence when it comes to understanding common financial terms. RRSP vs TSFA. Simple interest vs compound interest. Do you know what these terms mean?
It’s time to get confident about your money and we’re here to help. Below are a few terms to get you started. Understanding these terms will not only increase your financial knowledge but will also help you start feeling confident about your money and the decisions you make.
Savings Account vs. Chequing Account
Savings accounts are a place where your money is meant to grow and shouldn't be used for everyday spending. Many savings accounts earn interest, helping your money grow faster and making them a great tool to use for your saving goals.
Chequing accounts are a place to deposit your money, such as your pay cheque, and use for your everyday spending. The money you want to save should be moved from this account into another account, such as your savings account, to take away the temptation of spending elsewhere.
Simple Interest vs. Compound Interest
Simple interest is calculated on the original amount, or what we like to call the principal. For example, if you were to deposit $1,000 into an account with an annual interest return rate of 3%, you'd receive $30 in interest each year. After 10 years, you'll have earned $300 in interest and have a total of $1300.
Compound interest is calculated on the principal amount AND on the accumulated interest of previous years. For example, if we used the same example as above, after the first year you'd receive $30 interest. In year two, the interest would be calculated on the principal amount and on the interest you previous incurred. ($1030 x 3% = $1060.90). After ten years, you'll have earned $343.92 in interest and have a total of $1,343.92.
Note: Compound interest is the type of interest applied most often when it comes to accounts, investments, loans, credit cards, etc.
RRSP vs. TFSA
RRSPs (Registered Retirement Savings Plans) allows you to contribute money into an investment that you can use as a tax deductible. This money will be taxed when you withdraw it. RRSPs can be invested in stocks, bonds, mutual funds, etc. and typically are locked in for a period amount of time.
RRSPs should be left until retirement, if not you can be charged a penalty. There are a few ways you can borrow money from your RRSP such as buying your first home, but you will have to pay back this amount by a certain time to not be penalized. More information can be found here.
TFSAs (tax-free savings accounts) allow you to contribute money to an investment but is not tax deductible. The positive with this type of account is that you aren't taxed when you withdraw the amount or on the earnings. You're allowed to contribute a maximum of $5,500 per year into a TFSA.
There is a bit more flexibility when it comes to TFSAs as you can take the money out whenever you'd like. This flexibility though can be a negative though as it can cause the temptation to spend vs. using as a long-term saving tool.
Variable vs. Fixed
A variable rate means your interest rate changes as interest rates change and can go up or down. If you have a variable rate on a loan, your payments will be the same but the amount you pay towards your principal may vary. In other words, if the variable rate decreases, you'll put more money directly towards your principal. If the variable rate increases, less money will go towards your principal and more will be applied to the interest.
Fixed rates stay the same and won't change even if the other interest rates change. A fixed rate will stay the same for the length of time you have set. The benefit of a fixed interest rate is that it protects you against any increases in interest rates.
Having a knowledge of these eight common financial terms can have a huge impact on your financial well-being and allow you make informed decisions when it comes to your money. Are there other financial terms you wish you knew more about? We want to know! Send us an email by using the Feedback Button on the right-hand side of this page and we'll be sure to include in an upcoming blog.