Clients want to know:

How much should I invest?

After reading this, you should understand:
The amount of funds your clients need to invest to reach
their financial objectives

Planning Finances
We have already reviewed some of the short and long-term needs that people usually
save for, such as retirement or higher education. You may find that a client requires
some basic financial-planning assistance in order to set specific, realistic, yet,
challenging financial goals. Once those goals have been identified you will gather
information about how achieve them. This is an extension of the Know Your Client
rule.
The information acquired helps you, as the agent, to understand your clients
financial position, including:
Insurance and investments that are in place;
Insurance and investment needs;
Debt obligations;
How much money is available for investment;
Which investments meet client objectives.
You will need to review tax returns, insurance policies, and wills and estate plans and
learn about your clients risk tolerance and lifestyle.
Quantitative information (such as amounts held as assets, liabilities, income, cash
flow, etc.) and qualitative information (such as lifestyle choices) will be required to
determine whether the objectives can be met. This will enable you to satisfy the
needs of your client with the appropriate product(s).
The process of developing strategies appropriate to the objectives of your client
results in recommendations that form a plan of action for the client. Implementation
of the plan becomes essential for the client to realize his or her goals.
You should monitor your clients ongoing needs through periodic reviews that take
into account any change in your clients financial situation.
Copyright 2011 Oliver Publishing Inc. All rights reserved. 239

LLQP

Investing wisely is a lot

more than wishful
thinking. The investor
must make a
commitment to his or
her goals, assign a
dollar figure to them,
and develop a strategy
to reach the goals.

What must an agent do before offering specific investment advice to a client?

A
B
C
D

Complete a risk-reward questionnaire

Provide the history of investment returns
Complete a net worth statement to determine how much money is available to invest
Determine a clients most important personal financial goals and order them
according to importance and need.

Assigning a Dollar Value to Savings

Putting an actual dollar amount on financial goals turns those goals into objectives.
The challenge for the financial planner is to take todays dollar figures and turn them
into the numbers needed in the future. Luckily, you will be provided with software
and other selling tools by your employer to assist you in this task. But if you know
how to do the math, you can provide answers to your clients, even in situations
when your computer or other aids are not available.
Some basic investment concepts will help you and your client understand the nature
of money and how it works. These concepts are:
The time value of money;
The present value of money;
The future value of money;
Dollar-cost averaging.

The Time Value of Money

The time value of money is simply the difference between the amount of money that
is invested, and the sum to which it will grow over time. This is because of the
interest that can be earned on that sum and the power of compounding.
Understanding this concept and its related calculations are essential tools for financial
planners and life agents, because they can be used to show clients how much they
need to save now.
240 Copyright 2011 Oliver Publishing Inc. All rights reserved.

How Much Should I Invest?

As an agent you will be

equipped with many sales tools
to explain investment
performance to your clients.
However, the cardinal rule
always applies: Past
performance does not guarantee
future results.

The time value of money shows that it makes more sense for a person to receive
$1,000 today, rather than wait to receive the same $1,000 ten years from now. This is
because the $1,000 invested now at 5% would be worth $1,628.89 in ten years,
because of interest earned and compounding. Also, inflation will reduce the value of
the $1,000, so that its purchasing power in ten years will be less than it is today.
Why is the time value of money important to financial planning?
A
B
C
D

It allows agents to determine how much money they will make from a clients
investments over specific periods of time.
It gives agents the ability to guarantee investment growth projections.
The time value of money allows clients to decide how rich they will be by the time
they retire.
Clients can decide on the amount and results of their savings and the amount of
money that will be available to them in future.

The Present Value of Money

If given the choice of paying $1,000 now or in ten years, a person should elect to pay
it in ten years, because he or she would have to invest only $614 today at 5% interest
in order to have $1,000 in ten years time. The sum of $614 is called the present
value of money.
Actuaries use present values in calculating premiums to decide how much must be
invested now in order to grow to meet the death benefits required at a future date.

Present value of
money
The present value of
money is the amount
that must be invested
today to yield a certain
amount at a future date.

The present value of a single sum begins with determining how much money is
required at a future date. It shows how much must be invested now to grow to that
amount. Working backwards from a future date is called discounting.

Copyright 2011 Oliver Publishing Inc. All rights reserved. 241

LLQP

The formula for the present value of a single sum will reveal the amount to be
invested today to achieve the amount needed in the future:
present value (PV) =

future value (FV)

(1 + interest rate [I]) n (the number of discounting periods)

For example, how much would you need to invest today in order to have $100 in two
years time? Lets say current two-year interest rates are 6.25%, compounded
annually.
PV

100
(1 + .0625)2
=
100
(1.0625 x 1.0625)
=
100
1.1289
= $88.58 must be invested today

Using a Financial Calculator

A financial calculator can perform present value and future value functions quickly
and easily. However, the LLQP student must know how to use the formulas to
calculate these values as shown above and in the following discussion on future
value.
*Note: A Sharp EL-733A financial calculator has been used to illustrate these
calculations. Consult the manufacturers instructions when using another make.
The result may be achieved using a financial calculator as follows:

Key
100(+/)
6.25
2
COMP

Press
FV
i
n
PV

Display Shows
100
6.25
2
$88.58

A higher interest rate with more discounting periods will produce a smaller present
value number. Conversely, lower interest rates and/or fewer discounting periods
produce a larger present value number.

242 Copyright 2011 Oliver Publishing Inc. All rights reserved.

How Much Should I Invest?

The Future Value of Money

The future value of money is greater than todays value because interest is earned on
the money and the interest compounds. Compounding means the money grows at a
faster rate, since interest is earned on interest.
The formula that reveals how much the money, plus compounded interest, becomes
over a period of time is:
future value (FV) = present value (PV) x (1 + interest rate [I]) n (the number of compounding periods)
For example, if you deposited $2,000 today in a GIC that was paying 4.5% interest
annually, how much money would you have in three years?
FV = 2,000 x (1.045)3
= 2,000 x (1.045 x 1.045 x 1.045)
= 2,000 x (1.141)
= $2,282 would be the value of the investment in three years
The result may be achieved using a financial calculator, as follows:

Key
2,000(+/)
4.5
3
COMP

Press
PV
i
n
FV

Display Shows
2,000
4.5
3
$2,282.33

If you deposited $5,000 in a GIC that was paying 4.5% interest annually, how much
money would you have in 10 years?
A
B
C
D

$8,150.15
$7,965.00
$7,779.20
$7,764.85

Personal Factors That will Affect Savings

You now understand how time and compounding work to the advantage of the
investor. It is also essential to calculate in the effects of:
The type of return the investor seeks to achieve;
The risk tolerance of the investor;
Inflation;
General economic factors.

Copyright 2011 Oliver Publishing Inc. All rights reserved. 243

LLQP

The Type of Return

Investment returns can be earned in the form of:
Interest (often guaranteed up front);
Dividends (never guaranteed);
Capital gains (never guaranteed).
Interest
Interest is earned in savings accounts, term deposits, Guaranteed Investment
Certificates (GICs), mutual funds (invested in funds that return interest), and bonds.
Interest is taxed at an investors marginal tax rate (MTR).

+ FILE
See file 41
for more details on
the taxation of
investments.

Dividends
Corporate dividends are a share of profits that have been earned by the corporation.
They are distributed to shareholders on a pro-rata basis. Dividends are paid at the
discretion of the board of directors of the company; they are not guaranteed.
Dividends from Canadian corporations receive preferential tax treatment, whereas
dividends from foreign corporations do not.
Capital Gains
Some investments that produce capital gains are stocks, mutual funds (when the fund
invests in investments that earn capital gains), and segregated funds (also when the
fund invests in investments that earn capital gains).
Capital gains are also earned on mutual funds and segregated funds when units are
sold at a higher price than that at which they were purchased.

Stocks do not have

guaranteed returns
nor guaranteed
dividends. They are
suited to the
investor willing to
take on additional
risk for additional
return.

Gross Returns vs Net Returns

An investor must know whether a stated return is the gross return or net return. Gross
return is the total gain or loss of a security over a specified period, usually expressed
as a percentage. However, costs are incurred in achieving the gross return. A mutual
fund, for instance, charges management fees. Those costs and fees are deducted from
the gross return to provide the net return; it is also expressed as a percentage.
244 Copyright 2011 Oliver Publishing Inc. All rights reserved.

How Much Should I Invest?

Yield to Maturity
The yield to maturity refers to the rate of return anticipated on a bond if it is held to
its maturity date. These returns are most accurately sourced from a published bondyield table or a financial calculator.

Risk Tolerance of the Investor

There is a direct relationship between the risk of an investment and its return. Quite
simply: more risk = greater returns; less risk = lower returns.
The investor who seeks risk is called a speculator; the one who accepts a degree of
risk is called risk-tolerant, and the one who avoids risk is called risk-averse. The
speculator would receive the highest returns and incur the largest losses, the risktolerant investor would see lower returns and less losses, and the risk-averse investor
would receive the lowest returns and probably no losses.
What is the risk that investors face? There are two: one risk is whether the principal
amount invested will be returned and risk two is the amount of growth that can be
achieved on the principal.
Risk tolerance is a function of many factors, including age, gender, personal biases,
and previous investing experience.
It is essential to accept some investment risk in order to keep real returns above the
rate of inflation. If returns fall below the inflation rate, the investor will suffer a drop
in his or her standard of living over time that can seriously diminish quality of life.

Women are typically

more conservative
investors than men.
Risk-aversion also
increases with age:
the older the client,
the less likely he or
she is to take on a
risky investment.

Copyright 2011 Oliver Publishing Inc. All rights reserved. 245

LLQP

Why is risk a four-letter word?

A
B
C
D

Risk means different things to different people.

There are 10 principal kinds of risk that agents have to understand before making
investment recommendations to clients.
Ascertaining investment risk is one of the toughest jobs facing an agent.
Risk is the daily, real possibility for capital loss.

Guaranteed Returns vs Non-Guaranteed Returns

Some investments guarantee the return of principal only, some guarantee income, and
some guarantee a return of principal, plus growth. There is a trade-off to be made
between safety and returns. As we have seen above, the riskiest investments produce
the highest rate of returns. Guaranteed investments pay a lower rate of return than
those that are non-guaranteed, but they are safest. Those investors with a low risk
tolerance will accept the lower return for peace of mind.
The following chart shows the degree of risk against return. Savings accounts and
Canada Savings Bonds, both guaranteed, are the most safe, with the lowest returns.
Jewellery, gold, and art, on the other hand, top the scale of risk and returns.

Investment Risk-Return Chart

High

RISK

Low

Jewellery, gold, art

Specialty mutual funds
International mutual funds
Equity investment
Canadian equity mutual funds
Bonds
Canadian fixed-income mutual funds
Real estate
Guaranteed Investment Certificates (GICs)
Treasury bills
Savings Accounts/Canada Savings Bonds
EXPECTED RETURNS

246 Copyright 2011 Oliver Publishing Inc. All rights reserved.

High

How Much Should I Invest?

Inflation
Inflation erodes the real value of an investment. For example, if an investor receives
6% interest rate on an investment and the inflation rate is 2%, the nominal rate of
return is 6%; the real rate of return is 4% (6% 2%).
When tax is deducted, the real rate of return after taxes is determined. It is the
actual amount left in the pocket of the investor. The formula for the after-tax real
rate of return is:
(nominal interest rate x (1 marginal tax rate) inflation rate
(1 + inflation rate)
For example: an investor earns 6% on an investment, the inflation rate is 2%, and the
investor has a marginal tax rate of 40%. The investors after-tax real rate of return is:
6% x (1 40%) 2%
1 + 2%
= 1.6%
1.02%
= 1.57%
Inflation is cyclical; that is, the rate of inflation rises and falls according to a number
of economic factors. When inflation rates rise, so too do interest rates, and if they
climb too high, eventually a recession can result. Over the last ten years, the inflation
rate in Canada has averaged just less than 2%.

General Economic Factors

Investments are affected by a variety of global and national factors. International
business, stock markets, and world conditions play a large role, in addition to
Canadian government fiscal and monetary policy. Fiscal policies determine how the
government will raise income through taxation and how the government spends that
income (i.e., expenditures).

Fiscal policies
Determine how
the government
will raise income
through taxation
and how the
government will
spend that
income.

Copyright 2011 Oliver Publishing Inc. All rights reserved. 247

LLQP

Monetary policy
How the
government
manages the
money supply

is how the government manages the money supply. Changes in

fiscal and monetary policies affect interest rates and the rate of economic and
corporate growth.
Monetary policy

Is it prudent to own investments that offer a guaranteed rate of return?

A
B
C
D

If a client is risk-averse, investments that guarantee capital and offer a fixed rate of
return represent the best choice.
It is if the net return of the investment meets or exceeds the combined effects of
inflation and taxes over the term of the investment.
Guaranteed investments should always form part of an investment portfolio, but the
amount allocated to such investments will depend on the goals of the individual
investor and the time required to meet those goals.
All of these answers

248 Copyright 2011 Oliver Publishing Inc. All rights reserved.