The DeGroote School of Business asked experts Waquar Ahmad, Amir Akbari, Zohair Alam, William Huggins and Qian Yang five big questions about money, from the safest way to invest to the difference between good and bad debt.
Here’s what they had to say.
What is the difference between good and bad debt?
When the money hits our hands, all debt feels great: It gives us access to more money than we currently have.
But what separates good debt from bad is what happens next: If that borrowed money reduces our future financial flexibility, it’s likely bad debt.
One of the simplest ways to identify bad debt is to look closely at the interest rate. If that rate is 10 or 15 per cent or even higher, that’s usually a warning sign. Why? Because when you’re paying that much interest, it’s unlikely that whatever you bought with that debt is generating an even higher return. So that debt is slowly eroding away your wealth.
In contrast, good debt is that kind of borrowing that helps increase our future financial capacity. A classic example is usually student loans: By borrowing to get a college education, you’re investing in skills and credentials that in many cases increase your lifetime income.
Zohair Alam, assistant professor, Finance and Business Economics
What does smart risk-taking look like for an average individual?
Casual traders are generally going to get outperformed by the sophisticated traders, and they should expect that. You can’t spend an hour on Thursday night and figure out within a month how you’re going to beat the market. For household investors, don’t try to maximize your upside, but rather the goal is to stay in the game. That means long-term investment in a relatively safe strategy. The safest strategy is broad diversification.
Second, your diversification should be done inexpensively. A cheaper form of investment is an index fund, which doesn’t pay a manager to try to beat the market. It buys the whole market. I would also strongly recommend that people use their government tax shelters — like registered retirement savings plans (RRSPs) and tax-free savings accounts (TFSAs) — and max them out to the extent they possibly can. Most of your savings should be done in a tax-free environment; there’s no better vehicle for it.
Will Huggins, assistant professor, Finance and Business Economics
What are the differences between short-term and long-term investment vehicles?
We encourage people to save so that the short-term goals — like your next vacation, or a car — can be met. When you’re investing for the purpose of saving, you put your money in safer vehicles — not stocks, but bonds, GICs and things that don’t grow too fast but maintain their principle.
For investments with a long-term perspective, a lot of Canadians invest in RRSPs and TFSAs. Because you have so long to build up your savings, you can actually invest in the capital market by investing in stocks, ETFs (exchange-traded funds), and mutual funds — vehicles that are a bit more risky but provide you with higher rates of return over a long period of time.
Waquar Ahmad, assistant professor, Finance and Business Economics
Why does our purchasing power decrease with inflation?
Central banks print money, but because they’re not able to perfectly see the supply of goods or demands in the whole economy, sometimes the amount of money in print is greater than the amount of merchandise and services circling around the economy. So prices go up.
Secondly, people have sticky expectations for the future. As a rational person, I expect my salary to go up steadily. And that also means the cost of doing business is also going up, because your salary is part of the cost of business operations. The whole economy is an amplifier: Your expectation translates to higher expectations for other people.
The third reason is the increasing pricing power of big corporations. It’s hard to live our lives without certain businesses and services, so big corporations can increase their prices without losing customers.
Qian Yang, assistant professor, Finance and Business Economics
What are tariffs and do they help local companies?
Tariffs, in simple terms, are extra taxes paid to buy foreign goods and services. They make foreign goods more expensive relative to local goods, creating more demand for domestic companies and more jobs for the people who work in them.
Often, the money the government raises through these taxes (paid by local consumers) is redistributed to local companies in the form of subsidies. These subsidies provide an additional advantage to domestic firms by making their products cheaper than foreign goods and/or by supporting their investment.
The effectiveness of these subsidies and tariffs for the overall economy in the short or even long run is uncertain. They work well in sensitive sectors where governments want to avoid foreign dependence. However, they can also act in unexpected ways that impede innovation, growth, and competition. In addition, they tend to have an inflationary effect, at least for foreign goods and services.
Amir Akbari, associate professor and area chair, Finance and Business Economics
This article was original published by the DeGroote School of Business for Financial Literacy Month. Click here for the original article.