Coming into a sum of money unexpectedly carries with it some decision challenges, especially when that money needs to sustain you financially. Do you pay off debt? Invest in the market, GIC, or something else? Read along as financial expert Mubina walks our reader, Martha, through how to handle her cash influx.
PLEASE NOTE:
While this advice is coming from an expert, everyone’s finances are different and require an individualized analysis. This response is solely based on the information provided in the question. More discussion around the questioner’s situation may result in different recommendations. We strongly recommend working with you’re own financial advisor to address your specific financial needs.
The question
A few years ago, I was in an accident. As a result, I received a $450,000 settlement that I need to make last because I can’t work full-time anymore. I have about $15,000 left to pay on my car, no mortgage, and $5,000 in credit card debt. Two questions.
Martha M.
1.Should I pay off all the debt and then invest the rest, or invest and continue to pay off the debt?
2.What’s the best way to invest the money so I can take out some money each month and still make it last?
The answer
Dear Martha,
Your situation requires careful financial planning to ensure your $450,000 settlement provides long-term security while managing your existing debt obligations. Let me address both of your questions with strategies tailored to Canada’s current financial landscape.
The decision to pay off debt versus investing depends largely on interest rates. With your $20,000 total debt ($15,000 car loan plus $5,000 credit card debt), I recommend a hybrid approach that prioritizes high-interest debt while leveraging Canada’s low-rate environment.
As immediate action, I’d recommend paying off your credit card debt. It carries the highest interest among all credit lines, probably with an annual interest rate between 19 and 29%. This far exceeds any guaranteed returns you could earn through conservative investments. Pay this $5,000 immediately to eliminate this high-cost burden.
When it comes to your car loan, the interest rate is crucial. If it’s below 6-7%, consider continuing to service the loan. It’s important to note that the Bank of Canada has cut interest rates in the past year, and the low-interest rate environment may stay for a long time. This has created a lower rate environment, providing borrowers with higher savings on their interest payouts.
For maximum financial security, I recommend paying off both debts entirely, leaving you with $430,000 to invest. This debt-free foundation provides peace of mind and eliminates monthly payment obligations.
Next, let’s decide on your investment strategy for monthly income. Your investment approach should balance capital preservation with income generation. Given your need for monthly withdrawals and inability to work full-time, I’d recommend adopting a conservative strategy while also investing in wealth creation and preservation. Largely, your corpus can be split between fixed-return investments, growth assets and emergency funds.
Fixed-Return Investments:
Guaranteed Investment Certificates (GICs) should form your investment foundation. GICs are an investment product offered by banks and financial institutions. Investors must deposit money for a fixed period. At the end of the period, investors receive 100% of the amount invested along with interest. The rate of interest varies across financial institutions and durations. What’s more, these guaranteed returns come with deposit insurance protection through the Canada Deposit Insurance Corporation (CDIC) for amounts up to $100,000 per financial institution.
You could consider dividing about $200,000 across multiple terms and financial institutions. For example:
1-year GIC: $50,000
2-year GIC: $50,000
3-year GIC: $50,000
5-year GIC: $50,000
This approach captures varying GIC interest rates while maintaining liquidity. When each GIC reaches its maturity date, reinvest in a new 5-year term to continuously benefit from potentially higher long-term GIC interest rates. Further, GIC investments maturing at different times provide opportunities to reinvest at potentially better rates or adjust terms based on your changing needs.
Types of GICs to consider:
Cashable GIC: Provides flexibility if you need money before the term ends, though it typically offers lower GIC interest than non-redeemable GIC options
Fixed-rate GIC: Offers guaranteed, predictable returns with a fixed interest rate throughout the term
Variable-rate GIC: Interest rate fluctuates with market conditions, potentially beneficial if rates rise
Market-linked GIC: Returns tied to stock market index performance while protecting your invested amount
Diversification through multiple institutions
Spread your GIC investments across various financial institutions, including banks and credit unions. Credit unions often offer competitive rates compared to traditional banks. A federal credit union provides the same deposit insurance protection as chartered banks, ensuring your money remains secure.
Growth component
Allocate $150,000 to a diversified portfolio of mutual funds focusing on:
- Canadian dividend-paying stocks
- Government bonds
- Market index funds tracking major stock indices
This portion provides growth potential while generating dividend income. However, understand that stock market investments carry risks, and values fluctuate with market conditions.
Emergency funds
Maintain $50,000 in a high-interest savings account for immediate needs. This provides liquidity without penalties while earning modest interest. Some financial institutions offer promotional rates on savings accounts that can complement your GIC strategy.
Tax-efficient strategies
Maximize your Tax-Free Savings Account (TFSA) contribution room. TFSA investments grow tax-free, making them ideal for your situation. Consider placing your highest-yielding investments within TFSA accounts first. For amounts exceeding TFSA limits, consider Registered Retirement Income Funds (RRIFs) or non-registered accounts. Do you understand the tax implications of each?
Monthly income planning
Based on the above portfolio, you’d be generating a monthly income from the following sources:
- GIC interest payments
- Dividend income from mutual funds
- Strategic withdrawals
Rate environment considerations
Current rates in Canada reflect the Bank of Canada’s monetary policy. While short-term rates remain relatively low, longer-term deposits often provide better returns. Monitor rate changes and be prepared to adjust your portfolio, especially your GIC investments, accordingly.
Variable interest rate products might become more attractive if the Bank of Canada raises rates in response to economic conditions. Conversely, fixed-rate products provide certainty in an uncertain environment.
Consider consulting with a fee-only financial planner who can provide personalized advice without sales pressure. Review your strategy annually. Interest rates, your income needs, and market conditions will evolve.
Conclusion
Your settlement money represents financial security, not a windfall to maximize returns aggressively. Focus on preservation first, income generation second, and growth third. The combination of debt elimination and conservative investing should provide the monthly income you need while preserving capital for years to come.
Thanks for submitting your question!
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