Basics of Investing
Investing doesn't have to be complicated to be effective.
Investing doesn't have to be complicated to be effective.
Just as your daily food intake draws from the basic food groups. Your investments can be slotted into three fundamental categories:
Your investment objectives differ from those of other investors. So should your portfolio.
A given portfolio could be 100% cash, or 100% equities, or anything in-between. The precise mix is determined by both your investment objectives and what you want your portfolio to do for you.
While you can build an effective portfolio using individual cash, bond and stock selections, you may decide that a packaged approach makes more sense for you. Mutual funds and managed accounts bring professional money management to your portfolio and eliminate the need to pick individual stocks and bonds.
Take a closer look at the investment components that you can choose from when constructing your personal investment portfolio and consider which investments make the most sense for you.
Short-term investments make perfect sense when you have short-term goals, like purchasing a house or business, or paying for next year’s education expenses. Invest in cash when you cannot afford to be caught in a short-term stock market decline. Another reason to hold cash is to have buying power in reserve for future bargain hunting in the stock market.
Real world cash investments go by names like treasury bills, bankers acceptances, Canada Savings Bonds, money market mutual funds, and bonds and guaranteed investment certificates (GICs) that mature within one year. From 1950 – 2002, 5-year GICs produced an average rate of return of 7.2% a year.*
Think of a bond as a personal loan that you make to the government, or to a corporation. A bond is a fixed income investment, as are term deposits and GICs. When you invest in a bond, you agree to lend your money at a fixed rate of interest, with repayment of your principal on a fixed date. Typical maturity dates range from 1 to 30 years into the future.
The three primary reasons you would buy bonds include:
From 1950 – 2002, five-year GICs produced an average rate of return of 7.2% a year, with no losing years. Long-term Canada bonds (18-year term) returned an average rate of 6.7%, with 13 negative years during the 52-year period.*
Unlike GICs, even government-guaranteed bonds fluctuate in price as interest rates change. While fluctuation is not loss, if you are investing in bonds you must consider the effect of inflation on your after-tax interest and eventual principal repayment. Do this to ensure that you are not losing purchasing power over time.*
The term stock or equity refers to an investment in common shares. When you own stock, you are a co-owner of a business, profiting if the business prospers, and suffering if the business flounders.
Because equities have historically outperformed cash and bonds over the long-term, consider stocks and stock-related assets if you want to compound your capital at the highest available rate over long periods of time, generally five years or more. If you are investing for your retirement, or for post-secondary education expenses, or for income that rises over time and attracts less tax than interest income, equities may make good sense.
Equities are more variable and unpredictable, however, than either cash or bonds. Over short holding periods, stock prices can be quite unstable. On the other hand, you may find short-term volatility desirable if you consider trading profits more important than long-term compounding. In both cases, diversification is required to spread your risk over a variety of different stocks.
From 1950 – 2002, the Canadian stock market returned on average 10.5% per year. Adjusted for currency, the US stock market returned 12.3% over the same period. During these 52 years, both the Canadian and the US market suffered 12 losing years, about 23% of the time.*
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The Canaccord Investment Counselling Program offers a level of expertise that is traditionally reserved only for institutional investors. Now, they are accessible to you. Portfolios offered through the program are carefully selected and reviewed on an ongoing basis. An added benefit is the peace of mind you get knowing that portfolios in Canaccord’s Investment Counselling Program are constantly monitored and evaluated — by both Canaccord’s product management team and a leading third-party portfolio oversight program.
Just as sugar and spice do not fit neatly into the four food groups, there are a number of investments that are difficult to classify. Alternative investments range from vehicles that combine features of bonds and stocks (income trusts), stocks and options (structured products), tax-driven products (limited partnerships), to investments wrapped within insurance policies (universal life).
Additional alternative investments include hedge funds, which are designed to offset swings in the stock market, and options, which can be used both to protect your portfolio and as source of profit, if skillfully traded. You may encounter split shares, which divide common shares into separately traded growth and income components.
Alternative investments make sense once you have built a diversified portfolio. First lay a solid foundation for yourself. Then explore the sugar and spice of alternative investments.
You don’t need reminding that investing your money, like driving your car, carries considerable risk. Life itself is risky. But while risk is unavoidable, you can reduce its cost. The key to reducing risk is to know what you are doing, to look before you leap.
Thinking about investment risk, most investors worry about losing money, making mistakes, being lied to, and becoming poor. These negative thoughts can lead to an overly conservative investment strategy, one that may not accomplish your life goals due to low returns, high taxation, and a decline in purchasing power.
Other investors embrace risk, hoping to make a fast buck, seeking to become wealthy without work, skill or patience. Common sense tells you how this approach will turn out in the long run.
Here’s what you need to know before you invest. Ask yourself these two questions:
What is my money for?
When will I need my money back?
How you answer these questions will help you determine your correct investment strategy. For example, if you answered that your money is for your retirement twenty-five years from now, you need a very different investment strategy than if you answered that your money is your down payment for a house purchase in the next two years.
After you outline your basic strategy, you’ll need to define your investment policy. Consider how diversified you should be, based on your investment knowledge. What types of investments are too risky – or too conservative – for you? Start with your asset mix decision, and then work down to the individual investment level.
All investing is essentially the art of putting cash in now to get even more cash out later. How much later usually determines the magnitude of your result. The so-called magic of compounding does require time to work.
For example, starting to save for retirement five years before you are set to retire will probably be unsuccessful. At the other extreme, if you put away money for your children’s retirement when they are young, they may not have to save a dime for their old age. That is a powerful use of time.
Thousands of client relationships tell us that the five most common reasons to seek investment advice are:
In each case, your task as an investor is to define your purpose and set a time frame within which your goal will be realized.
For example, if you are saving to pay for your child’s post-secondary education expenses, you and your advisor will need to determine how much the future cost may be, your ability to contribute funds today and in the future, the expected rate of return on your investment, and how much time you have to accomplish your goal.
A similar set of questions applies to your retirement plans.
As you go through life, it increasingly appears that time itself is your most precious resource. You can’t save up your time to spend it later. You must use your time now.
That is the spirit of a sound investment philosophy. What you must do is simply harness what time is available in the most productive way possible and apply the rarest ingredient of all – patience. The long-term reward of great investment advice is more time for you to do what you really want to do with your life, not what you have to do. Time is truly the best-kept secret of the rich.
* Past performance does not guarantee future returns, mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.