Back to the Basics: A Glossary For Investing / by Jennifer Chan

 

Welcome to Investing 101.

If you haven’t started investing or you’re currently investing in something that you can’t explain, this introductory post may be helpful for you.

Here, I will summarize the main types of investments: cash, GICs, bonds, stocks, mutual funds, index funds (a form of mutual funds) and ETFs. More in-depth posts are forthcoming on the different investments!

Guaranteed Investment Certificate (GIC)

An investment that acts like a deposit. When you purchase a GIC, you’re essentially loaning a bank/trust company your money for a predetermined amount of time (i.e. 5 years). You are guaranteed to get your money back after that time. Generally, the longer you agree to loan your money, the higher the interest rate will be.

  • Pros: This is one of the safest investments out there.
  • Cons: The interest rate is low so your money will hardly grow.

Bonds

You’re lending your money to a company or a government for a set period of time. The term can range from 1 – 30 years. In return, the company or government will pay you an interest rate. When the bond becomes due after the term, they are supposed to back you back the initial value of the bond in full. Example: You buy a 10-year bond from the government with an initial value of $5,000. The bond pays a fixed interest rate of 4% a year. After 10 years, the government will give you $5,000. You’ll also receive 4% in interest. Your return will be $2,000 over 10 years. You can potentially lose or gain money if you sell a bond before the end of the term.

  • Pros: Relatively safe investment
  • Cons: The return isn’t as high as stocks or mutual funds

Stocks

When you buy stock in a company, you become a part owner of that company. There are two ways to make money with stocks: 1) the stock increases in value. So, if you sell a stock for more than you originally paid, you will have a capital gain. However, if you sell a stock for more than you originally paid, you will have a capital loss. Prices of stocks are volatile and it's incredibly hard to "time" the market. 2) the company you own stock in pays dividends. The dividend you receive is contingent on how many shares of that company you own. Dividends can be paid in cash or in stock. Dividends are usually paid out on a quarterly basis. However, companies are not required to pay dividends. There is also no guaranteed amount. But generally, when a company is doing well, they will increase the dividends to keep shareholders happy.

  • Pros: Potentially lucrative with high interest rates.
  • If you invest in companies with dividends, you can generate passive income
  • Cons: Stock prices are volatile
  • People try to beat the market and often don't

Mutual Funds

A mutual fund is a collection of investments, including stocks, bonds, GICs and other funds. All mutual funds have their own objective, which will determine what investments are included in their fund, as well as what percentage of each. For example, a conservative mutual fund will have a higher percentage of bonds and cash and less stocks. Incorporating more bonds and cash in a mutual fund makes it more stable and less volatile, however with lower returns. 

When you’re buying a mutual fund, you’re buying units or shares of the fund. The fund is actively managed by a portfolio manager who makes all the investment decisions.

  • Pros: Spreads out risk because there’s diversification
  • Once you’re set-up, it’s passive investing
  • Someone else takes care of the decisions
  • Depending on the mutual fund, investment returns are generally higher than GICs and bonds
  • Cons: The Management Expense Ratio ("MER") is high (the cost to run the mutual fund)
  • Past performance does not guarantee future performance
  • Level of risk is dependent on type of mutual fund
  • You could potentially lose money

Index Funds

An index fund is a type of mutual fund. Index funds tend to replicate a market index. A market index is a calculated value of several stocks or other investments together. Market indexes are intended to represent an entire stock market and tracks that market’s performance over time. For example: the S&P 500 Index is calculated by combining 500 large-cap U.S. stocks together into one index value. Investors who invest in an index fund that replicates the S&P 500 Index can track the performance of the S&P 500 Index and use that information when comparing their own portfolio returns.

  • Pros: Lower MERs because you don't have a portfolio manager figuring out what to buy/sell
  • Once you're set up, it's passive investing
  • Broad index funds tend to outperform mutual funds
  • Warren Buffet recommends investing in a S&P 500 low-cost index fund.. enough said
  • Cons: MER fees are still higher than ETFs
  • Past performance does not guarantee future performance
  • Level of risk is dependent on type of index fund
  • You could potentially lose money

Exchange Traded Funds (ETFs)

An ETF is an investment fund that holds a bunch of different investments, like stocks or bonds, and managed by a professional money manager. Similar to mutual funds, ETFs try to spread out risk by diversifying what’s in their investments. Unlike mutual funds, ETFs trade on the stock market. You can buy and sell ETFS in a similar way that you would as regular stocks.

  • Pros: Generally, the MER fees are the lowest available - this is the main reason people choose ETFs.
  • You typically pay a fee for every trade - if you only trade a few times a year + the low MER = you're saving a ton of money
  • No minimum amount to get started
  • Cons: Level of risk is dependent on type of ETF
  • Past performance does not guarantee future performance
  • You could potentially lose money
  • Requires a little more effort to get started (because ETFs trade like stocks, you need to open a trading account) - You can open an account with a full-service firm where an advisor gives you advice and potentially trades on your behalf, or you can open one yourself online through a discount brokerage and buy and sell without advice

It's Up To You

What’s exciting about investing is that you can decide what path you want to take to financial freedom. It all comes down to your risk tolerance and how much time you have left to invest. For the average individual, it’s not necessarily how much money you stuff into your RRSP or TFSA, but rather how much time you have for compound interest to work its magic.

Generally, the younger you are, the riskier you can afford to be. Remember, if you’re investing for the purpose of retirement, you won't be touching that money for another 30 – 40 years. Start now!