People invest for lots of reasons. You might have a specific goal, like a vacation or a down payment on a home, or a longer-term objective of achieving financial independence and security in retirement. Maybe you want to invest in a new venture, or build enough wealth to build a legacy for future generations.
Whatever your reasons, it’s important to start with the basics; understanding the difference between saving and investing, what types of investments make sense for your particular timeline and risk tolerance, and why it’s critical to start early and invest regularly.
Saving and investing. What’s the difference?
Saving and investing are often referred to in the same way, but they’re not the same thing.
Saving is the practice of setting money aside for a specific goal, or for an emergency fund. It’s money that you might need access to quickly, and money that you don’t want to expose to too much risk. To put it in perspective, if you’re going to need the money within three years or less, it should be in a savings account or a lower risk vehicle like a GIC.
Investing is a longer-term strategy, where you put money into stocks, bonds, mutual funds or other types of securities, to build wealth. You have to assume some risk with these types of investments, but with sufficient time, the risk might be worth it given the potential returns. This is often called the “risk return trade off.”
Ultimately, saving is important, but investing is too. If you don’t invest over the long term, you’ll probably miss out on market opportunities to grow your portfolio. And with interest rates where they are now, your savings won’t even keep up with inflation.
Investment types and risk
We’ve established that people invest for different reasons. Let’s look into some of the different type of investments and the risks that go along with them.
Stocks: A stock is a unit of ownership and purchased in what are known as shares. When you buy a share, you’re purchasing a partial ownership stake in a company. This means you’re entitled certain benefits. Stocks are usually bought and sold on a stock exchange, where they fluctuate based on investor demand. Historically, they’ve had higher returns than other types of investments, but this often means higher risks as well.
Bonds: A bond is a “fixed income” investment. Much like a loan, it’s an agreement between a lender (the investor) and a borrower (the issuer). Corporations and governments issue bonds to raise money, and they compensate investors based on the bond’s interest rate. Unlike stocks, bonds don’t sell on an exchange. Bond prices fluctuate based on investor demand and they typically have less risk than stocks.
Mutual funds: Mutual funds are professionally managed investments, made up of a pool of stocks, bonds, money market investments and other assets. These funds give investors access to diverse bundle of investments at a low price. There are wide selection of mutual funds on the market, and the objectives and holdings of the fund determine the risk level. Mutual funds are an easy way to start investing in the market.
Exchange traded funds: ETFs are investment funds made up of stocks and bonds. Like a mutual fund, they’re affordable – you pay one price for the whole bundle. Unlike a mutual fund, trade on a stock exchange. While there are various types of ETFs, many aren’t managed by a human. Instead, they’re programmed to track an index.
Cash, GICs and money market mutual funds: These are the the safest investments, but they also offer the lowest returns. The chances of losing money on cash-based investments are low, so they make sense if you're saving for something specific in the short term, or nearing a financial goal.
How to be a more successful investor
Invest early. Invest often. The sooner you start, the more opportunity you’ll have to see your investment grow over time. The good news is, you don’t need a lot of money to get started. Set up regular automatic payments, for $25, $50, or $100 per month, and watch your money grow. Making regular contributions helps you take advantage of "dollar cost averaging," a strategy that smooths out your contributions and may help protect your portfolio against large swings in the market.
Reinvest income, always. This is essentially the power of compounding. If you reinvest the income earned on your initial investment, you increase your total investment value.
Diversification is critical. Spread your money across a variety of investments to minimize your risks. If one investment does poorly, you could offset this loss with another investment that has a higher rate of return. This is how you reduce your overall risk.
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