Guaranteed Investments
These include Bonds or Guaranteed Investment Certificates (GICs), representing a low-risk form of investing. Think of purchasing a GIC as like lending money to a bank. The bank commits to regular interest payments and repays the principal upon the term's completion. Canadian banks’ robustness makes this low-risk, whereas government bonds offer a high guarantee due to their ability to meet obligations through taxation. The degree of risk with corporate bonds hinge on the company's financial strength, varying in risk based on each company's stability.
Equity Investments
Companies finance operations by issuing shares. As a shareholder, you partake in the company's ownership and its fortunes, which can fluctuate. Companies reward shareholders either through reinvesting profits to enhance value or via dividends. This will vary based on each company's stage—growth-oriented companies reinvest for expansion, while mature firms often offer dividends.
Various factors influence company profitability and, consequently, share prices. Economic conditions, commodity prices, management capabilities, and the risk-free guaranteed investment returns impact the volatility of share prices. The attractiveness of equity gains often diminishes as interest rates on guaranteed investments rise.
Risk Assessment
Evaluating potential profit against potential loss quantifies the risk/reward trade-off. For instance, lending $100 to a buddy for 2 months in exchange for a $120 repayment offers a 20% return in a couple of months. This is a great rate of return if you are certain of repayment. However, if the risk of non-repayment is high, the potential loss outweighs the gain.
Similarly, when investing in stocks, calculating potential gains against potential losses informs risk assessment. A 25% potential return from a stock where there is an equal probability of share price dropping 50% results in an unattractive risk/reward ratio. Mitigating this ratio involves seeking investments with at least a 2:1 ratio, favoring higher potential gains against potential losses. Comparing the probability of a gain and the potential upside of a stock to the guaranteed risk free return of GIC or bonds is also another consideration.
Portfolio Diversification
Balancing guaranteed and equity investments and diversifying across industries and companies minimizes overall portfolio volatility. The potential portfolio downside could be offset with a portion of the portfolio earning guaranteed returns. Mutual funds or ETFs offer diversified ownership in a large investment portfolio, catering to various preferences, from guaranteed-focused to stock-focused, making them an ideal option for new investors with limited funds who are seeking diversification and professional management.
Starting early and making informed investment decisions is key to securing long-term financial success. Balancing risk and reward, understanding various investment options, and diversifying portfolios are pivotal.