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Retirement Planning: Investments
Whether you're investing in an RRSP or a non-registered account, you'll need to decide what type of investments to choose. There are three basic types of investments or asset classes: cash, fixed income, equity. Cash Cash investments include short-term instruments that can be cashed in at any time such as:
These investments are low-risk in that your capital is generally protected and will not go up or down in value while you are holding the investment. However, the return on cash investments is quite low in comparison to other asset classes. Cash investments are suitable for holding emergency funds or saving for relatively short-term needs. They are not the best choice for a long-term investment goal such as retirement. Fixed Income Fixed income investments, or debt instruments, include the following:
When you choose an investment from this asset class, you are actually lending your money to the organization offering the investment. In return, you have the guarantee that your original investment (the principal) will be paid back to you on maturity, and you are also paid interest for lending your money. Fixed income investments pay regular interest income, but the interest rate tends to be higher than that paid on cash investments. With government or corporate bonds, there may also be a capital gain or loss to declare on the sale of the bond. Fixed income investments are an important component of a long-term investment portfolio. While they don't allow for growth of your capital, they do provide stability and a reasonably good rate of return. Equities An equity investment represents partial ownership of a company. As a shareholder, you can share in the profits of the company in the form of regular dividends, as well as an increase in the value of the stock price if the company grows and becomes more profitable. However, if the company does not do well, there may be no dividends, and the value of your investment could fall. Equity investments also include properties such as real estate and tangible assets such as artwork, gold bars, and precious jewels. These investments tend to be more speculative than share ownership, and are generally not recommended for a retirement planning portfolio. Stock ownership, however, is an important piece of a long-term investment portfolio. While the value of your stock investments will fluctuate (sometimes dramatically) year by year, studies have shown that the long-tem returns will outpace those provided by fixed income investments. The growth of capital provided by share ownership will help to protect your portfolio against the effects of inflation over time. Mutual Funds Mutual funds are not an asset class in and of themselves. A mutual fund is simply a way of pooling your investment capital with other investors, and putting it in the care of a professional money manager who will decide what specific investments to buy. Mutual funds can invest in any underlying asset class, and should be categorized accordingly when you are looking at your asset mix. Money market funds are considered a cash investment, and are a good place to hold funds needed over the short term. Fixed income investments include bond and mortgage funds. Equity funds are by far the largest category of mutual funds, and can vary significantly in the types of companies they invest in and their risk profile. Balanced funds include a mix of equities and fixed income investments within the one fund, and can be a good starting point for a new investor. Risk and Reward Risk and reward go hand in hand. The lowest risk investments (cash vehicles) provide the lowest reward. This concept holds true even within asset classes. The equity class, for example, includes a variety of risk and reward levels. A widely diversified Canadian equity fund will be lower risk than a precious metals fund, although it will not provide the opportunity for the large gains that a specialty fund can produce over certain time periods. The key to successful investing is to construct a portfolio with exposure to the various asset classes in a proportion that provides you with investment growth at a risk level you're comfortable with.
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Last Update: 2005-08-22