Mini Glossary for Investors
Let’s be honest, the cost of living has skyrocketed. Rampant inflation has us all scrambling to some degree to make ends meet. So where does investing stand in all this? Some of us barely have time to think about it. And if you add financial jargon to the mix, it can be daunting for anyone who isn't an expert in the field.
We've put together this mini glossary to help you make sense of the investment lingo. Have a look, it's less complicated than it sounds!
Diversification is an effective investment strategy to reduce risk while maintaining some level of return. In a nutshell, diversification means you’re not putting all your eggs in the same basket. It’s investing in several different product categories to create a diverse portfolio. That means you may suffer losses in some categories but make gains in others. It’s all about balance, and that’s always a smart play.
Mutual funds are a type of investment vehicle that pools together the money of multiple investors. These funds are professionally managed by fund managers who allocate the fund’s assets among different securities (diversification) to produce returns for the group of investors.
Mutual funds offer several advantages:
- They’re an affordable solution.
- Professionals manage your money.
- You benefit from portfolio diversification.
- Pooled assets mean you can invest smaller sums.
Like mutual funds, segregated funds pool together the money of multiple investors. The key difference is that segregated funds come with insurance that protects most, if not all, of the capital you invest. Sounds good, right? Only life insurance companies offer this type of fund.
Talk to your advisor about it!
Management fees and operating expenses
All mutual funds are subject to management fees and operating expenses. These, among other things, cover:
- administrative expenses
- portfolio management services
- advisor commissions
Such fees are in addition to any purchase or redemption fees you may have to pay, and are taken directly from the fund.
It’s important to factor them in when making your investment choices. Some securities have rather high transaction costs. The same can be said of the fees charged by some firms. In the end, fees can have a serious impact on your returns.
Your investment horizon is the length of time you intend to hold and grow an investment. It's the period between when you first invest your money and moment you when withdraw it. This time frame influences your choice of investments.
So, if you're aiming for a long-term goal, you should choose investments that yield higher returns in the long run. Your capital may fluctuate in the short term, but you’re in it for the long haul.
On the other hand, if you’re saving for a goal in the near future, you may want to consider putting your cash somewhere safer and readily accessible. Short-term investments typically offer lower returns, but they also translate into more stability, lower risk and liquidity.
Your investor profile depends on several factors, including your:
- financial situation
- investment goals
- risk tolerance
- investment horizon
- investment knowledge
Yep, there's more to consider than you think! The more you narrow down your investor profile, the easier it is to identify the investments that are right for you.
The different types of savings plans
These days, it takes a lot of willpower and effort to set money aside. All the more reason to put your savings in the right place based on your needs and goals. But with so many options out there, it's hard to find your way around! RRSPs, TFSAs... these abbreviations no doubt ring a bell, so let’s dive in a little deeper. Here’s a breakdown of the main savings plans out there and what they’re used for.
Registered Retirement Savings Plan (RRSP)
The RRSP is a tax-deferred savings vehicle mainly used for growing your retirement nest egg! This plan’s key features are as follows:
- RRSP contributions are tax deductible and can lower your taxable income (as long as you don’t go over your annual contribution limit).
- The interest you earn on your investment grows tax free.
- You will, however, have to pay taxes on the amounts you withdraw.
Tax-Free Savings Account (TFSA)
The TFSA is another savings product where your savings grow tax-free. Here's how it works:
- Like an RRSP, the interest you earn on your investment is tax-free.
- Unlike an RRSP, a TFSA does not give you a tax credit.
- You don't pay taxes on the money you withdraw.
First-Time Home Buyers Tax-Free Savings Account (FHSA)
This new savings plan was introduced on April 1, 2023. If you're looking to save for your first home purchase, this solution is right up your alley. Here's how it works:
- Your contributions are tax-deductible.
- Your investment grows tax-free.
- Withdrawals towards a property purchase are tax-free.
- The annual contribution limit is $8,000 per person ($16,000 for a couple), for a lifetime limit of $40,000 ($80,000 for a couple).
Registered Education Savings Plan (RESP)
The RESP is a savings vehicle used to save for your children's education, while raking in some substantial government grant money. Here are its features:
- Your contributions aren’t tax-deductible but do attract government grants.
- Earnings on your contributions and grants grow tax-free.
- You don’t pay taxes on the contributions you withdraw at plan maturity.
- Students are taxed on the amounts they withdraw for school, which consist in grant money and the income earned (on grants and your contributions).
Non-Registered Savings Plan
You've maxed out your RRSP, TFSA and pension fund contributions? This plan allows you to invest more funds for your retirement or any other personal project.
Risk and risk tolerance
Risk is the possibility of earning a lower return than anticipated or losing all or a part of the amounts you invested.
Risk tolerance refers to all the factors that influence your willingness to invest in riskier investments, including your:
- investment horizon
Rate of return
The rate of return measures an investment's performance in relation to the initial amount invested. It can be positive if your investment yielded a profit, or negative if you suffered a loss.
Different types of investments
Depending on your investor profile, you may choose to invest in higher- or lower-risk investments. As a general rule of thumb, you'll benefit from building a diversified portfolio that combines different types of investments. This strategy helps you make the most of your savings without breaking the bank. Once again, you have several options to choose from.
Equity securities are an ownership interest in a company (commonly known as shares or stocks). These give you a voting right in the company’s decision-making and entitle you to receive dividend payments. The more equity securities you hold, the greater your interest in the company.
It's a risky investment as market value can fluctuate unpredictably. This means the potential of a significant loss or gain is greater.
Fixed-income securities are basically loans made by investors to a corporation or other entity to finance and expand its operations. In return, investors receive periodic interest payments for a set period of time.
These securities include treasury bills, bonds, guaranteed investment certificates (GICs) and so forth. They carry less risk than equity shares. On the other hand, they carry no right to share in the profits of the company issuing the security.
Volatility is the most widely used statistical measure in finance. It measures the fluctuation—the increases and decreases—of a financial asset and is therefore used to assess risk. The greater the volatility of your investment, the greater your exposure to significant and rapid losses.
Now you're better equipped to invest like a pro, or at least understand what your advisor is suggesting.