Investing For Canadians All-in-One For Dummies

By Andrew Dagys

Make smart financial decisions with the simplified science of investing

Investing For Canadians All-in-One For Dummies helps take the confusion and worry out of growing your money with investments. Investing can be complicated, but it doesn't have to be. This book helps you put your finances in order and get ready to become an investor. It also shows you how to step into the world of stocks and bonds, in the Canadian marketplace and beyond. Discover the benefits of investing in ETFs, precious metals, cryptocurrency, and real estate. You'll even learn how to make money in day trading. Whatever your financial situation and goals, this Canada-specific guide has the jargon-free information you need to move forward. Use your newfound investing knowledge to make your money work for you!

• Understand how investing works and explore your investment choices
• Grow your wealth with stocks, bonds, real estate, and other investment types
• Learn the basic rules, regulations, and tax codes for investing in Canada
• Get a primer on cryptocurrency, day trading, and other hot topics

For Canadians who want to get started with investing or learn more about ways to invest, this Dummies All-in-One is a clear and valuable resource.

• Language: English
• Publisher: Wiley
• Release date: Oct 25, 2024
• ISBN: 9781394294640

Book preview

Introduction

Making investment decisions can be intimidating and overwhelming. Investors have a ton of options available to them, and sorting through the get-rich-quick hype can be exhausting. Investing for Canadians All-in-One For Dummies is here to help you with an overview of the investing landscape unique to Canada.

Since the last edition of this book, the Canadian economy evolved in ways that impacted how most of us invest. High interest rates may make life difficult for debtors but are embraced by risk-averse bond investors. New innovations in artificial intelligence (AI) made stock investors who were willing to take some risks quite happy, especially if they invested in AI computer chip manufacturers early on. For those Canadian investors who wish to keep things a bit more simple, exchange-traded funds (ETFs) of all types are always out there to research. Investment options are available for virtually every risk appetite, and this book explains the nuts and bolts of these options, all in the context of a changing investment landscape.

Importantly, this book is meant for you to consider and research the world of investing, and the common as well as unique investment options available to you. This book isn’t written to provide you with personal investment advice. That’s because the goals and financial objectives of every Canadian, like you, are bound to be different. Only a personal qualified financial advisor or tax expert who knows your personal situation very well can make investment, tax, or other financial recommendations to you.

About This Book

Investing for Canadians All-in-One For Dummies provides guidance, tools, and resources for determining and making the right investments for your needs. Here, you get tips on investment choices, risks, and returns as well as the basics on stocks, bonds, mutual funds, precious metals, day trading, cryptocurrencies, and real estate.

A quick note: Sidebars (shaded boxes of text) dig into the details of a given topic, but they aren’t crucial to understanding it. Feel free to read them or skip them. You can pass over the text accompanied by the Technical Stuff icon, too. The text marked with this icon gives some interesting but nonessential information about investing.

One last thing: Within this book, you may note that some web addresses break across two lines of text. If you’re reading this book in print and want to visit one of these web pages, simply key in the web address exactly as it’s noted in the text, pretending as though the line break doesn’t exist. If you’re reading this as an e-book, you’ve got it easy — just click the web address to be taken directly to the web page.

Foolish Assumptions

Here are some assumptions about why you’re picking up this book:

You’re a millennial or novice investor and eager to find out more about saving, investing, and taking care of long-term needs.

You’re an experienced investor who wants even more sound guidance and trusted investment strategies.

You want to improve your financial situation and build your wealth.

You’re interested in methods beyond stocks, such as mutual funds, day trading, gold and silver, and cryptocurrencies.

You recognize the importance of seeking personal face-to-face advice from a qualified investment and tax professional, especially regarding the fast-changing world of taxation.

You’re intrigued by real estate investing and want to know more about available opportunities in Canada and abroad.

Icons Used in This Book

Like all For Dummies books, this book features icons to help you navigate the information. Here’s what they mean.

Remember If you take away anything from this book, it should be the information marked with this icon.

Technical stuff This icon flags information that digs a little deeper than usual into a particular topic.

Tip This icon highlights especially helpful advice about investing.

Warning This icon points out situations and actions to avoid as you enter and move through the world of investing.

Beyond the Book

In addition to the material in the print or e-book you’re reading right now, this product comes with some access-anywhere goodies on the web. Check out the free Cheat Sheet for information on Canadian ownership investments, Canadian stock exchanges, and the risks of real estate investing in Canada. To get this Cheat Sheet, simply go to www.dummies.com and search for "Investing for Canadians All-in-One For Dummies Cheat Sheet" in the Search box.

Where to Go from Here

You don’t have to read this book from cover to cover, but you can if you like! If you just want to find specific information on a type of investment strategy, take a look at the table of contents or the index, and then dive into the chapter or section that interests you.

For example, if you want the basics of investing, flip to Book 1. If you want to explore stock and mutual fund investing, check out Books 2 and 3. If you prefer to find out more about investing in gold and silver, day trading, and cryptocurrencies, flip to Books 4, 5, and 6. Or if you’re considering real estate, Book 7 is the place to be.

No matter where you start, you’ll find the information you need to enter the world of investing and make the right decisions for your needs. Good luck!

Book 1

Entering the World of Investing

Contents at a Glance

Chapter 1: Grasping the Fundamentals of Investing

Getting Started with Investing

Setting Financial Goals

Exploring Your Investment Choices

Considering Investment Strategies

Diversifying Your Investment Assets

Determining Your Investment Tastes

Chapter 2: Weighing Risks

Understanding Market-Value Risk

Examining Individual-Investment Risk

Financial Risk: Loading Up on Debt

Understanding Interest Rate Risk

Inflation Risk: New Kid on the Block

Market Cycle Risk: A Roller Coaster

Liquidity Risk: Help, Let Me Out!

Exploring Tax Risk: The Uninvited Guest

Political and Governmental Risk: Vote for Me!

Chapter 3: Evaluating Investment Returns

Analysing Returns

Managing Debt to Maximize Your Returns

Chapter 4: Understanding How Different Investments Are Taxed

Examining Interest Income

Understanding Dividend Income

Eyeing Capital Gains and Losses

Looking At Foreign Exchange Gains and Losses

Exploring Deferred-Income Tax Shelters and Plans

Determining Whether to Invest Inside or Outside Your RRSP or TFSA

Grasping Taxation of Dividend Income

Focusing on Taxation of Funds

Considering Taxation of REITs

Detailing General Tax Rules for Bonds

Identifying Taxation of Fixed-Income Securities

Chapter 1

Grasping the Fundamentals of Investing

IN THIS CHAPTER

Bullet Understanding what investing is

Bullet Setting your sights on your financial future

Bullet Checking out your investment options

Bullet Distinguishing between growth and income investing

Bullet Protecting your assets with diversification

Bullet Gauging your tolerance for risk

In many parts of the world, life’s basic necessities — food, clothing, shelter, and taxes — consume the entirety of people’s meagre earnings. Although some Canadians do truly struggle for basic necessities, the bigger problem for other Canadians is that they consider just about everything — eating out, driving new cars, hopping on airplanes for vacation — to be a necessity. However, you should recognize that investing — that is, putting your money to work for you — is a necessity. With today’s inflationary environment, careful and risk-aware investing is a necessity to just keep up with inflation. If you want to accomplish important personal and financial goals, such as owning a home, starting your own business, helping your kids through university or college (and spending more time with them when they’re young), retiring comfortably, beating inflation, and so on, you must know how to invest well.

It’s been said, and too often quoted, that the only certainties in life are death and taxes. To these two certainties you can add one more: being confused by and ignorant about investing. Because investing is a confounding activity, you may be tempted to look with envious eyes at those people in the world who appear to be savvy with money and investing. Note that everyone starts with the same level of financial knowledge: none! No one was born knowing this stuff! The only difference between those who know and those who don’t is that those who know have devoted their time and energy to acquiring useful knowledge about the investment world. In this chapter, you begin to build your understanding of investing on a firm foundation of the fundamentals.

Getting Started with Investing

Before this chapter discusses the major investing alternatives, consider a question that’s quite basic yet important. What exactly does investing mean? Simply stated, investing means you have money put away for future use.

You can choose from tens of thousands of stocks, bonds, mutual funds, exchange-traded funds, and other more exotic investments. To help you on this journey, this book takes you through your options, explains those options to you, and provides you with tips, warnings, and reminders of key points and more. Even after you’ve read this book, in whole or piecemeal, you’ll have only touched the tip of the investing knowledge iceberg. In the meantime, congratulations on the start of your journey and desire to figure out even more about investing than you already do!

Remember If you wanted to and had the ability to quit your day job, you could make a full-time endeavour out of analysing economic trends and financial statements and talking to business employees, customers, suppliers, and so on. However, you shouldn’t be scared away from investing just because some people do it on a full-time basis. Making wise investments need not take a lot of your time. If you know where to get high-quality information and you purchase well-managed investments, you can leave the investment management to the best experts. Then you can do the work that you’re best at and have more free time for the things you really enjoy doing.

An important part of making wise investments is knowing when you have enough information to do things well on your own versus when you should hire others. For example, foreign stock markets are generally more difficult to research and understand than domestic markets. Thus, when investing overseas, investing in a mutual fund where a good money manager decides what stocks to hold is often a wise move.

In most cases, you can reap competitive returns while only paying minimal fees by investing in exchange-traded funds, or ETFs. ETFs are what’s known as index funds. They’re designed to give investors the same return as a particular stock market index, such as the Toronto Stock Exchange. (A stock market index is a measurement of the overall performance of a basket of stocks. The S&P/TSE Composite Index, for example, measures the overall performance of about 250 large companies in a variety of different industries.) If an index rises by 8.5 percent in 12 months, investors in an ETF that tracks that particular index will see their investment gain by a similar amount, minus a fraction of a percent for the fees paid to the fund’s managers.

This book gives you the information you need to make your way through the complex investment world. The rest of this chapter helps you identify the major investments and understand the strengths and weaknesses of each.

Setting Financial Goals

You need to set your personal financial goals for a variety of reasons. The overall reason is that a goal represents a North Star for you to follow when economic and corporate events get choppy and unpredictable. Goals stabilize your emotions which in turn can help you avoid poor investment decisions, such as selling an investment vehicle too soon at an unfavourably low price or buying something at too high of a price. Here are other reasons why goal setting is critical:

Goals help you define your investment objectives and what you want to achieve with your investments in terms of returns (profits). This also in turn lets you figure out the appropriate amount to invest and the timeline needed to reach your goals, whether that’s saving for a car, a down payment on a house, or retirement or for saving for retirement.

Specific, realistic, and measurable goals within preset timelines let you better track your progress (and the performance of your investment portfolio) and help you make necessary course corrections to your investment strategy. This could involve reevaluating your risk tolerance or asset allocation if market conditions take a turn for the worse. Goals keep you on track to meet your targets.

Setting investment goals motivate you to stick to your plan and therefore help you avoid impulsive and ill-timed decisions. Aligning your investments to defined objectives also gives you a sense of financial purpose.

Exploring Your Investment Choices

Investments come in a variety of shapes, sizes, and colours. Yup, shape and colour too! Think precious metals like gold and silver or real estate. In some cases, investments have no shape at all because they don’t physically exist. Bitcoin, Ethereum, or Solana anyone? The list of financial instruments and other investable assets is endless. This book presents the most common five, six, or seven investment types. You get the picture. We start here with only a snapshot. Detailed discussion of each of these is unpacked in great detail in various other chapters.

Stocks

Stocks represent ownership (a piece of the action and slice of the ownership pie) in publicly traded companies. Stocks provide the potential for high returns, but they also come with significant volatility and a real risk of losing all or a part of the money you originally put in. Investing in stocks lets you take part in the growth and profitability of businesses, though stock prices can fluctuate greatly based on market sentiment and company performance. Book 2 is all about stocks.

ETFs and mutual funds

An exchange-traded fund (ETF) is a pooled financial instrument (a basket of stocks, bonds, commodities, and more) that can be bought and sold like an individual stock. ETFs can be designed to track anything, including a specific investment strategy (for instance a basket of investments that grow fast but are risky or investments that earn income but are safer).

Mutual funds are similar to ETFs. Mutual fund companies pool money collected from investors like you and invest those funds in a diversified portfolio of securities. As with ETFs, they provide diversification. Mutual funds also come in various styles and risk levels, making them a popular choice for both beginner and experienced investors alike.

Book 3 discusses both of these funds in detail, including contrasting the differences and teasing out the similarities between each other and among other investment types.

Precious metals

Precious metals like gold and silver are often considered a hedge against inflation and protection during uncertain economic times. Metals don’t generate regular income. However, precious metals are expected to act as a store of value and are relied upon to provide stability to an investment portfolio, especially during times of turbulence, volatility, and inflation. Book 4 discusses precious metals in greater detail.

Real estate

Real estate investment allows you to build wealth through ownership of residential, commercial, industrial, and other property types. This asset class can provide rental income; and if you were lucky enough to own residential property early on, give you capital gains (when proceeds exceeds your cost). However, real estate also requires significant upfront capital, loads of ongoing maintenance, and types of management responsibilities and headaches that stocks and mutual funds don’t usually trigger.

Real estate also offers you several investment options beyond just buying and renting out properties. Real estate investment trusts (REITs) provide a more hands-off approach, allowing you as a REIT investor to get exposed to various types of real estate, without contractually or traditionally owning or physically managing properties. Book 7 explores REITs and real estate.

Considering Investment Strategies

Investment strategies generally fall into one of two broad categories:

Growth investing: Where an investor wishes to make profits quickly but in doing so takes on more risk. In this case that may mean losing money just as fast.

Income investing: This type is more cautious in nature and involves a lower tolerance of risk of loss.

Other investing approaches (like value investing) exist but growth and income investing are the foundational ones.

Here we cover the nuts and bolts of these core investing approaches.

Growth investing

A growth investing strategy involves targeting companies with high growth potential. This strategy prioritizes future earnings growth over current stock valuation. Investors focus on sectors like technology and healthcare among other sectors. They seek companies with innovative products (like weight loss pills), patents, and growing market share. Successful growth investing requires assessing management quality, market trends, and balancing risk through diversification across companies and sectors.

The bottom line here is that investors want their money to grow (versus just trying to preserve it). Growth investors look for investments that appreciate. The faster the better. Appreciate is just another way of saying grow. If you bought a stock for $8 per share and now its value is $30 per share, your investment has grown by $22 per share — that’s appreciation. We know we would appreciate it.

Appreciation (also known as capital gain) is probably the number-one reason people invest in stocks. Few investments have the potential to grow your wealth as conveniently as stocks. If you want the stock market to make you loads of money (and you can assume some risk), head to Book 2, Chapter 3, which takes an in-depth look at investing for growth.

Warning Stocks are a great way to grow your wealth, but they’re not the only way. Many investors seek alternative ways to make money, but many of these alternative ways are more aggressive than stocks and carry significantly more risk. You may have heard about people who made quick fortunes in areas such as commodities (for example wheat, pork bellies, or precious metals), options, and other more sophisticated investment vehicles. Keep in mind that you should limit these riskier investments to only a small portion of your portfolio, such as 5 or 10 percent of your investable funds, and you should always understand the type of security (stock, bond, and so on) you’re invested in. Experienced investors, however, can go higher.

Remember To succeed in growth investing, investors must understand the differences between growth and value investing:

Value investing is all about finding undervalued stocks trading below their inherent worth, with the expectation that the market will eventually recognize their true value and the stock price will rise. Value investors focus on a company’s fundamentals, such as low price-to-earnings (P/E) and price-to-sales (P/S) ratios, to identify value stocks. They believe that the market often overreacts to negative news, creating opportunities to buy quality stocks at bargain prices. Just like Warren Buffett does. Value stocks tend to be stable in price action.

Growth investing focuses on companies with strong earnings growth potential, even if they’re presently trading at higher valuations. Growth investors prioritize future growth over current valuation. Growth stocks are often volatile in terms of day-to-day prices.

Income investing

Income investing is a strategy designed to create an overall investment portfolio (that can contain a mix of stocks, bonds, and everything in between) that generates regular income for you. The main purpose of income investing is to give you a steady stream of income through dividends, bond yields, interest payments, and even rent in the case of REITs.

Typical income-investing portfolios include dividend-paying stocks, government or corporate bonds and money market funds including ETFs. Income investing strives to maximize income while minimizing risk. However, there are still risks involved, such as poor bond yields or returns of the type experienced in 2022 and 2023. Nevertheless, income investing is a good way to grow wealth over the long term. Many Canadian investors use a healthy combination of both growth and income strategies to balance more immediate cash flow needs with long-term wealth accumulation goals.

The balance between income or growth investing depends on your financial goals, risk appetite, and time horizon. For example, income investing may be more suitable for Canadians in or close to retirement, while a heavier emphasis on growth investing may suit younger investors with more time on their side.

Tip Not all investors want to take on the risk that comes with making a killing. (Hey … no guts, no glory!) Some people just want to invest in the stock market as a means of providing a steady income and preserving wealth. They don’t need stock values to go through the ceiling. Instead, they need dividend-paying and stable stocks that perform well consistently.

Remember If your purpose for investing in stocks is to create income, you need to choose stocks that pay dividends. Dividends are typically paid quarterly to stockholders on record as of specific dates. How do you know if the dividend you’re being paid is higher (or lower) than other vehicles (such as bonds)? To answer that question and other questions about income investing, turn to Book 2, Chapter 4.

Diversifying Your Investment Assets

A key concept behind investing is the need to diversify your holdings. In other words, don’t put all your eggs in one basket. Diversification places a floor on the amount of money you can lose if things don’t work out as you expected with your investments. This can mean that you start to experience real losses, or you think that potential losses are just around the corner. We explore a couple of ways for you to diversify your investments to manage your risk.

Reducing risk

Diversification is a strategy for reducing risk by spreading your money across different investments. It’s a fancy way of saying, Don’t put all your eggs in one basket. But how do you go about divvying up your money and distributing it among different investments? The easiest way to understand proper diversification may be to look at what you shouldn’t do:

Don’t put all your money in one stock. Sure, if you choose wisely and select a hot stock, you may make a bundle, but the odds are tremendously against you. Unless you’re an expert on a particular company, allocating your money across several different stocks is a good idea. As a rule, the money you tie up in a single stock should be money you can do without.

Don’t put all your money in one industry or country. We know people who own several stocks, but their stocks are all in the same industry. Again, if you’re an expert in that particular industry, it might work out. But just understand that you’re not properly diversified. If a problem hits an entire industry, you may get hurt. Similarly, and as we mention earlier in this chapter, don’t have all your stock holdings in the stock market of one country.

Don’t put all your money in one type of investment. Stocks may be a great investment, but you need to have money elsewhere. Bonds, bank accounts, Treasury securities, real estate, and precious metals are perennial alternatives to complement your stock portfolio. Some of these alternatives can be found in mutual funds or exchange-traded funds (ETFs). We really love ETFs and think that every serious investor should consider them; see Book 3 for more information.

Remember Okay, now that you know what you shouldn’t do, what should you do? Until you become more knowledgeable, follow this advice:

Keep only 5 to 10 percent (or less) of your investment money in a single stock. Because you want adequate diversification, you don’t want overexposure to a single stock. Aggressive investors can certainly go for 10 percent or even higher, but conservative investors are better off at 5 percent or less.

Invest in various industries and hold several stocks in each industry (four or five stocks, and no more than ten, in each). Which industries? Choose industries that offer products and services that have shown strong, growing demand. To make this decision, use your common sense (which isn’t as common as it used to be). Think about the industries that people need no matter what happens in the general economy, such as food, energy, and other consumer necessities. See Book 2, Chapter 1 for more information about analysing stocks.

Understanding asset classes

To diversify your investment portfolio, the first step is to understand asset classes, which include stocks, bonds, cash, and other types of financial instruments.

Remember Common types of financial instruments and assets by which to diversify your investment portfolio include

Stocks

Bonds

Cash and cash equivalents such as savings accounts, short-term GICs, and term deposits, all with low returns but high liquidity

Real estate

Commodities and natural resources like timber, oil, wheat, and precious metals that can do well during inflation

Cryptocurrencies as a new asset class with high volatility and potential for significant returns, but also extremely high risk to the downside

Alternative investments such as private equity and hedge funds that can provide diversification but incur a higher cost and have low liquidity

Canadian investors can diversify by asset class by allocating a mix of stocks, bonds, and cash. They can be a combination of domestic and foreign holdings. For example, a growth-oriented portfolio might consist of 75 percent stocks, 20 percent bonds, and 5 percent GICs. The stocks may further be a 50/50 Canadian-to-foreign source in nature. You can also mix things up by diversifying within asset classes by selecting different sectors, industries, or themes such as green investing (investing in companies who say they have the environment in mind).

Remember Rebalance your investment portfolio from time to time (at least consider it semi-annually) to maintain your target asset allocation and remain aligned with your investment strategy, something that we discuss in the "Considering Investment Strategies and Diversifying Your Investment Assets" sections of this chapter. The end game for you is to create a diversified investment portfolio that can withstand various economic cycles and unexpected global or domestic unwanted events.

Determining Your Investment Tastes

Many good investing choices exist: You can invest in real estate, the stock market, mutual funds, exchange-traded funds, or your own or some else’s small business. Or you can pay down mortgage debt more quickly. What makes sense for you depends on your goals as well as your personal preferences. If you detest risk-taking and volatile investments, paying down your mortgage, as recommended earlier in this chapter, may make better sense than investing in the stock market.

To determine your general investment tastes, think about how you would deal with an investment that plunges 20 percent, 40 percent, or more in a few years or less. Some aggressive investments can fall fast. You shouldn’t go into the stock market, real estate, or small-business investment arena if such a drop is likely to cause you to sell low or make you a miserable, anxious wreck. If you haven’t tried riskier investments yet, you may want to experiment a bit to see how you feel with your money invested in them.

Tip A simple way to mask the risk of volatile investments is to diversify your portfolio — that is, to put your money into different investments. Not watching prices too closely helps, too — that’s one of the reasons real estate investors are less likely to bail out when the market declines. Stock market investors, on the other hand, can get daily and even minute-by-minute price updates. Add that fact to the quick phone call or click of your computer mouse that it takes to dump a stock in a flash, and you have all the ingredients for short-sighted investing — and potential financial disaster.

INVESTING AS COUPLES

You’ve probably learned over the years how challenging it is just for you to navigate the investment maze and make sound investing decisions. When you have to consider someone else, dealing with these issues becomes doubly hard given the typically different money personalities and emotions that come into play.

In many couples, usually one person takes primary responsibility for managing the household finances, including investments. As with most marital issues, the couples that do the best job with their investments are those who communicate well, plan, and compromise.

Here are a couple of examples to illustrate this point. Martha and Alex scheduled meetings with each other every three to six months to discuss financial issues. With investments, Martha came prepared with a list of ideas, and Alex would listen and explain what he liked or disliked about each option. Alex would lean toward more aggressive, growth-oriented investments, whereas Martha preferred conservative, less volatile investments. Inevitably, they would compromise and develop a diversified portfolio that was moderately aggressive. Martha and Alex worked as a team, discussed options, compromised, and made decisions they were both comfortable with. Ideas that made one of them very uncomfortable were nixed.

Henry and Melissa didn’t do so well. The only times they managed to discuss investments were in heated arguments. Melissa often criticized what Henry was doing with their money. Henry got defensive and counter-criticized Melissa for other issues. Much of their money lay dormant in a low-interest bank account, and they did little long-term planning and decision making. Melissa and Henry saw each other as adversaries, argued and criticized rather than discussed, and were plagued with inaction because they couldn’t agree and compromise. They needed a motivation to change their behaviour toward each other and some counselling (or a few advice guides for couples) to make progress with investing their money.

Aren’t your long-term financial health and marital harmony important? Don’t allow your problems to fester! One of the most valuable — and difficult — things for couples stuck in unproductive patterns of behaviour to do is to get the issue out on the table. For these couples, the biggest step is making a commitment to discuss their financial management. Once they do, it’s a lot easier for them — or their financial advisor — to explain their different points of view and then offer compromises.

Chapter 2

Weighing Risks

IN THIS CHAPTER

Bullet Understanding different types of risk

Bullet Developing a sense of your risk tolerance

Bullet Avoiding and mitigating risks

Canadian stock investors face many types of risks, which we cover in this chapter. The simplest definition of risk in the context of investing is the possibility that your investment will lose some (or all) of its value. Yet you don’t have to fear risk if you understand it and plan for it. You must understand the oldest equation in the world of investing — risk versus return. This equation states the following:

If you want a greater return on your money, you need to accept more risk. If you don’t want to accept more risk, you must expect a lower rate of return.

This point about risk is best illustrated from a moment in one of our investment seminars. One of the attendees told us that he had his money in the bank but was dissatisfied with the rate of return. He lamented, The yield on my money is pitiful! I want to put my money somewhere where it can grow. We asked him, How about investing in common stocks? Or what about growth-oriented exchange-traded funds? They both have a solid, long-term growth track record. He responded, Stocks? ETFs? I don’t want to put my money there. It’s too risky! Okay, then. If you don’t want to accept and tolerate more risk, don’t complain about earning less on your money. Risk (in all its forms) has a bearing on all your money concerns and goals. That’s why understanding risk before you invest is so important.

This person — as well as the rest of us — needs to remember that risk is not a four-letter word. (Well, it is a four-letter word, but you know what we mean.) Risk is present no matter what you do with your money. Even if you simply stick your money in your mattress, risk is involved — several kinds of risk, in fact. You have the risk of fire. What if your house burns down? You have the risk of theft. What if burglars find your stash of cash? You also have relative risk. (In other words, what if your relatives find your money?)

Be aware of the different kinds of risk that we describe in this chapter, so you can easily plan around them to keep your money growing. And don’t forget risk’s kid brother … volatility! Volatility is about the rapid movement of buying or selling, which, in turn, causes stock prices to rise or fall rapidly. Technically, volatility is considered a neutral condition, but it’s usually associated with the rapid downward movement of stock because this causes anxiety and means a sudden loss for investors.

Understanding Market-Value Risk

Although the stock market can help you build wealth, most people recognize that it can also drop substantially — by 10, 20, or 30 percent (or more) in a relatively short period of time. After peaking in 2000, Canadian and U.S. stocks, as measured by the major Indexes representing the value of large companies (for Canada, the S&P/TSX Composite Index, and for the United States, the S&P 500 Index), dropped about 50 percent by 2002. Stocks on the Nasdaq, which is heavily weighted toward technology stocks, plunged more than 76 percent from 2000 through 2002!

After a multiyear rebound, stocks peaked in 2007 and then dropped sharply during the financial crisis of 2008. From peak to bottom, Canadian, U.S., and global stocks dropped by some 50 — or more — percent.

In a mere six weeks (from mid-July 1998 to early September 1998), large-company Canadian and U.S. stocks fell about 20 percent. An Index of smaller-company U.S. stocks dropped 33 percent over a slightly longer period of two and a half months.

If you think that the stock market crash that occurred in the fall of 1987 was a big one (the market plunged by about a third in a matter of weeks), look at Tables 2-1 and 2-2, which list major declines over the past 100-plus years that were all worse than the 1987 crash. Note that two of these major declines happened in the 2000s: 2000 to 2002 and 2007 to 2009.

TABLE 2-1 Most Depressing Canadian Stock Market Declines

*

* As measured by changes in the TSE/TSX Composite Index

TABLE 2-2 Largest U.S. Stock Market Declines

*

* As measured by changes in the Dow Jones Industrial Average

After reading this section, you may want to keep all your money in the bank — after all, you know you won’t likely lose your money, and you won’t have to be a nonstop worrier. Since the Canada Deposit Insurance Corporation (CDIC) came into existence, which protects deposits at banks and trust companies up to $100,000, people don’t lose 20, 40, 60, or 80 percent of their bank-held savings vehicles within a few years, but major losses prior to then did happen. Just keep in mind, though, that just letting your money sit around would be a mistake.

Remember If you pass up the stock market (or any other market like the longer-term real estate or bond markets) simply because of the potential market-value risk, you miss out on a historic, time-tested method of building substantial wealth. Instead of seeing declines and market corrections as horrible things, view them as potential opportunities or sales. Try not to give in to the human emotions that often scare people away from buying something that others seem to be shunning.

The following sections suggest some simple things you can do to lower your investing risk and help prevent your portfolio from suffering a huge fall (or drawdown).

Examining Individual-Investment Risk

A down-draft can put an entire investment market on a roller-coaster ride, but healthy markets also have their share of individual losers. For example, from the early 1980s through the late 1990s, Canadian and U.S. stock markets had one of the greatest appreciating markets in history. You’d never know it, though, if you held one of the great losers of that period.

Consider a company now called Navistar, which has undergone enormous transformations in recent decades. This company used to be called International Harvester and manufactured farm equipment, trucks, and construction and other industrial equipment. Today, Navistar makes mostly trucks.

In late 1983, this company’s stock traded at more than US$140 per share. It then plunged more than 90 percent over the ensuing decade (as shown in Figure 2-1). Even with a rally in recent years, Navistar stock still trades at less than US$20 per share (after dipping below US$10 per share). Lest you think that’s a big drop, this company’s stock traded as high as US$455 per share in the late 1970s! If a worker retired from this company in the late 1970s with $200,000 invested in the company stock, the retiree’s investment would be worth about $6,000 today! On the other hand, if the retiree had simply swapped his stock at retirement for a diversified portfolio of stocks, which you find out how to build in Book 2, his $200,000 nest egg would’ve instead grown to more than $5 million!

A line graph titled ‘NAVISTAR INTL (NAV)’ shows the stock price performance of Navistar International over time. The y-axis ranges from 0 to 250, and the x-axis represents years, though specific years are not fully visible. The graph indicates a significant decline in stock value, with notable points marked as '1Q ‘93’ and '1Q ‘95’.

© John Wiley & Sons, Inc.

FIGURE 2-1: Even the bull market of the 1990s wasn’t kind to every company.

Like most other markets, the Canadian stock market paled by comparison with the U.S. juggernaut in the 1990s, but this country has had its share of stocks that have plummeted in value. How about Dylex, which through its many brand-name outlets, such as Suzy Shier, at one time took in one out of every ten dollars consumers spent in retail clothing outlets? The stock, which began the 1990s at $24, ended the decade languishing beneath the $10 mark, dwindling lower and lower until the company eventually went under in 2001.

And then, of course, there’s Nortel. In the late 1990s, many investors happily recounted how well they’d done by buying Nortel. They often had made two, three, even ten times or more on their original investment. Nortel, or so people were told, just couldn’t keep up with the internet-driven demand for its products. At its peak, Nortel employed 90,000 workers worldwide and was worth nearly $300 billion.

Well, in a matter of months, the company’s cheerleaders were proven to be completely, hopelessly wrong. Nortel crumbled, and by October 2002 it had literally turned into a penny stock, trading at under a buck. Many investors were now calling Nortel one of their worst moves. By the end of 2008, the stock was taken off the New York Stock Exchange because it had had an average closing price below U.S.$1 for more than 30 days. By the end of the decade, Nortel had been also delisted by the Toronto Stock Exchange and went bankrupt.

Just as individual stock prices can plummet, so can individual real estate property prices. Today, real estate prices for many property types (like residential and industrial) are sky high. Is a drop in prices over the next few years in the cards? Price volatility can exist in any asset class, which is a topic discussed in Chapter 1.

Tip Here are some simple steps you can take to lower the risk of individual investments that can upset your goals:

Do your homework. When you purchase real estate, a whole host of inspections can save you from buying a money pit. With stocks, you can examine some measures of value and the company’s financial condition and business strategy to reduce your chances of buying into an overpriced company or one on the verge of major problems. Book 2 gives you information on researching your stock investment.

Diversify. Investors who seek growth invest in securities such as stocks. Placing significant amounts of your capital in one or a handful of securities is risky, particularly if the stocks are in the same industry or closely related industries. To reduce this risk, purchase stocks in a variety of industries and companies within each industry. (See Chapter 1 for more about diversifying your investments.)

Hire someone to invest for you. The best funds offer low-cost, professional management and oversight as well as diversification. Stock funds typically own 25 or more securities in a variety of companies in different industries.

THE LOWDOWN ON LIQUIDITY

The term liquidity refers to how long and at what cost it takes to convert an investment into cash. The money in your wallet is considered perfectly liquid — it’s already cash.

Suppose that you invested money in a handful of stocks. Although you can’t easily sell these stocks on a Saturday night, you can sell most stocks quickly through a broker for a nominal fee any day that the financial markets are open (normal working days). You pay a higher percentage to sell your stocks if you use a high-cost broker or if you have a small amount of stock to sell.

Real estate is generally much less liquid than stock. Preparing your property for sale takes time, and if you want to get fair market value for your property, finding a buyer may take weeks or months. Selling costs (agent commissions, fix-up expenses, and closing costs) can approach 8 to 10 percent of the home’s value.

A privately run small business is among the least liquid of the better growth investments that you can make. Selling such a business typically takes longer than selling most real estate.

To protect yourself from being forced to sell one of your investments that you intend to hold for long-term purposes, keep an emergency reserve of three to six months’ worth of living expenses in a money market account or high-interest savings account. Also consider investing some money in highly rated bonds (see Book 3, Chapter 4), which pay higher than money market yields without the high risk or volatility that comes with the stock market.

Financial Risk: Loading Up on Debt

The financial risk of investing is that you can lose your money if the company whose stock or bond you purchase loses money or goes belly up. This type of risk is the most obvious because companies do go bankrupt.

Remember You can greatly enhance the chances of your financial risk paying off by doing an adequate amount of research and choosing your stocks carefully (which this book helps you do — see Part 3 for details on picking winners). Financial risk is a real concern even when the economy is doing well. Some diligent research, a little planning, and a dose of common sense will help you reduce your financial risk.

Technology and other high-risk stocks littered the graveyard of stock market catastrophes during the Tech Wreck of 2000–2001 and during the Great Recession of 2008–2009 because investors didn’t see (or didn’t want to see?) the risks involved with companies that didn’t offer a solid record of results (profits, good cash flows, growing sales, and so on). When inflation reared its head out of a decade’s long hibernation, equity investors and debt-laden companies were caught off guard and the stock market corrected in 2022. When you invest in companies without a proven track record or loaded with way too much debt, you’re not investing, you’re speculating.

Investors who did their homework regarding the financial conditions of companies represented by internet technology and other growth stocks discovered that these companies had the hallmarks of financial risk — high debt, low (or no) earnings, and plenty of competition. Meme stocks, which are shares of companies whose prices are driven up by a speculative horde of investors grouping together on Reddit, also created a lot of volatility, and puzzled and unhappy faces. Although some were winners, even more were meme stock-holding losers. Smart investors steered clear, avoiding tremendous financial loss. Investors who didn’t do their homework were lured by the status of these companies or market exuberance and lost their shirts.

Nevertheless, some investors found gems, including names, such as eBay, Amazon, and Shopify. The homework they did allowed them to seize great opportunities if they held onto those stocks over the rough periods. Today, brand-new companies are emerging in the decarbonization, innovation economy, and other emerging industries.

Warning Individual investors who lost money by investing in these trendy, high-profile companies don’t deserve all the responsibility for their tremendous financial losses. Some high-profile analysts who frequent the media must take some responsibility for investor losses in flavour-of-the-month stocks by fuelling the feeding frenzy.

The time periods we discuss in this section may someday be case studies of how euphoria and the herd mentality (rather than good, old-fashioned research and common sense) ruled the day (temporarily). The excitement of making potential fortunes gets the best of people sometimes, and they throw caution to the wind. Historians may look back at those days and say, "What were they thinking?" Achieving true wealth takes diligent work and careful analysis.

Remember In terms of financial risk, the bottom line is … well … the bottom line! A healthy bottom line means that a company is making money by growing its revenues and controlling its costs. And if a company is generating cash (not just paper profits), you can make money by investing in its stock. However, if a company isn’t making money, you won’t make money if you invest in it. Cash flow and profits are the lifeblood of any company. See Book 2, Chapter 5 for the scoop on determining whether a company’s bottom line is healthy.

Understanding Interest Rate Risk

You can lose money in an apparently sound investment because of something that sounds as harmless as interest rates have changed. Interest rate risk may sound like an odd type of risk, but in fact, it’s a common consideration for investors. Be aware that interest rates change on a regular basis, usually as a way to manage inflation. Interest rate fluctuations create some challenging moments. We have seen this happen in a big way in 2022 and 2023 when many of the world’s central banks executed a series of interest rate hikes in response to rising inflation. Only now are rates stabilizing and dropping.

Banks set interest rates, and the primary institutions to watch closely are the Bank of Canada and the U.S. Federal Reserve (the Fed), which are both national central banks. The Bank of Canada and the Fed raise or lower their interest rates, actions that, in turn, cause Canadian and U.S. banks to raise or lower their interest rates accordingly. Interest rate changes affect consumers, businesses, and, of course, investors.

Demonstrating interest rate risk

Here’s a generic introduction to the way fluctuating interest rate risk can affect investors in general: Suppose that you buy a long-term, high-quality corporate bond and get a yield of 6 percent. Your money is safe with your return locked in at 6 percent. Whew! That’s 6 percent. Not bad, huh? But what happens if, after you commit your money, interest rates increase to 8 percent? You lose the opportunity to get that extra 2 percent interest. The only way to get out of your 6 percent bond is to sell it at current market values and use the money to reinvest at the higher rate.

The only problem with this scenario is that the 6 percent bond is likely to drop in value because interest rates rose. Why? For example, the bond yielding 6 percent is a corporate bond issued by Lucin-Muny (LM). According to the bond agreement, LM must pay 6 percent (called the face rate or nominal rate) during the life of the bond and then, upon maturity, pay the principal. If the investor buys $10,000 of LM bonds on the day they’re issued, the investor gets $600 (of interest) every year for as long as they hold the bonds. If they hold on until maturity, they get back their $10,000 (the principal). So far so good, right? The plot thickens, however.

Say that the investor decides to sell the bonds long before maturity and that, at the time of the sale, interest rates in the market have risen to 8 percent. Now what? The reality is that no one is going to want the investor’s 6 percent bonds if the market is offering bonds at 8 percent. What’s the investor to do? They can’t change the face rate of 6 percent, and they can’t change the fact that only $600 is paid each year for the life of the bonds. What has to change so that current investors get the equivalent yield of 8 percent? If you said, The bonds’ value has to go down, you’re right. In this example, the bonds’ market value needs to drop to $7,500 so that investors buying the bonds get an equivalent yield of 8 percent. (For simplicity’s sake, we left out the time it takes for the bonds to mature.) Here’s how that figures.

New investors still get $600 annually. However, $600 is equal to 8 percent of $7,500. Therefore, even though investors get the face rate of 6 percent, they get a yield of 8 percent because the actual investment amount is $7,500. In this example, little, if any, financial risk is present, but you see how interest rate risk presents itself. The investor finds out that you can have a good company with a good bond yet still lose $2,500 because of the change in the interest rate. Of course, if the investor doesn’t sell, they don’t realize that loss. (For more on the how and why of selling your stocks and other financial instruments using brokers, check out Book 2, Chapter 2.)

Affecting even bond funds

Bond funds fluctuate in price daily; the portfolio manager is regularly turning over the portfolio (buying and selling bonds in the fund), and market interest rates are constantly fluctuating. Be aware that interest rates (at the time of writing) are still rising, so even investing in a bond fund can have significant short-term risk if rates rise even more, or the up and down interest rate cycle repeats itself in the future. This differs somewhat from bank deposits and investments (GICs, term deposits, and so on), which pay the specified interest yield as long as they are held to maturity.

Remember Historically, rising interest rates have had an adverse effect on stock prices. We outline several reasons why in the following sections. Because the Canadian and U.S. economies are heavily indebted, rising interest rates are an obvious risk that threatens both stocks and fixed-income securities (such as bonds).

Hurting a company’s financial condition

Rising interest rates have a negative impact on companies that carry a large current debt load or that need to take on more interest-sensitive debt, because when interest rates rise, the cost of borrowing money rises, too. Ultimately, the company’s profitability and ability to grow are reduced. When a company’s profits (or earnings) drop, its stock becomes less desirable and consequently its stock price falls.

Affecting a company’s customers

A company’s success comes from selling its products or services. But what happens if increased interest rates negatively impact its customers? The financial health of a company’s customers directly affects the ability to grow sales and earnings.

Affecting investors’ decision-making considerations

When interest rates rise, investors start to rethink their investment strategies, resulting in one of two outcomes:

Investors may sell any shares in interest-sensitive stocks that they hold. Interest-sensitive industries include real estate, technology, and the financial sector. Growth stocks in any industry are especially vulnerable as most carry significant debt. Although increased interest rates can hurt these sectors, the reverse is also generally true: Falling interest rates boost the same industries. Keep in mind that interest rate changes affect some industries more than others.

Investors who favour increased current income (versus waiting for the investment to grow in value to sell for a gain later) are attracted to investment vehicles that offer a higher yield. Higher interest rates can cause investors to switch from stocks to bonds or bank certificates of deposit. However, these investors may not realize that they can stay in equities and take advantage of higher interest rates! Some ETFs, such as Horizons High Interest Savings, are designed to maximize income but preserve capital. Many ETFs like this one also exist.

Hurting stock prices indirectly

High or rising interest rates can have a negative impact on any investor’s total financial picture. What happens when an investor struggles with burdensome debt, such as a second mortgage, credit card debt, or margin debt (debt from borrowing against stock in a brokerage account)? They may sell some stock to pay off some of their high-interest debt. Selling stock to service debt is a common practice that, when taken collectively, can hurt stock prices.

Remember Because of the effects of interest rates on stock portfolios, both direct and indirect, successful investors regularly monitor interest rates in both the general economy and in their personal situations. Although stocks have proven to be a superior long-term investment (the longer the term, the better), every investor should maintain a balanced portfolio that includes other investment vehicles. A diversified investor has some money in vehicles that do well when interest rates rise. These non-equity vehicles include Canadian money market funds and other variable-rate investments whose interest rates rise when market rates rise. These types of investments add a measure of safety from interest rate risk to your stock portfolio. (We discuss diversification in Chapter 1.)

Remember Closely related to interest rate risk is the concept of credit risk. Some companies loan money to other organizations. In this case, the lending company expects to receive interest revenue from the borrowing company. Credit risk is the risk of the lending company losing all or part of the principal or interest amount if the borrower fails to repay the loan or otherwise doesn’t meet a contractual obligation. Be sure to review the company’s financial reports. (We show you how in Book 2, Chapter 5.)

Inflation Risk: New Kid on the Block

Inflation is a term almost all Canadians have heard about and more importantly experienced! In a nutshell, inflation is the artificial expansion of the quantity of money. To consumers, as you now know, inflation shows up in the form of higher prices for goods and services like food and home maintenance.

To fight inflation, central banks, such as the Bank of Canada, raise interest rates, which is one of the many negative impacts of inflation. Inflation risk is also referred to as purchasing power risk. This term just means that your money doesn’t buy as much as it used to. For example, a toonie that bought you a sandwich in 1990 barely bought you a candy bar a few years later. For you, the investor, this risk means that the value of your investment (a stock that doesn’t appreciate much, for example) may not keep up with inflation.

Say that you have money in a bank savings account currently earning 1 percent. This account has flexibility — if the market interest rate goes up, the rate you earn in your account goes up. Your account is safe from both financial risk and interest rate risk. But what if inflation is running at 5 percent? At that point, you’re losing money.

Inflation is a topic that even economists wrestle with. Even they can’t predict if and when inflation can be wrestled under control by the central banks (with money supply and interest rate changes) and/or by government fiscal policy (spending or taxation levels). The key point to remember is that inflation is a powerful economic and social force to be reckoned with. Leave the crystal ball predictions for the economists to figure out!

Market Cycle Risk: A Roller Coaster

People talk about the market and how it goes up or down, making it sound like a monolithic entity instead of what it really is — a group of millions of individuals making daily decisions to buy or sell stock. No matter how modern our society and economic system, you can’t escape the laws of supply and demand. When masses of people want to buy a particular stock, it becomes in demand, and its price rises. That certain price rises higher if the supply is limited. Conversely, if no one’s interested in buying a stock, its price falls. Supply and demand is the nature of market risk. The price of the stock you purchase can rise and fall on the fickle whim of market demand.

Millions of investors buying and selling each minute of every trading day affect the share price of your stock. This makes it impossible to judge which way your stock will move tomorrow or next week. This unpredictability and seeming irrationality are why stocks aren’t always appropriate for short-term financial growth.

Markets are volatile by nature; they go up and down, and investments need time to grow. Market volatility is an increasingly common condition that we have to live with. Canadians should be aware that stocks in general (especially in today’s up and down marketplace) aren’t suitable for short-term (one year or less) goals. Despite the fact that companies you’re invested in may be fundamentally sound, all stock prices are subject to the gyrations of the marketplace and need time to trend upward.

Warning Investing requires diligent work and research before putting your money in quality investments with a long-term perspective. Speculating is attempting to make a relatively quick profit by monitoring the short-term