Investing: Understanding the Basics
Before making investment decisions, it is important to understand basic concepts.
Risk is the level of uncertainty associated with an investment—that is, the possibility that the investment will not grow or that you may even lose part or all of it. Every type of investment involves some risk. Generally, the higher the potential return, the higher the risk will be.
Return is the profit or growth that an investor makes on an investment. The return can vary greatly, and for many types of investments it cannot be predicted with certainty. An investment’s return can come in two forms:
- income—including interest or dividends, or
- increased value (also called "capital gain"), enabling you to sell your investment for a profit.
You can have a negative return if your investment loses value (also called "capital loss").
Risk tolerance is the level of risk with which you are comfortable. If you are willing to take the chance of losing some or all of your investment in exchange for the potential of earning a larger return, you have a high risk tolerance. If you prefer little or no risk, your tolerance is low.
Liquidity is the ability to cash in or sell an investment quickly to gain access to the funds without significant penalty. Liquidity can be important if you are planning to use your savings or investments in the short term.
Diversification involves having a mix of investments. It is a way to reduce risk. By holding a variety of investments, you reduce the likelihood that all of them will not increase in value or lose money at the same time.
Taxes & investments
Taxes will affect the return on your investments, but taxes affect different investments in different ways. For example, you have to report interest income yearly and pay tax on it, but you may be eligible for a tax credit on income that you receive from dividends. With capital gains, you don’t have to pay tax until you sell or transfer an investment and receive some income, and then you pay tax only on half of the increase in value.
Visit the Canada Revenue Agency (CRA) for more information on capital gains.
Taxation is a complex area with many specialized rules. Unless your investments are very simple, it is helpful to get advice on tax planning from a professional with expertise in this area.
The Government of Canada has created a variety of registered savings plans that offer tax benefits to investors. They let you avoid or delay some of the taxes you pay. See Government saving and investment plans.
Source: Investing: Understanding the basics, Reproduced with permission from the Financial Consumer Agency of Canada (FCAC), 2015