Where do stocks, bonds, and GICs fit?
When it comes to investing, there seem to be countless options. To add to the confusion, there are also financial products that combine individual investments into one, such as mutual funds. A great way to get a handle on investments is to understand what category or class an investment belongs to. The categories are typically called asset classes, and the investments within each asset class share certain characteristics. By understanding these characteristics, you can understand which type of investments will work for you.
Three main investment asset classes – cash and equivalent, fixed income, and equities.
The three main investment classes are cash and equivalent, fixed income, and equities. Each have their own advantages and disadvantages, and they each have different risks associated with them.
Cash and equivalent
Cash and equivalent are the most basic type of investment. They are simply an agreement between you and another party, which is usually a financial institution. You provide them with your money, and they promise to pay back your money with interest at a later date. It’s much like a loan, but in this case you are the lender and the bank is the borrower.
The most common type of investment is a Guaranteed Investment Certificate (GIC). GICs are widely available at all financial banking institutions. They are typically for a term of one to five years and the interest rate you receive on your investment is pre-determined. Cash and equivalents are the least volatile of the asset classes because you know in advance what your return will be. Historically this asset class has the lowest expected return, which is due to their stable nature.
A fixed income investment is similar to a cash investment in that there is interest paid on the investment, but there is further potential for gain or loss.
The most common fixed income investment is a bond. Bonds are issued by either a corporation or government. An investor purchasing the bond is entitled to receive their initial investment back when the bond matures, plus interest payments in the mean time. The interest payment is called a coupon and is usually paid every six months. The coupon rate is determined when the bond is issued and will not change in the bond’s lifespan.
Where a cash investment is an agreement between the investor and a financial institution, a fixed income investment is an agreement between the issuer and the security (bond) holder. An investor holding a bond can sell it to another investor before it matures. This is where there is potential for further gain or loss. Bond prices can change based on changes in interest rates and changes in the credit quality of the issuer.
Among the three asset classes, fixed income falls in the middle in terms of expected returns and the volatility (ups and downs) of those returns.
Most commonly known as stocks, equities are typically the most talked about investments. A stock is a security that signifies ownership in a company. That ownership represents a proportional share of a company’s assets and earnings.
The most common type of equity investment is a common share and entitles the shareholder to vote at shareholders’ meetings and receive dividends (a portion of the profits that does not go back in to the company).
Common shares are traded on stock exchanges and their values are determined by what other investors are willing to pay for them. An investor’s return from holding equities is determined by the value of the shares on the stock exchange as well as any dividends received.
Equities are the most volatile of the three asset classes but they also have historically provided the highest return. Since the prices of stocks change so quickly, up and down, they require a longer term outlook in order to reap their benefits.
With so many investment options available, it can be tough to determine where to invest your money, and what level of risk you are comfortable with. If you’re deciding which investment class will work best for you, an ATB Wealth advisor can help.