GayFinanceBasics

The ABCs of investing

September 5, 2005

You believe in the old saying, money makes money. So you scrimp and save to come up with a few extra dollars to invest. But, with all the investment choices open to you, the biggest question you face is this: Where should I put my money to get the most from my money? And the answer is this simple and this complicated: It all depends on you, your unique needs, goals and risk tolerance. To help you make the best choices for you, let's start with an investment primer. Here are the ABC (and D)s of investing:

A is for Asset Allocation -- the key to the long-term health of any investment portfolio.

An asset allocation program helps you determine the right mix of investments, selected from different classes of financial assets (see B below) that best suits your goals and risk tolerance. Each asset class has different levels of return and risk, so each will behave differently over time , for example, when one investment or market is not performing well, others may have superior performance and lift your overall return. But, it is also a fact that all asset classes will grow over the long term, even though each does so at different rates at different times.

B is for Basic Asset Classes -- the three major investment types available to you.

• Cash, which includes money in bank accounts and other short-term investments such as Treasury bills and money market mutual funds. Cash investments are low risk but usually provide low returns.
• Fixed-income investments, which include bonds, mortgages and bond or mortgage mutual funds, GICs and other interest-generating securities (other than cash). Most of these are considered low to moderate risk, and returns can vary.
• Equity investments, which include stocks or mutual funds that invest in stocks. These offer the potential for high returns but with the greatest level of risk.

C is for Tax Cost of Investing -- the amount of tax you pay on returns depends on the type of investments you choose. Obviously it is the goal of every investor to make money on their investments, but there is almost always a tax cost associated with returns. The asset class/investment type dictates the amount of tax you may have to pay:

• Interest income is fully taxable -- meaning that if you're in the 40 per cent tax bracket, you'll pay 40 cents of tax for every dollar of interest income you earn.
• Dividends from qualifying Canadian companies are generally taxed more favourably than interest income because they receive a Dividend Tax Credit.
• Capital gains get a big tax break -- only 50 per cent of a capital gain is included in income for tax purposes.

You can reduce, defer or even eliminate taxes on your investments with a number of strategies. For example, it's generally a good idea to keep highly taxed interest-generating investments inside your tax-sheltered RSP and more reasonably taxed dividend- and capital gains-producing investments in the non-registered portion of your portfolio.

D is for Diversification -- spreading your investments among asset classes to improve returns and reduce overall risk. When it comes to investing, the old saying, never put all your eggs in one basket is the best advice you can get -- because when you put all your nest eggs (money) into a single (investment) basket, two things can happen: you can win big (highly unlikely) or you can lose big (more likely).

A properly diversified portfolio with investments strategically selected from the three main asset classes should match your tolerance for risk and help ensure you achieve your investment goals. Your financial advisor can help design an investment portfolio that gives you the best bang for your hard-earned investment bucks.

This page is part of the GayFinance series.