Examine the risk-versus-reward relationship of a security before you take the plunge. Strategic investment planning starts with an honest appraisal of your own risk tolerance.
There are many investments you can buy to increase your net worth. Your returns are usually determined by the risk-versus-reward relationship of these investments. That means the more risk you incur, the greater should be your reward. If you buy a one-year GIC, your investment risk is low. You get your capital back, along with a guaranteed payment of, say, two per cent — a low rate of reward, indeed.
Stock investors take on more risk. That’s because they could lose their entire investment. The rewards, however, are significantly higher. A one-year, two-per-cent GIC return is less than the 5.2 per cent the S&P/TSX Composite Index has gained so far this year.
Since stocks have historically offered higher compound returns, the main problem is to find companies whose shares are more likely to give you the gains that will achieve the goals of your strategic investment planning, yet limit the risk of losing your capital.
Which equities are best for you?
Whether you invest mostly in stocks, or mostly in mutual funds, we think one of the best places to start is with the securities on our recommended lists. That’s because they frequently turn the risk versus reward equation upside down: they combine high quality and low risk with decent rewards, such as the big banks or Mawer Canadian Equity Fund do.
Whether you’re a retired investor who’s more concerned with income and capital preservation, or a younger investor who’s more interest in growth, we think the core of your portfolio should be made up of securities like those on our recommended lists. But which ones are best for you? It’s difficult for us to make precise recommendations because each investor has a different strategic investment plan and different risk-tolerance levels. But here are a few suggestions.
Suggestions for your portfolio
When you begin to invest, create a strategic investment plan to build a portfolio with a core holding of high-quality stocks or mutual funds, such as those we rate very conservative or conservative. This applies to all of the stocks and most of the mutual funds we include in our recommended lists. When it comes to foreign equity, emphasize global stocks and international stock funds over higher-risk regional funds. Once you’ve established a solid base of conservative securities, you can then go on to add smaller, non-core positions in more aggressive securities, if that suits your strategic investment objectives and risk tolerance.
Many investors prefer to avoid higher-quality securities in the beginning because they’re attracted by more glamourous holdings, such as high-flying biotechnology stocks. They believe you can’t make a lot of money in a short period of time by buying boring, high-quality securities. That may be true, but it’s virtually certain you won’t lose your initial investment capital, either. And it can often take longer to re-build your investment capital from a low-quality investment that has gone bad than it does for a high-quality investment to double in value.
And remember, when it comes to investing in individual stocks, pay attention to the economic sector in which a company operates. You’ll usually find more conservative, stable investments among financial sector stocks, utilities and consumer goods stocks, such as Loblaw. If you’re a conservative investor, you’ll want to emphasize these sectors over manufacturing companies stocks and natural resources such as mining stocks and oil and gas stocks.
Money Reporter, MPL Communications Inc.
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