1. The Investment Environment

Investment

Any asset you put money into expecting income or an increase in value

Goal of investing

To grow money to achieve long-term financial goals

Portfolio

A collection of different investments held by an investor

Return

The reward from investing, earned through income or price appreciation

Sources of return

Income (interest, dividends) and capital gains

Liquidity

The ability to quickly buy or sell an investment without losing value

Security

A financial claim issued by firms or governments, such as stocks or bonds

Property

A real asset such as real estate, land, gold, or collectibles

Real property

Land, buildings, and things permanently attached to land

Tangible personal property

Physical assets like gold, artwork, antiques, or collectibles

Direct investment

Investor directly owns the asset or claim

Indirect investment

Investor owns assets through a professional manager (mutual funds, ETFs)

Debt investment

Investor lends money and earns interest (bonds)

Equity investment

Investor owns part of a business (stocks)

Derivative security

A security whose value depends on an underlying asset

Examples of derivatives

Options and futures contracts

Risk

Uncertainty about the return an investment will generate

Low-risk investment

More predictable returns with lower average return

High-risk investment

Less predictable returns with higher expected return

Diversification

Holding different types of assets to reduce overall portfolio risk

Short-term investment

Maturity of one year or less

Long-term investment

Maturity longer than one year

Domestic investment

Security issued by a company in your home country

Foreign investment

Security issued by a company in another country

Households in financial system

Typically net suppliers of funds

Businesses in financial system

Typically net demanders of funds

Government in financial system

Typically net demanders of funds

Financial institutions

Banks, mutual funds, and insurance companies that channel funds

Financial markets

Markets where financial assets are bought and sold

Individual investor

A person managing their own money

Institutional investor

Professionals managing money for others

Common stock

Represents ownership in a corporation

Stock returns

Dividends and capital gains

Fixed-income securities

Bonds and other debt instruments paying interest

Preferred stock

Ownership claim with fixed dividends and no maturity

Convertible bonds

Bonds that can be converted into common stock

Mutual fund

A pooled portfolio of investments managed professionally

Money market mutual fund

A mutual fund that invests only in short-term securities

ETF

Like a mutual fund but trades on an exchange like a stock

Hedge fund

Less regulated fund with higher risk and higher minimum investment

Option

A contract giving the right but not obligation to buy or sell an asset

Futures contract

A legally binding agreement to buy or sell an asset in the future

Tax-advantaged investments

Investments that reduce taxes and increase after-tax returns

Examples of tax-advantaged accounts

RRSP and TFSA

Investment plan

A long-term roadmap guiding investment decisions

Investment Policy Statement (IPS)

A document outlining goals, risk tolerance, and rules

Key parts of IPS

Current situation, goals, time horizon, risk tolerance, guidelines

Active income

Income earned from working, such as wages or salaries

Portfolio income

Income from investments like interest, dividends, and capital gains

Passive income

Income from rents, royalties, or partnerships

Capital gain

Occurs when an asset is sold for more than its purchase price

Capital loss

Occurs when an asset is sold for less than its purchase price

Capital gains tax in Canada

Only 50 percent of realized capital gains are taxable

Life cycle investing

Adjusting investments based on age and stage of life

Growth-oriented stage

Ages 20–45, higher risk and growth-focused investments

Middle-age consolidation

Ages 46–60, balanced growth and income

Retirement stage

Focus on income and capital preservation

Business cycle

Economic expansions and contractions over time

Stocks in expansion

Tend to rise

Stocks in recession

Tend to fall

Interest rates and bonds

Bond prices move opposite interest rates

Short-term investments purpose

Provide liquidity and emergency reserves

Discount basis investment

Bought below face value and earns interest at maturity

Advantages of short-term investments

High liquidity and low default risk

Disadvantages of short-term investments

Low returns and inflation risk

Residual claim

Shareholders receive what is left after all obligations are paid

Why stocks are riskier than bonds

Shareholders are residual claimants

Limited liability

Shareholders can only lose what they invested