Are you wondering where to invest your money next? Below, we outline a few types of investments worth considering and look at the pros and cons of each investment.
Table of Contents
Key Points
- GICs are a safe bet for risk-averse investors, offering guaranteed returns and principal protection, making them suitable for goals like retirement or tuition savings.
- Government Bond Funds are another low-risk option, ideal for beginners or those seeking stable cash flow, and they invest in debt securities issued by governmental agencies.
- S&P Index Funds offer a way to tap into the performance of large U.S. companies, providing higher returns at the cost of greater volatility, making them suitable for a longer investment horizon of at least three to five years.
- Dividend Stock Funds allow you to earn through both capital appreciation and regular dividend payouts, offering a mix of long-term growth and short-term income.
- Each investment type caters to different risk tolerances and financial goals, from the ultra-safe GICs to the more volatile but potentially rewarding S&P Index Funds.
Guaranteed Investment Certificates
Guaranteed investment certificates, otherwise known as GICs, are investment instruments commonly found in Canada. They are worth considering for risk-averse investors. They are extremely safe, incredibly low-risk, and well-suited to a wide range of investment goals.
Whether you recently retired or are saving up for your child’s college tuition, a guaranteed investment certificate can help you get there. With a GIC, the investor agrees to lend a bank or other financial institution money for a set length of time (known as the term). You are then guaranteed to get your principal amount back at the end of the term.
Depending on the type of GIC your purchase (e.g. if it’s a fixed-rate GIC), you might also be guaranteed a return on your investment at the agreed-upon interest rate.
Pros of GIC Investments
Guaranteed Returns
The primary allure of GICs is the guarantee on your investment. You’re promised a specific interest rate over the life of the certificate, regardless of market conditions.
Low Risk
GICs are considered very low-risk investments. They’re often backed by institutions with a strong track record, making the chance of losing your investment quite slim.
Variety of Terms
You can pick from a wide range of terms, from a few months to several years. This flexibility allows you to tailor the investment to your financial goals and time horizon.
Fixed or Variable Interest Rates
While most GICs offer fixed interest rates, some provide variable rates tied to market indexes, giving you the chance to earn more if the market performs well.
CDIC Protection
In Canada, GICs are often covered by the Canada Deposit Insurance Corporation (CDIC), which insures your investment up to a certain limit in case the issuing institution fails.
Simple and Easy to Understand
GICs are straightforward. You invest a sum of money for a fixed term at a fixed (or sometimes variable) interest rate. No need for an economics degree to get started!
Cons of GIC Investments
Lower Returns Compared to Other Investments
The safety of GICs comes at the cost of lower potential returns. You’re unlikely to make as much money as you would with riskier investments like stocks or real estate.
Lack of Liquidity
Once you lock your money into a GIC, it’s typically stuck there until the term ends. Some GICs offer the ability to cash out early, but often at the cost of losing the interest you’ve earned.
Inflation Risk
The interest rate might not keep up with inflation, especially for long-term GICs. This could erode the purchasing power of your investment over time.
Opportunity Cost
By locking your money in a GIC, you may miss out on higher returns from other investment opportunities that come along.
Limited Potential for Capital Gains
Unlike investments like stocks, which have the potential for significant capital gains, the return on a GIC is predetermined and generally modest.
No Tax Advantage
Interest earned from GICs is fully taxable, unlike certain other types of investments that offer tax advantages, such as some retirement accounts.
Government Bond Funds
Government bond funds, especially short-term government bond funds, may be another worthwhile investment option. Government bond funds are either mutual funds or ETFs that invest in debt securities issued by the federal government and other governmental agencies.
Like GICs, government bond funds are relatively low-risk, making them an ideal choice for first-time investors or those looking for cash flow.
Pros of Government Bond Funds
Low Credit Risk
Since these funds invest in bonds issued by a government, they’re generally considered to be low-risk when it comes to the likelihood of default. Governments rarely default on their debt obligations.
Stable Income
Government bond funds typically pay out interest on a regular basis, offering a steady and predictable income stream. This makes them popular among retirees and other income-focused investors.
Liquidity
Unlike some other types of investments, government bond funds usually offer high liquidity. You can buy or sell your holdings on any business day without significant impact on the market price.
Diversification
These funds can be a good way to diversify a portfolio that is heavily weighted in more volatile assets like stocks or commodities.
Inflation-Protected Options
Some government bond funds invest in inflation-protected securities, which can help preserve the purchasing power of your investment over time.
Professional Management
The fund is managed by professionals who make decisions about which specific bonds to buy or sell, saving you the time and effort of doing it yourself.
Cons of Government Bond Funds
Lower Yield
The safety of government bonds often translates to lower yields compared to corporate bonds or stocks. You’re trading the potential for higher returns for lower risk.
Interest Rate Sensitivity
When interest rates rise, the market value of existing bonds falls. Government bond funds are susceptible to this interest rate risk, especially those that hold long-term bonds.
Fees and Expenses
Managed funds come with fees that can eat into your returns. Even a seemingly small annual fee can add up over time.
Limited Growth Potential
Unlike stocks, which have the potential for capital appreciation, the growth potential of government bond funds is generally limited to the interest payments you receive.
Tax Liabilities
The income generated by government bond funds is usually subject to federal income tax, and possibly state and local taxes as well, unless you hold them in a tax-advantaged account.
Opportunity Cost
By investing in a lower-yield asset, you might miss out on potentially higher returns from other types of investments.
S&P Index Funds
If you’re not too risk-averse and high returns are what you’re after, consider S&P Index Funds. S&P Index Funds is based on roughly 500 of the largest companies in the United States, which includes some of the most successful companies in the world, such as Amazon, Berkshire Hathaway, and more.
Like other funds, S&P Index Funds offer instant portfolio diversification – a major plus for those looking to conveniently diversify their investments in one fell swoop. They also offer better returns than most traditional banking products or bonds, but the downside is with the potential for better returns comes greater volatility.
Investors who choose to invest in S&P Index Funds are generally better off leaving their money invested for a minimum of three to five years. Therefore, S&P Index Funds may be a wise choice for anyone who can afford to leave their money tied up for that time frame.
Pros of S&P Index Funds
Broad Diversification
Investing in an S&P Index Fund exposes you to 500 different companies across various sectors. This helps to spread risk and can provide a more stable return over time.
Cost-Effectiveness
These funds are generally cheaper to manage because they simply aim to mimic the S&P 500. Lower fees mean more of your money is actually invested, which can make a significant difference over time.
Strong Historical Returns
Historically, the S&P 500 has delivered robust returns, making it an attractive investment for those looking for decent growth potential.
Passive Management
The fund is passively managed, meaning it requires less frequent buying and selling of assets. This results in lower transaction costs and less impact on your returns.
Simplicity
It’s a straightforward investment vehicle that’s easy to understand. You don’t need to sift through individual stocks or bonds; you’re essentially buying a small piece of 500 different companies in one go.
Tax Efficiency
The low turnover rate in S&P Index Funds often means fewer taxable events, making them more tax-efficient compared to actively managed funds.
Cons of S&P Index Funds
Lack of Flexibility
Because these funds mirror the S&P 500, there’s no room for the fund manager to make adjustments based on market conditions. In declining markets, the fund will likely decline as well.
Limited Exposure to Other Asset Classes
Investing solely in an S&P Index Fund limits your exposure to other types of assets like bonds, international stocks, or real estate, potentially reducing diversification benefits.
No Downside Protection
There is no mechanism to protect against losses. When the market dips, so does your investment.
Potential for Over-Concentration
Although the S&P 500 is diverse, it’s still heavily weighted towards certain sectors and large companies, which can expose you to specific market risks.
Dividend Yields
The dividend yields for S&P Index Funds may not be as high as those for some other types of investments, like certain bond or dividend-focused funds.
Opportunity Cost
You’re giving up the chance for outperformance. Unlike actively managed funds, index funds won’t try to beat the market.
Dividend Stock Funds
The fourth and final type of investment worth considering is dividend stock funds. Dividend stock funds are a type of stock market investment that come with a surprise bonus in the form of dividend payouts.
For those that don’t know, dividends are a part of a company’s profit that is paid to shareholders (e.g. investors). Therefore, when you invest in a dividend stock fund, you can gain money on your investment in the long-term while earning cash through dividends in the short term.
Please note that dividend payout schedules vary by the company but may be once per quarter.
Pros of Dividend Stock Funds
Stable Income
One of the most appealing aspects of dividend stock funds is the regular income they generate. This makes them popular among retirees and other investors seeking a stable cash flow.
Potential for Capital Appreciation
In addition to dividends, these funds offer the possibility of capital gains, giving you two ways to earn a return on your investment.
Lower Volatility
Dividend-paying companies are often well-established and financially stable, which can result in less volatility compared to the broader stock market.
Reinvestment Opportunities
You can choose to reinvest your dividends to purchase more shares, thereby compounding your returns over time.
Tax Benefits
Qualified dividends are often taxed at a lower rate than ordinary income, offering some tax advantages.
Diversification
These funds usually invest in a variety of dividend-paying companies across different sectors, which can help diversify your portfolio.
Cons of Dividend Stock Funds
Limited Growth Potential
Companies that pay dividends may invest less in their own growth, potentially capping long-term capital appreciation.
Tax Liabilities
While some dividends receive favourable tax treatment, others do not. Also, frequent trading within the fund can lead to capital gains taxes.
Management Fees
Like other managed funds, dividend stock funds come with management fees that can erode your returns over time.
Interest Rate Sensitivity
Dividend stocks can be sensitive to changes in interest rates. When rates rise, the dividend yields may become less attractive compared to other investments like bonds.
Concentration Risk
Dividend stock funds may lean heavily towards specific sectors like utilities or consumer staples, which could expose you to sector-specific risks.
Market Risk
While they are generally less volatile, dividend stock funds are still subject to the ups and downs of the stock market, which can impact your investment value.
This article is for information and educational purposes only and does not form a recommendation to invest or otherwise. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.