Understanding investment tools
The investment industry is plagued with confusion and clutter. One reality of the industry is that there are far too many choices to choose from. Investors can buy a myriad of investments like GICs, mutual funds, stocks, income trusts, property, markets, etc. Furthermore, once you decide to invest in one of these categories, there are thousands of different places to buy from and even more specific investments to select. Those looking for an advisor to help guide them through this confusing maze of investments will have just as difficult a time picking the right advisor.
We all have biases toward different investments and the reality is different investors will choose different investments. I hope to outline some different investment options available to investors and talk simply about some of the good and bad points.
Three basic types of investments
When it comes to categorizing investments, I tend to look at three basic categories: Guaranteed investments, non-guaranteed investments, and hybrid products.
1. Guaranteed investments
One of the most common and recognized guaranteed investment is the GIC or Guaranteed Investment Certificate. Essentially, guaranteed investments provide investments with two types of guarantee – a guarantee of capital and a guaranteed return.
Other investments that fit into this category are high-interest bank accounts, Canada Savings Bonds, Strip Bonds, T-Bills and term deposits.
It’s no surprise that the most appealing characteristic of these guaranteed investments is a simple fact that you cannot lose money. Certainty, predictability, and familiarity are all reasons why investors buy guaranteed investments.
Typically, there are three common negatives when we talk about guaranteed investments. The first concern is low returns. In fact, today we are in the midst of some of the lowest interest rates ever. The second concern is taxation. Guaranteed investments typically have the least tax-efficient form of investment income – interest income. Finally, it has been proven time and time again that guaranteed investments have a very difficult time keeping up with inflation.
2. Non-guaranteed investments
With low-interest rates, investors tend to look for alternatives to boost returns. Unfortunately, the tradeoff for higher returns is that you must accept the fact that there will not be guarantees of performance. Investors choosing non-guaranteed investments will have to deal with the world of uncertainty.
In this category, you will find things like mutual funds, stocks, real estate, gold, income trusts, hedge funds, wrap accounts or discretionary money management. In all these cases, you must accept a higher level of risk in return for some higher potential long-term returns.
Of course, when the markets were roaring upward, it was much easier on the heart to take this higher level of risk. But when things are dropping, the rewards are not present and the risks seem too high. Welcome to the world of non-guaranteed investments.
3. Hybrid products
Hybrid products have often been called the investment that gives you the best of both worlds. These investments provide characteristics of both guaranteed investments and non-guaranteed investments. The hybrid product category is a newer one that is rapidly growing in size and popularity.
Similar to a guaranteed product, hybrids will guarantee that your capital will be returned to you over a specified period of time. Different products have different time frames that usually range from 3 to 10 years. However, they are similar to non-guaranteed investments in that the returns of these investments are linked to an underlying non-guaranteed investment.
In this category you will find things like index-linked GICs, mutual fund linked GICs, Principal Protected Notes, and segregated funds. While these products seem to have the best of both worlds there are a lot of different varieties in this category. Make sure you shop wisely or get the help of a financial advisor.
My two cents
Sorting through the maze of investments becomes more challenging every day as new products and new ideas come out. The best place to start when picking investments is to take the time to understand risk and understand how important it is to have guaranteed products in your portfolio. Remember that every product has merits and while guaranteed products have a lot of appeals, every guarantee has a tradeoff. Good luck!