This section is prepared for those who want to get a better understanding of investing, have an RRSP account, plan to open one in the future or for people who are a part of group pension plan at their place of employment. It will also help people who simply invest part of their disposable income. The author of this article has tried to simply present important aspects and maximum information necessary to make an investment decision. It is essential for every investor to understand basic principles of investing. The rules, shown below, will always remain same regardless of what type of service you use to make your investment - investing company, insurance agency or any bank.

To make reading and understanding easier, the article has been divided into different sections.

• Structure of investment funds "mutual funds"
• Why should mutual fund investment interest you
• Investor’s protection
• Where you can invest your money
• 5 groups of investment funds
• What gives a better final result - regular monthly investment or one-time deposit
• Investment’s risks
• Strategy "Asset Allocation"

Active investment - when you or a broker perform the purchase of stocks from stock exchange. For most investors this is not a good option. It requires a thorough knowledge and a constant observation of the market. That is hard to do when you have a regular full time job and other responsibilities.

On top of that, sometimes, your broker will not be performing in the best of your interest. That is because his/her commissions come directly from the process of buying and selling. This means that your investment portfolio will always be in action of buying and selling, but there is no guarantee that your broker, even a very experienced one, will know exactly when it is a good time to sell and/or buy. Nobody can predict the future.

That is why most people prefer the second option - passive investment. What does that mean - passive investing? It is investing performed through investment funds. These are referred to as mutual funds. Every investment fund is a complex, because in its structure it includes a number of companies and always a major bank.

1. Level of Professionalism: You do what you are good at, while a team of professionals deals with your investment. It’s a team because, if you are dealing with a big, world known firm, such as Fidelity, AGF, Mackenzie etc., then you are looking at a large amount of professionals. It could be 300 or 400 people, located in different parts of the world, working on behalf of one investment fund and their objective is to increase our capital.

2.Suitable for any level of income. You can invest as little as $25 per month or make a one-time investment of $500 or $1,000.

3. Risk Management: The risk of loosing your investment is a lot lower compared to you making your own investments into the market. Why? Because, individually you can only purchase stocks of a few companies. Your expectations are to see an increase in the value of these stocks. If even one of these companies isn’t performing well, you loose money. Imagine that you put your money into investing fund that has a large amount of investors like yourself - millions and millions. Risk becomes substantially lower, because with this money it is possible to purchase stocks of two, three or four hundred companies. Problems in some of these companies will not have much of an effect on your savings.

4. Liquidation: Investment fund is required to accept your stocks and exchange them for cash at any time, as you wish.

5. An ability to transfer your money from one fund into another inside the investing company.

• The money you invest are kept separately from managers’ assets and nobody has an ability to spend the money on another purpose.
• All assets are kept in major banks and are protected by "Canadian Banking" and "Trust Legislation". In other words these assets are even separated from banks assets.
• Every fund has an independent auditor who reports to board of directors according to government rules and regulations.
• In some provinces there is extra protection for investors in case of bankruptcy of an investment fund. In Ontario this includes "Provincially operated Contingency Funds", which is meant for an unexpected occurrences.

1. Investment funds that buy government papers, issued for a short term (less than a year). For example, 3-months Treasury Bills. They never lose value. The gain was different from year to year, but they were always gained. It is risk free, absolutely guaranteed mutual fund. Another small issue is that there is never guarantee on what the gain will be each year. At this point of time it is about 2%.

2. Investment funds that buy government bonds issued for a long term - 10, 15, 20 years (more than 1 year). In these funds there is a slight chance that bonds will lose some of their value. However, when they gain, they gain more then short-term papers.

How do funds, that work on bonds, government papers, bring a negative result? To answer this you have to understand how bonds work. Organizations, when buying bonds issued by the government or a large corporation, expect to hold them until the end of their term, for example, 10 years and get an average annual return - 7%-9%. If the bonds are returned before the end of its term, none of the annual return will be received.

Now, why would anybody wants to return bonds? Let’s consider the following situation: if current prime rate is around 4% and government is issuing bonds with an interest of 6%. This way it’s more reasonable for large investors to choose government bonds over banks. That is what companies do - purchase bonds at 6% annual return rate for next 10 years. What happens in 2 years? Economic condition of the country changes and the prime rate rises to 6%. At this point government issued bonds will have a higher return rate - 8% - 9% to encourage new investments. The market now has same 10-year bonds, except for now government guarantees a return of 8% - 9% per year. What’s more attractive? It is of course to purchase new bonds and return the old ones. At this moment the bond can be sold at cheaper price, because the situations in economic changed and today nobody would like to give original price for that bond. With a mass exchange of bonds in portfolio returns of an investment fund can even be negative. From this derives dependency: if the prime rate in the country increases, then profit on the investment funds, that work with bonds, drops; if the prime rate in the country decreases, then profit on the investment funds, that use bonds, rises.

3. Investment fund invests money into company stocks, the fund purchases shares of 100, 200 or 300 companies, hoping that the value of these companies will increase in the future, accordingly, value of the investment fund will also increase and everybody wins. Below you can see the picture with S&P/TSX composite index. This index could be compared with the regular mutual fund, holding in its portfolio only stocks of hundreds different companies. Potentially the investor can gain more here for a long period, compare with the funds, working only with bonds, but the risk is increase significantly in the equity funds.

1^st group - Safety - funds that only work with short term government papers. These are reliable, guaranteed and risk free, with a steady relatively low returns. Today, the rate is around 2%.

2^nd group - Income - these funds work with long term bonds. There are other funds of this kind, like Mortgage Funds, Dividend Funds.

3^rd group - Income and Growth - these are funds that balance their purchases between bonds and company stocks. The ratio between the two varies. Some funds use 70% and 30%, some 50% and 50%, others 30% and 70%.

4^th group - Growth - investment funds that work with companies stocks. Companies have no specifications, they could be American, Canadian or any other foreign company. General principal remains: stock purchase is accompanied by risk.

5^th group - Aggressive Growth - these are aggressive funds that focus on one market (for example, Asian) or narrow their investments to a certain sector of the economy, like raw materials and high-tech industries. There are possible high returns as well as big losses.

This break down of investment funds into 5 groups is genuine for all funds because these groups are general. They show the relation between profit and the risk, regardless of how you will be presented with them: through investment company, insurance company, bank, or at work (where you will have to chose one of the options for your group investment plan). All funds that exist, whether in Canada, US, or anywhere else in the world can be broken down into these 5 groups. There are different branches that can usually be identified by their name. If the name includes words like "Money Market" or "Short Term Investment", they belong to the 1st group. If the name includes "Bond" or "Global Bond" or "Canadian Bond", they belong to the 2nd group, which gives you more profit with an extra risk to it. If the name includes words such as "equity", "aggressive", "global", "international", then these are the funds that work with stocks (Equity Funds). If it is a fund that has it balanced its name will say so - "Balanced Funds".

The question is which fund should you chose. This is a very serious decision and it is best that you understand that the longer you invest the more risk you are allowed to take. On the contrary, if the fund withdrawal time is close, less aggressive you investments should be. Of course, there are other things you will take into consideration. Economy experiences its ups and downs, sometimes quite noticeable. When that happens you want to feel comfortable about your investment. Financial advisor should discuss each situation and make individual recommendations using special tests. You can see which group of investment funds you should chose using this test.

When planning long-term investment, you should always include investment funds that use stock market. The younger you are the more aggressive you can be. Since nobody can predict future market trends, it is important to invest on regular basis.

If a $1,000 is invested in TSE-300 and is left there for 10 years, then average annual return will be about 10%, so $1,000 will turn into $2,612. If in that 10 years you skip 10 days with highest growth, then potential annual return will only be about 6.7% and you will receive $700 less.

Since it is impossible to predict when market will have its best days the right decision is to invest on regular basis (every month, for example).

This table shows an example of monthly investments of $200 into a fund that is increasing in value. Since the price per unit has grown from $10 to $15, the fund makes 50% profit per year. That is good. Since the price per unit keeps growing the same investment allowed us to buy less units every month. In the end, 190.9 units purchased in a one-year period brought a profit of 19.3%.

Now, let’s see how the same investment works in a slightly different fund. This fund did not increase in value, hence 0% profit. On the contrary, half way through the year price of the unit was 50% lower then the initial value. At this time, since the investments were made every month, same $200 has bought bigger number of units. Towards the end of the year, when the unit price bounces back to its initial value, the number of units purchased has increased to 293. Simple calculation shows that with this fund total return was 22%, which is even better than the previous one. This strategy is called "Dollar Cost Averaging".

Since the unit price always changes it is impossible for us to predict best and worse days. Changes will always exist. With monthly investments your investments hit both, good and bad days, which averages out to a good result.

Of course, there are different situations, but I want you to understand that monthly investments are not only easier (its easier to invest smaller amounts every month then a large sum at the end of the year), and it is also gives you a better final result.

I am sure you know this situation - January, February come, it is time to pay taxes and everyone would like to pay less. The best way to do so is to make payments in RRSP but there is no money. Of course, RRSP loan can be taken with very low interest but it is a big one-time payment. Some deposit $10,000, some $1,000 or $5,000 and the problem is that no one can say at what point of investment cycle the money is invested. Everyone understands - buy when it is cheap, sell when it is expensive. So to say for sure what day this will be - good or not is practically impossible. But there is not much choice. We invest money today because it’s February, last opportunity to invest into an RRSP. Paying off this loan during the year is like investing monthly but it’s a little different. The money is invested in February, one-time payment, and the debt for that is returned through out the year. There is a risk - at what stage of the cycle have you invested your money. Specialists recommend - try to make yourself put away monthly contribution to an RRSP amount that you are aloud to invest at the end of the year to reduce your taxes. To fix a sum to be invested during the year, to actualize your goals, it is a good idea to make an investment at the beginning of the year.

When investing there is a certain risk:

• Company is not doing so well this quarter - this effects stock value (business risk).
• Depending on stock demand the value may increase or decrease (market risk).
• Profitability of government bonds (long term and short term) depends on the prime rate (interest-rate risk).
• With the long term government bonds, bringing certain profit every year, there is a risk - at what current market rate will this profit be invested (reinvestment risk).
• Inflation risk. There is a chance that inflation will overcome your annual profit when investing into guaranteed low return funds (purchasing power risk).
• Investing internationally creates risk associated with currency exchange rate (currency risk).

Pic. 1

Pic. 2

Let’s also visualize clock (Pic. 2).

Considering that unit price goes up and down, top point (12 o’clock) - fund’s unit price is at its highest, bottom point (6 o’clock) - fund’s unit price at its lowest. Unit price changes. Everybody knows that buying should be done at lowest price (6 o’clock) and selling at the highest price (12 o’clock). Every investment fund has its own cycle. Funds that work with different style of operations and under different conditions has the same cycle of unit price, shifted in time. Unit value in one fund can be at the bottom of the cycle (6), another funds unit value could be at the top of the cycle (12), while third and fourth could be at 9 and 3.

Keep in mind that no fund can really identify at what point of the cycle their unit value is. For that future has to be predicted. Taking this in consideration investor might consider to change fund because currently owned unit price could be at its bottom point 6, but there is no guarantee that next fund you invest in won’t be at 6 as well. It could also be that you invest at 12 and still lose. If the investor stays with the same fund, stocks will go back up, you may even profit more if you invest on regular basis (Pic. 3).

Pic. 3

Financial advisor’s job is to pick investment funds that are moving in different directions to balance out the changes appropriate to any fund.

This way investor’s portfolio will be less active, which brings fewer worries to the investor.

Still, corrections are necessary from time to time. This requires help of financial consultant. I invite you for an individual discussion of your future plans about an extra income during your pension. Investment program can be started with any monthly investments (as low as $25).

I Home I Basics of Investing I Investor Profile Questionnaire I Calculators I CIBC Principal Protected Notes (PPNs) I