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FINANCIALLY AESTHETIC · GUIDE 28/37
ARE YOU READY TO INVEST? GOALS, RISK & TIME HORIZON
FA-6.1 · Investing & Wealth Building
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BEFORE YOU INVEST
Investing before your cash base is ready can force you to sell at the worst possible time.
The Emergency Fund Before an Investment
An emergency fund is an amount of money you set aside to deal with unexpected events. At some point in your life, you may have to deal with an emergency or unforeseen expenditures.
Such surprises usually don’t give you time to adjust your budget accordingly.
Here are a few examples:
- car repairs
- an emergency trip to the vet
- job loss
- a health issue that prevents you from working
Don’t confuse unforeseen expenditures with occasional expenses such as school supplies, winter tires, or even holiday expenses. These occasional expenses should already be factored into your budget.
Setting up an emergency fund helps you:
- deal with unexpected events without going into debt
- avoid high-cost loans (such as payday loans or a cash advance on a credit card)
- maintain financial control
- have peace of mind
It’s important to choose the right type of account to build your emergency fund. The money should be easily and quickly accessible in case of an emergency.
Look for the following features in your savings account:
- Your account is separate from your everyday checking account for transactions
- You pay little to no transaction fees
- You don’t pay any penalties for withdrawals
- You earn interest on your savings
Ideally, you should aim to save the equivalent of 3 to 6 months’ worth of your usual expenses. You can also aim for 3 to 6 months’ worth of income. Both methods work, so choose whichever is easier for you.
These amounts may seem hard to reach. That’s why you should save gradually.
Saving a small amount on a regular basis makes a big difference in the long term.
Before using all or part of your emergency fund, first determine whether you’re actually facing an emergency. Perhaps this expense can wait until you’ve had a chance to save the required amount.
If you’re not sure, go back to your list of needs and wants. An emergency is a major, sudden need that isn’t part of your current budget and wasn’t planned for.
When it comes to an emergency, don’t hesitate to use your emergency fund. The purpose of the emergency fund is to prevent you from having to resort to expensive credit options.
Although your emergency fund should always be easily accessible, don’t be tempted by its balance. Leave it untouched for a true emergency.
Pay Off High-Cost Debts Before Making an Investment
Remember that it’s usually best to pay off your debts first, because the interest you pay on those debts is generally higher than the returns your investments generate.
Set Your Financial Goals
Savings and investments can help you achieve your financial goals. It’s a good idea to write down your goals.
To find the investments and investments that are right for you:
- set your goals, such as savings for retirement or a down payment on a home, and prioritize them
- Set a specific dollar amount for each goal
- set a timeline for achieving your goals
As your life changes, so do your financial goals. Review your savings and investment plans regularly.
Investment Horizon: Short term, medium term, or long term
Your goals may be:
- short term (2 years or less)
- medium term (3 to 5 years)
- long term (6 years or more)
The amount of time you have to reach your goals can influence how you save and invest.
If you’re saving for an emergency fund or a major purchase within the next year or two, you can focus on your savings. The goal is to protect your money while keeping it easily accessible.
Short-term savings and investments:
- savings accounts
- short term deposits
- short term guaranteed investment certificates (GICs)
- cashable savings bonds
Ask your financial institution or financial advisor about the different types of short-term investments they offer and how they work.
Long-term investments:
- Bonds, such as Canada Savings Bonds
- mutual funds
- index deposit accounts
- stocks
- Long-term deposits
- Guaranteed Investment Certificates (GICs)
Please note that some investments are complex and involve risks. Talk to an investment professional or financial advisor to find the investments that are right for you.
Long-term savings options:
- Registered Retirement Savings Plan (RRSP)
- Registered Education Savings Plan (RESP)
- Registered Disability Savings Plan (RDSP)
- Tax-Free Savings Account (TFSA)
Investment Horizon and Volatility
With equity investments, it’s not uncommon to see declines or gains of more than 20 or 30 percent in a single year. And when investing for just one year, an investor has almost as much chance of incurring a loss as of making a gain. For this reason, equity investments should be viewed as long-term investments - at least 5 years, and more reasonably 10 years or more - to increase the chances of returns.
Understanding Risk: Tolerance and Capacity
Many investments offer the potential for higher rates of return but come with a certain risk level. This risk becomes more acceptable if your goals are long term, since you have more time to recover from any financial losses.
Your level of risk tolerance depends on your emotional willingness to accept risk and your financial ability to absorb losses. This is known as risk tolerance or risk appetite.
There are many types of risk, including:
- the risk of losing money if domestic or global markets decline
- the risk that an investment cannot be sold quickly enough to avoid a loss
- the risk that the return on your investments will not be high enough to keep pace with inflation
- the risk associated with investing in certain types of companies, such as those in an unregulated industry
A higher level of risk may be acceptable if your investment horizon is long term. This is because you have more time to recover from financial losses.
The value of a stock or fund fluctuates constantly. Volatility is a measure of the magnitude of these ups and downs.
Knowing the level of volatility of an investment is therefore useful for assessing the risk of that investment: when volatility is high, the value of the invested capital can drop significantly.
High volatility is generally accompanied by the prospect of attractive returns. However, high returns can never be guaranteed.
Stock prices fluctuate to a greater or lesser extent depending on investors’ uncertainty about the future of the listed company.
Collective investment vehicles (funds and SICAVs), which are invested to varying degrees in equity investments, also fluctuate. But they are generally less risky than individual stocks because a diversified portfolio across multiple securities fluctuates less than any single security. Their volatility, measured by the average change in value over the past five years, is generally assessed for funds and SICAVs on a scale - known as the “return and risk scale” - ranging from 1 to 7.
Funds rated 7 - generally equity funds - are the most volatile; this means that their price fluctuations, whether up or down, can be significant and may erode the invested capital at any time.
Being aware of the possibility of a loss at the end of an investment is one thing. But before investing, every investor must also understand their ability to tolerate fluctuations during the life of the proposed investment. You need to be able to remain calm if your investment suddenly drops by 10%. Talk to your financial advisor: the questions they ask you are designed to determine your risk tolerance and thus assess whether your profile is suited to a more or less volatile investment.
Deciding Whether to Invest on Your Own or with Guidance
You can invest on your own if:
- you are confident in your investment knowledge
- you have the time to monitor financial market trends
Many people work with a financial advisor or financial planner to help them plan for and achieve their financial goals.
INVESTOR CHECK
Define the goal and horizon, protect near-term cash needs and only invest risk you can financially and emotionally hold.
RISK NOTE
This guide is financial education, not a promise of returns or personalized investment advice. Products, tax treatment and investor protections vary by jurisdiction.
- Investor.gov - Introduction to investing - United States - investing basics.
- Investor.gov - Beginner's guide to asset allocation - United States - asset allocation and diversification.
