How does your money grow when you invest?
Investing can help you increase the value of your money over time. Your money could grow through interest, dividends and capital gains.
- Interest
Interest works by returning a percentage of your investment over time. Simple interest adds a percentage of your original investment. But compound interest resets your starting balance each year, so that the interest rate is based on a larger amount than the year before. Compound interest can help you grow your money faster.
Some investments, like guaranteed income certificates (GICs) and bonds, pay interest. One advantage of these investments is you know exactly how much money you’re going to earn when you invest.
Compound interest can be a simple yet powerful aspect of your saving and investing strategy. Try our freecompound interest calculatorto see the magic of compound interest for yourself.
2. Dividends
Dividends are one way to make money from investing in stocks. When you own stock, or shares, you own a share in a company. Dividends give investors ashareof what the company makes. The money comes from the company’s profits. You get a regular income from these investments. Dividends can be reinvested into more shares of the company or taken as income.
Not all stocks pay dividends. For dividend paying stocks, the amount and frequency of the dividends depends on how well the company did that year and the type ofstockyou own. For example, common and preferred shares may receive dividends, but preferred shareholders usually receive them on a fixed schedule.
3. Capital gains
A capital gain happens when you sell a capital asset for more than what you paid for it. Usually this refers to assets that you bought for investment purposes. This includes investment products such as mutual funds, ETFs, stocks, and bonds. Crypto assets are also considered capital assets.
Real estate is considered capital property. This means if you sell real estate or land, and make a profit, you will have a capital gain.
The opposite of a capital gain is a capital loss. If you sell an investment or other capital asset for less than you paid for it, you’ll have acapital loss. You can claim a capital loss to offset your tax paid on capital gains. Learn more about capital gains from the Canada Revenue Agency.
There are different ways to grow your money depending on the type of investment you choose. Each one may involve different levels of risk. Some may be easier to liquidate than others, if you need access to your money sooner. Learn more about the different types of investments.
How are your investing earnings taxed?
Money you earn from investments, through interest, dividends, or capital gains, is considered income. You may owe tax on the money you earn, if it is considered taxable income. This depends on the type of investment account you have.
If your investments are in a registered account, such as a Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP), it is tax-sheltered. This means your money grows tax-free while it is in the account, and it is not considered taxable income.
However, depending on the type of account, your money may be considered taxable income when you withdraw it from the account. This is the case with RRSPs, but not TFSAs. It’s important to check the rules for contributions and withdrawals for the account you select.
If your investments are in non-registered accounts, such as with an investment broker, there is no special tax-sheltered status. This means your earnings will be considered taxable income.
If you earn income from your investments or from savings interest, you’ll receive a tax slip showing your earnings. Keep all your tax slips in a safe place so you’ll be ready to claim your income accurately when you file your annual tax return. Learn more about howtaxes affect your investments.
It’s also a good idea to make time to track your investing returns. If you work with an advisor, they may do this for you. If not, there are ways you can calculate this yourself. Learn more about tracking your returns.
The longer your investing horizon, the more compound interest, dividends, or capital gains can work to your advantage. It’s never too late to get started. Consider your time horizon to meet your investing goals.
How can you balance risk and return?
Interest, dividends and capital gains are all ways to make money from investing. However, they also result from different types of investing strategies. While there are many ways to grow your money, investing returns are rarely guaranteed. For this reason, it’s important to think beyond your investing growth strategy. You should be aware of your comfort with risk and your approach to diversification. It can be helpful to also understand investing strategies, such as dollar-cost averaging.
Consider your level of risk
When choosing investments, make sure they are a good fit for your risk tolerance.
Generally, the higher the potential investment return, the higher the risk. If you are comfortable choosing higher risk investments, you could potentially get a higher return. However, you could also lose some or all of your investment. Conversely, if you choose only lower-risk investments, then your returns may be lower. Your investment earnings might not keep pace with inflation.
Consider the benefits of diversification
When you diversify your investment portfolio, it means you hold different types of investments.
The value of any single investment can change over time, sometimes without warning. This can happen because of fluctuations in the stock market, or economic events that affect the market as a whole. Volatility is when the value of investments changes over time, either higher or lower. An investment with a fairly consistent value, such as a GIC, is considered to have low volatility. Stock prices that gain or lose quickly have high volatility.
Diversification is a way of spreading investment risk by choosing a mix of investments. If you hold just one investment and it performs badly, you could lose all of your money. If you hold a diversified portfolio
with a variety of different investments, it’s much less likely that all of your investments will perform badly at the same time. The profits you earn on the investments that perform well offset the losses on those that perform poorly.
Consider the benefits of dollar-cost averaging
The value of investments can fluctuate over time. There is also a risk of investing too much at one time, if the value starts to drop. Dollar-cost averaging is when you invest over time in regular intervals, to spread out your investment risk.
For example, if you were to invest $1,000 each month instead of $12,000 at one time, you would be dollar-cost averaging at monthly intervals. The overall cost of your investment averages out over time, as you buy at higher or lower prices each month.
Dollar-cost averaging can be a convenient way to plan your investing contributions based on your monthly budget. You could plan to set aside small amounts each month for investing based on how much you know you can afford. This could help you reach your investing goals while staying within yourbudget.
An advantage of dollar-cost averaging is that you are not trying to focus on timing the market or thinking about the optimal time to invest. It can be an ideal strategy if you have a longer time horizon.
There are potential disadvantages of dollar-cost averaging, including the risk of increased transaction costs depending on how often you buy investments. And with dollar-cost averaging, you could miss out on putting extra money into an early investing opportunity where values may increase.
Understanding your comfort with risk is important as you develop your investing strategy. If you take too little risk, you may not reach your goals. If you take too much risk, you could lose some or all of your money. Learn more about why risk matters.
