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Key takeaways

  • Stocks represent a share of ownership of a company.
  • There are two main types of stocks: common and preferred.
  • Companies issue stocks to raise money. Investors buy stocks with the hope they will increase in value as the company grows.
  • Investing in stocks can help you to grow your wealth and outpace inflation.

Stocks represent small ‘pieces’ of ownership of a company. They are also called shares or equities. Privately owned companies may choose to issue stock and make it available to buy on the stock market. The company can then use the money raised to fund the company’s business activities, launch new projects, or to expand and acquire other companies. The first time a company ‘goes public’ with an issue of stock is called an Initial Public Offering (IPO). 

How stocks work?

Four reasons to invest in a company’s stock

  1. You participate in the company’s success. If the company is doing well, its stock price will go up in value. If you sell your stock for more than what you paid, you will receive a positive return on your investment. This is called a capital gain. Higher returns help grow your wealth, and can also offset the impact of inflation, which can erode the value of your investments over time. On the other hand, a capital loss occurs when you sell a stock for less than you what you paid.
  1. You participate in the company’s decisions. At annual meetings with other shareholders and company management, you can vote on important company matters. These include:
    • Electing board members
    • Deliberating on corporate actions and policies
    • Assessing the company’s financial statements

Typically, the more shares of the company you own, the more votes you get.

  1. You may receive regular income in the form of dividends. If you own dividend-paying stocks, you may receive a little extra income in your portfolio each quarter. These are called dividends. Dividends are paid to shareholders out of a company’s earnings. Dividend income can help to top up your returns and offset the impact of market declines. In addition, dividends from Canadian companies receive preferential tax treatment through the dividend tax credit. This can reduce the amount of tax you pay on dividend income. Dividends are classified as either “eligible” or “non-eligible” to reflect the tax rate paid by the issuing company. Non-eligible dividends receive the federal dividend tax credit and eligible dividends receive the enhanced federal dividend tax credit.
  1. You can take advantage of lower tax rates. When you sell a stock for more than you paid, you can receive favourable tax treatment on the capital gains, or profits. Capital gains are not taxable within a registered plan like a RRSP, RESP or TFSA. If you are investing outside a registered plan, only 50 percent of your capital gains are taxed at your marginal tax rate – which is based on your annual income and differs between provinces. Let’s say you purchase $2,000 worth of stock in a non-registered account. You then sell it for $4,000. Your capital gain is $2,000. You will declare half of it -- $1,000 -- as income and pay tax on it at the same rate as your other income.
Common stocks: These are what you are most likely to see being bought and sold day-to-day in the stock market. They typically come with voting rights for shareholders.

Preferred shares: combine features of both common stocks and bonds. They offer shares of company ownership along with regular income from dividend payments. Unlike common stocks, preferred shares do not come with voting rights.

What makes a stock price go up or down?

Many factors determine a stock price and the returns you earn from it. In general, the price you pay for a stock today is based on how well the markets expect the company to do in the future. These expectations are influenced by several factors, including:

  1. The overall health of the company. How has the company performed financially in the past? What are its future earnings expectations? Does the company currently have any debts? What is the company’s management structure? Who sits on the board of directors?
  2. Macroeconomic trends. How is the broader economy doing? Are supply chains keeping up with consumer demand? Is the unemployment rate low or high? What is the outlook for interest rates?
  3. Investor sentiment. How do investors feel about the company? Are they confident about its prospects or future plans? Does the company receive positive or negative media coverage? 

Before you invest

  • Plan to diversify. Stocks offer many opportunities to diversify. For example, U.S. equities provide broad sector exposure to some of the world's largest companies, such as Microsoft and Amazon. International equities add exposure to both developed and emerging opportunities outside North America.

    The chart below shows the range of returns of different types of investments, from highs to lows. You can see that generally, stocks outperform fixed income and cash. However, if you hold a diversified portfolio, with a mix of different investments, over time you will tend to even out the highs and lows. This creates a smoother investment experience.

A diversified portfolio can help you balance protecting and growing your wealth

Click to learn about the benefits of each asset type within a portfolio

Cash Equities Fixed income Diversified portfolio Reset
Historical returns refer to five-year rolling returns for a 25-year period ending December 31, 2021

Cash

  • Cash equivalents include GICs, T-bills and money market funds.
  • The growth potential for cash is low compared to other asset classes. So is the risk of losing money. In fact, the historical data shows cash equivalents typically don’t lose money.
  • Adding fixed income and equity, which offer the potential for relatively higher returns, can help your portfolio to grow and outpace inflation. These asset classes may also receive more favourable tax treatment if you are investing outside a registered plan like an RRSP or RESP.

Equities

  • The Canadian stock market is concentrated in the Financial, Energy and Materials sectors.
  • U.S. equities provide broad sector exposure to some of the world's largest companies. Many of these companies operate in global markets.
  • International equities offer more opportunities to diversify. They add exposure to both developed and emerging opportunities outside North America.
  • Historically, equities have had the highest growth. They also have the potential for higher losses. Equities receive the most favourable tax treatment if you are investing outside a registered plan like an RRSP or RESP.

Adding fixed income and cash to equities in your portfolio can help smooth out the ups and downs you may see with equities.

Fixed income

  • Fixed income include many different types of bonds.
  • Fixed income typically offers higher returns than cash investments. But a portfolio consisting only of fixed income investments may not provide the growth you need.
  • Adding equities to your portfolio can add growth and also help you take advantage of lower tax rates if you are investing outside a registered plan like an RRSP or RESP.

Diversified portfolio

  • Combining all three asset classes in your portfolio can help you benefit from the growth potential of equities and while you enjoy the increased stability and lower risk provided by cash and fixed income investments.
  • The right mix for you depends on your personal situation and preferences as an investor.

○ = average return

This chart shows five-year rolling returns for a 25-year period ending December 31, 2021. You can see the range of returns of each asset class – from highs to lows. Past performance is not a guarantee of future results. Five-year rolling returns refer to periods of 60 consecutive months with new periods beginning on the first day of each month.

Diversified Portfolio assumes monthly rebalancing as represented by 2% Cash, 38% Fixed Income, 15% Canadian Equities, 25% U.S. Equities, 15% International Equities and 5% Emerging Market Equities. Cash represented by FTSE TMX Canada 30 DAY T-Bill Index; Fixed Income represented by FTSE TMX Canada Universe Bond Index; Canadian Equities represented by S&P/TSX Composite Index; U.S. Equities represented by S&P 500 Index; International Equities represented by MSCI EAFE Index; Emerging Markets Equities represented by MSCI Emerging Markets Index. All returns are total returns in Canadian dollars, unless otherwise noted. Index returns do not reflect deduction of expenses associated with investments. If such expenses were reflected, returns would be lower. An investment cannot be made directly in an index.

  • Keep your risk tolerance and risk capacity in mind. While stocks have historically had the highest growth, they also have the potential for higher losses. Markets are unpredictable and no one knows exactly when they will move up or down. Too much exposure to these assets can introduce significant risk to your portfolio – especially if you don’t have a lot of time to recover from losses.

There are many ways to invest in stocks

You may choose to buy individual stocks one at a time. You can also choose investments that ‘pool’ together multiple different stocks into a single portfolio. These include:

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Speak with your advisor to learn more about these investment options and how to build a diversified portfolio that meets your needs.

Disclosure

Last update: August 29, 2022
This has been provided by RBC Global Asset Management Inc. (RBC GAM) and is for informational purposes only. It is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice. RBC GAM takes reasonable steps to provide up-to-date, accurate and reliable information, and believes the information to be so when provided. Information obtained from third parties is believed to be reliable but RBC GAM and its affiliates assume no responsibility for any errors or omissions or for any loss or damage suffered. RBC GAM reserves the right at any time and without notice to change, amend or cease publication of the information.