Before deciding on an investment, consider its liquidity, risk level and expected return. What do all these terms really mean?
This is the ability to buy or sell an investment quickly, without causing a significant effect on its price. Put simply, it means how fast and easily you can withdraw your money. Before investing, it’s essential to know when you think you’ll need your money.
Not all investments have the same liquidity. For example, certain products can’t be converted into cash before a set maturity date (e.g., 1 year, 7 years, 10 years). If you need your money before this date, you’ll have to pay fees that will reduce the return on your investment.
Risk is the possibility that you’ll earn a lower return on your investment than expected or even lose some or all of it. Generally speaking, the higher the promised return, the higher the risk.
If you think that a decrease in the value of your investment may keep you from sleeping at night, you’ll definitely be more comfortable with a low-risk investment. But remember, by definition, an investment always involves some degree of risk.
This is the gain you want to earn on your investments. It may be generated in the form of interest, dividends or capital gains.
- Interest is the payment received in exchange for lending money. Example: If you invest $1,000 in a guaranteed investment certificate earning 2% per year, you’ll receive $20 in interest after one year.
- Dividends are the portion of profits that a company distributes to its shareholders. Example: Company ABC pays its shareholders 30 cents for each common share they own, every three months (every quarter).
- A capital gain (or loss) is the difference between the selling price and the original purchase price of an investment. Example: You pay $12 to buy a share, and later sell it for $20. You have a capital gain of $8. On the other hand, if you pay $12 to buy it and sell it for $9, you have a capital loss of $3.