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TAXFlash News from IncomeTaxCanada.net
:: Know it or not, everyone has a vested interest in the stock market … even if you're not an equities investor
:: Tell a stock market investor that investing in equities is a risky venture and you may find yourself with one less friend. With the current bear market showing few signs of letting up, equity investors have been taking it on the chin during the past year or so. Think you’re not an equity investor? Think again. Whether we know it or not, most of us have a vested interest in the stock market. You may not own any shares directly but there’s a good chance either you or your pension fund own mutual funds. One of the benefits often cited when referring to mutual funds is the reduction of risk. Rather than buy individual stocks, investors are said to reduce risk by buying into a mutual fund that owns a diversified investment portfolio. Because mutual funds are professionally managed and diversified, mutual fund investors have reduced their risk. But what risk are they talking about? When mutual fund investors think of the risk associated with fund investing they tend to think in general terms – that is, the risk that a given fund will be worth more or less than its original purchase price. Ultimately, of course, this is the risk that is of greatest interest to mutual fund investors but this general risk is actually a composite of more specific risks, the mix of which varies from fund to fund. For example,
The recent performance of the Canadian dollar has highlighted the risk of currency fluctuationCurrency risk – when a mutual fund buys an investment denominated in a foreign currency there is a risk that changes in the value of the Canadian dollar relative to those foreign currencies will affect the value of the fund’s units. For example, if a mutual fund buys an investment denominated in US dollars and the Canadian dollar subsequently strengthens vis-à-vis the US dollar, all things being equal, the investment will be worth less when converted back to Canadian dollars,. Fluctuations in currency exchange rates can reduce or wipe out gains on investments denominated in a foreign currency – the opposite is also true. The recent performance of the Canadian dollar has highlighted the risk of currency fluctuation. Credit risk – companies and governments borrow money issuing debt instruments such as bonds in return. Credit risk is the risk that these borrowers will not be able to repay a debt in full or on time. Rating agencies assign ratings to these borrowers based on their ability to live up to their promises to repay their borrowings. Higher credit ratings mean lower credit risk and vice-a-versa. An example of credit risk is the recent downgrading of Telus debt by Moody’s Investor Service, a rating agency. The downgrade to below investment quality increased the credit risk of any mutual fund holding Telus debt. Foreign investment risk – whenever a foreign security is purchased there is a risk that value of the security could be influenced by policies of the foreign government, political or social instability. Financial reporting requirements and regulation of financial markets may be lower than in Canada increasing the foreign investment risk. This risk is high, for example, in Central and South American countries and, yes, of late, even in the good old USA has provided several examples of foreign investment risk. Interest rate risk – changes in the general interest rate will affect the value of mutual funds that invest in money market or fixed-income type securities. Although it may seem odd, the value of investments, such as bonds, tends to fall when interest rates rise. This occurs because when interest rates rise existing bonds pay lower rates than new ones, and hence are worth less. The opposite is also true – when interest rates fall, the value of bonds increases because existing bonds pay a higher return than new ones. Sector risk – this risk is associated with mutual funds that concentrate their investments in certain sectors or industries in the economy. Not surprisingly, some sectors are inherently more risky than other sectors – the emerging technologies sector carries greater risk than the financial sector for example. The above list is not exhaustive by any means – there are other risks such as derivative risk, liquidity risk and so on. The key point to understand is that a given mutual fund has a given mix of risks. As an investor, you need to assess whether the mix of risks fits within your comfort zone. If the mix doesn’t fit your level of comfort then you probably shouldn’t own the investment.
Free Tax Advice Article Submitted to Income Tax Canada.net exclusively by Jim Maroney Official details about this and other topics on income taxes can be found in English & Francais at www.ccra-adrc.gc.ca Income tax information offered by www.IncomeTaxCanada.net is done so without endorsement by Canada Revenue Agency (CRA) - l'Agence du Revenu du Canada (ARC) (formerly Canada Customs and Revenue Agency - l'Agence des Douanes et du Revenu du Canada CCRA-ADRC and formerly Revenue Canada – Revenu du Canada) or any Canadian government agency. The free advice is of a general nature for Canadian taxpayers seeking legal ways to reduce their personal and small business income taxes payable to the federal and provincial (or territorial) governments in Alberta, British Columbia, Manitoba, New Brunswick Newfoundland-Labrador, Northwest Territories, Nova Scotia, Nunavut, Ontario, Prince Edward Island, Quebec, Saskatchewan or Yukon. Specific taxation situations vary from taxpayer to taxpayer, province to province, territory to territory. The free tax advice here is only a general guide. Canadians should always seek individual guidance on accounting rules and tax laws from knowledgeable accountants and lawyers. To prepare your income tax return online and NetFile your Canadian income taxes electronically in English or Francais, please visit www.ufile.ca or www.impotexpert.ca websites. Additional information on financial products and services for Canadians can be found at www.CanadianCreditCenter.com. |
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Jim Maroney