The benefits of stock investing

Equities can serve as a cornerstone for most portfolios. In the chart below, you can see that stocks have a long track record of providing higher returns than bonds or cash alternatives . In fact, large domestic stocks have provided an average annualized return of 8.1% since 1994. But remember, you need to balance reward with risk. Generally, stocks with higher potential return come with a higher level of risk.

Compounding can work to your advantage as a long-term investor. When you reinvest dividends or capital gains, you can earn future returns on that money in addition to the original amount invested.

Systematic investing (or dollar cost averaging) does not guarantee a profit or protect against loss. Investors should consider their willingness to keep investing when share prices are declining.

Let’s say you purchase $10,000 worth of stock. In the first year, your investment appreciates by 5%, or a gain of $500. If you simply collected the $500 in profit each year for 20 years, you would have accumulated an additional $10,000. However, by allowing your profits to stay invested, a 5% annualized return would grow to $26,533 after 20 years due to the power of compounding.¹

Many companies choose to pay dividends on a regular basis, most often quarterly. Dividends can be used to supplement one’s income or may be reinvested to buy additional shares:

• If you’re using this money as a regular income stream, consider staggering your stocks’ dividend payments dates.
• If you reinvest your dividends and buy additional shares of stock, your money has the potential to grow faster. Dividends can be increased, decreased or eliminated at any point without notice.
• Historically, dividend payments have been an important part of the total return from stocks. Over the last 20 years, dividends that have been reinvested have accounted for roughly 50% of the total return in the S&P/TSX Composite.*

*Source: FactSet, S&P/TSX Composite and Edward Jones Calculations

Inflation reduces how much you can buy because the cost of goods and services rises over time. Equities offer two key weapons in the battle against inflation: growth of principal and rising income. Stocks that increase their dividends on a regular basis give you a pay raise to help balance the higher costs of living over time.

We filter stocks based on geography, longevity, financial risk and a company’s size before applying fundamental and valuation analysis.

We believe paying dividends is one important measure of a quality stock. A company’s ability to consistently raise dividends can demonstrate profitability. Companies that have excess cash flow and strong financial positions often choose to pay dividends to attract and reward their shareholders. As a result, they’re often less volatile than stocks that don’t pay dividends.

But beware of reaching for high yields. A higher-yielding stock could be a signal that investors are concerned whether the company can continue to pay its dividend. We’ve found these stocks are most at risk of cutting their dividends.

Investors should understand the risks involved of owning investments, including interest rate risk, credit risk and market risk. The value of investments fluctuates and investors can lose some or all of their principal.

Diversifying your investment portfolio can help protect against market fluctuation. Look at the following factors when you’re planning to diversify:

• Asset allocation – Your portfolio’s asset class mix is one of the most important factors in determining performance. Look at the size of a company (or its market capitalization) and its geographical market – Canada, U.S., developed international or emerging market.

  We recommend owning a diversified portfolio of domestic large-cap and mid-cap stocks. For the more volatile international, emerging-market and small-cap stocks, consider a mutual fund to help manage risk. Remember, while diversification cannot guarantee a profit or prevent a loss, it can help smooth out performance over time.

• Sector allocation – Once you’ve diversified by asset class, we recommend going deeper with diversification across the major market sectors and then industry sub-sectors. This is because economic cycles and market shocks can impact industries very differently.
• Investment concentration risk – At minimum, we recommend owning 15 individual stocks to limit overconcentration in any single stock or sector. If you’re using individual stocks as the primary way to gain large-cap equity exposure for your portfolio, then up to 30 stocks may be necessary.

While investing with a long-term view sounds simple enough, sticking to this principle requires discipline. We believe you should buy investments with the intention of owning them through good and bad markets. We base our investment guidance on a long-term view. For our stock recommendations, we typically use a three-to five-year outlook.

Market declines can be unnerving. But bull markets historically have lasted much longer and have provided positive returns that offset the declines. Also, market declines often represent a good opportunity to invest. Strategies such as dollar cost averaging and dividend reinvestment can help take the emotion out of your investing decisions.³

As the chart below illustrates, we believe no one can accurately “time” the market. An investor who missed the 10 best days of the market experienced significantly lower returns than someone who stayed invested during the entire period, including periods of market volatility. We recommend staying invested with a strategy that aligns with your financial goals.

This is not to say you should never sell a stock. From time to time, you may need to sell a stock to help maintain proper diversification among sectors or limit overconcentration in a stock position. Significant changes in a company’s fundamentals or a stock’s overvaluation may also be reasons to sell. And as your portfolio’s objective changes over time, the types of stocks you own may need to change to meet income needs or match your risk tolerance.