Equities serve as a cornerstone for most portfolios because of their potential for growth. In the following chart, you can see that stocks have a long track record of providing higher returns than bonds or cash alternatives. In fact, Canadian large-cap stocks have provided an average annualized return of roughly 10.3% over the past 20 years.¹

But remember — you need to balance reward with risk. Investing in equities involves risks. The value of your shares will fluctuate, and you may lose principal. And generally, stocks with higher potential return come with a higher level of risk, highlighting the importance of diversifying your portfolio to help manage risk.

Many companies choose to pay dividends on a regular basis, most often quarterly. While dividends can be increased, decreased or eliminated at any point without notice, investing in companies that pay dividends can provide these benefits:

• Supplement one's income - If you’re using this money as a regular income stream, consider staggering your stocks’ dividend payment dates.
• Source of investment - If you reinvest your dividends into additional shares of stock, your money has the potential to grow faster. Historically, dividend payments have been an important part of the total return from stocks. Over the past 20 years, dividends that have been reinvested have accounted for nearly 20% of the total return on stocks over the long term.¹

When you reinvest dividends or capital gains, you can earn future returns on that money – in addition to the growth of your original amount invested – called compounding returns. Compounding can work to your advantage, particularly when you invest over longer periods of time.

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.²

Inflation reduces how much you can buy because the cost of goods and services rises over time. However, stocks have historically provided protection against inflation in the long run, given the faster growth of stocks. 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.

Your portfolio's asset class mix is one of the most important factors in determining performance. Once you've determined your mix between stocks and bonds, consider using our strategic asset allocation guidance as the starting point for the asset class diversification of your stock portfolio. We recommend six equity asset classes, which are groups of stocks differentiated by their region and/or the size of their market capitalization.

Once you've diversified by asset class, we recommend going deeper with diversification across different equity styles. Performance of equity styles, such as growth or value, varies across the different phases of the economic cycle. We suggest owning a balanced mix of growth and value stocks to help smooth out performance over time.

Consider diversifying between the major market sectors and industry subsectors. Factors such as economic cycles, interest rates and market shocks can all impact industries very differently, just like they do for different equity styles.

You can invest in stocks by owning stock mutual funds, exchange-traded funds (ETFs), separately managed accounts (SMAs), individual stocks or a combination of these. When determining which type of investment may best meet your needs, consider the following:

Given the differences between each equity asset class, you may consider using different types of investments to gain exposure to them. For example, given the general quality and stability of Canadian and U.S. large- and mid-cap stocks, individual stocks may provide an appropriate option for you. However, for more volatile or lower-quality asset classes, such as small-cap stocks or emerging-market stocks, a more diversified investment – such as a mutual fund or ETF – may be a more appropriate option to help manage risks. Remember, while diversification cannot guarantee a profit or prevent a loss in a declining market, it can help smooth out performance over time.

Asset class definitions

To help balance a portfolio of individual stocks and limit overconcentration in any single stock or sector, we believe you should own at least 25 to 30 stocks in different industries, or 15 stocks in different industries if you also own equity mutual funds or ETFs. If it’s not practical for you to own this many stocks, focusing solely on well-balanced mutual funds or ETFs can help you achieve broad equity diversification.

SMAs, which involve directly owning individual stocks managed by a professional investment manager, often have minimum investment amounts of $50,000 or more. If you have a smaller amount to invest, owning mutual funds or ETFs may be more appropriate.

With individual stocks, you’ll need to monitor the quality and diversification of your portfolio on an ongoing basis. If you prefer to delegate these decisions to professional investment managers, then mutual funds, ETFs, or SMAs may be more appropriate.

With mutual funds, investors have less control of when they realize capital gains as capital gains may not only be realized when investors sell the mutual fund, but also when the mutual fund sells underlying investments. Actively managed funds with higher turnover can realize capital gains more frequently than those with lower turnover. Capital gains can also be realized when investor redemptions force the mutual fund to sell underlying stocks. For this reason, stock mutual funds may be more appropriate for less tax-sensitive investors or for tax-advantaged accounts.

ETFs can avoid taxable capital gain distributions that result from selling underlying securities to meet redemptions requests. Direct ownership of individual stocks, including through SMAs, can provide even more control over the potential tax impacts from investing, including potential opportunities to harvest losses more efficiently. With these investments, investors have their own cost basis and only pay taxes on capital gains realized when individual stocks are sold from their portfolios. ³

Mutual funds and ETFs are available across a wide range of strategies and can align with investor preferences and values, such as sustainable investing. SMAs and individual stocks offer transparency and the ability to tailor your investments to meet your unique needs and preferences. Your financial advisor can work with you to build a stock portfolio with only the companies you want to own.