What are investment funds made of?

Being invested with Co-operators means you have a stake in the global financial markets, which can be disorienting and hard to follow if you’re new to investing or if it’s something you’re not naturally curious about. As you gain experience along your investing journey, you’ll likely have questions about how financial market performance impacts your investments.

Below, we outline some basics to help you gain a better understanding of the contents and performance of your investment funds.

The basic components: Stocks, bonds and cash

Stocks, bonds and cash are the basic components of the global financial markets. Therefore, any mutual funds or segregated funds that we recommend include at least some exposure to these (to varying degrees).

The specific funds you hold would be based on your situation and personal investing profile, and the exact composition of each would be chosen by a professional money manager to meet its objective, but these basic components will have a significant influence on the performance of most portfolios:

Stocks

• A stock is a unit of ownership of a specific company.
• Stocks (also referred to as “shares” or “equities”) are issued by companies to raise money for growth and expansion.
• Stocks are traded primarily on stock exchanges, though private sales occur as well.
• Stocks can be risky, as values can fluctuate in the short term; this can then lead to losses.
• Generally speaking, it’s best to hold more equities in your portfolio earlier in your investing journey, and less as you approach your goals.

Bonds

• Bonds are units of debt – issued by companies and governments – that are considered tradeable assets. Bonds help the issuing body to raise capital.
• Bonds are often referred to as “fixed income” because they usually pay a fixed dollar amount (or “coupon”) to the holder. At their “maturity date,” the principal amount is paid back in full by the issuer.
• Typically, bonds have an inverse relationship to interest rates: their price falls when interest rates go up, lowering the bond’s potential return to the holder if the bond is not held to maturity.
• Generally speaking, the potential risk and return on bonds are moderate: lower than stocks, but higher than cash.

Cash

• Cash can refer to any short-term money market instruments, and international currencies. It is also used by investors as a “safe haven” to help manage risks.
• Currencies constantly fluctuate in relation to one another. These currencies – tracked by the currency exchange rate – then impact the value of assets.
• The U.S. dollar holds significant sway: many countries accept it for payment and/or directly peg their currency value to it.
• While the liquidity of currency makes it one of the safest investment options, it doesn’t protect your portfolio from inflation. As such, longer-term returns tend to be lower than other asset classes.

How do stocks, bonds and cash work together?

The stocks, bonds and cash held within your investment fund play an important role in managing risk. By holding a variety of different types of investments within a fund, the manager reduces the risk that all will perform poorly at once. Poor performance from certain components at any given time can be offset by stronger performance from others. This "diversification" enables managers to reduce the risk of a fund, sometimes without even sacrificing potential returns.

For example, bonds and stocks often move in opposite directions. When investors anticipate an economic downturn and corporate earnings begin to fall, stock prices will likely follow. Central banks may then cut interest rates to reduce borrowing costs and stimulate spending. This can lead to bond prices rising as existing bonds look more attractive compared to new issues with a lower coupon. If your portfolio includes both stocks and bonds, the increase in the value of bonds may help offset the decrease in the value of stocks. Cash provides the manager with a safe haven to further reduce risk during times of crisis, and the flexibility needed to fund day-to-day transactions.

Key take-aways

A basic understanding of how stocks, bonds and cash work together can provide you with ongoing insight into the performance of your portfolio. And, in the process, you’ll gain a better grasp on the importance of diversification.

From there, it’s knowing that your investments are professionally managed and recommended to you based your individual goals and objectives. Sticking to your plan and staying invested is the best defense against inevitable market downturns and your key to long-term success.

And our financial representatives are always here to answer your questions, so you can worry less about your investments.

For more information and resources, visit Market View. You can also read our weekly Investment Update for deeper insight into the latest news driving financial markets.