Equities Risk vs.

Return
Are there risks involved with equities or stocks? Yes. Equity investments are considered
higher risk than cash-type investments or bonds. However, the potential returns on
equity investments are correspondingly higher.

Volatility
While equities offer capital growth and dividends, you will also need to endure the
unpredictable ups and downs (risk) of the stock market. This is one of the many reasons
why equities are often more suitable for people with longer investing time horizons
and/or higher risk tolerance.

The following charts illustrate the volatility of the S&P/TSX Composite Index, the major
Canadian equity index. The first chart shows the index over a challenging 12-month
period. In the short term, it is clearly possible for the value of an investment to decline.
The second chart shows the same index over a 20-year period. Over this long time
horizon, the trend has been positive.

The above example uses the S&P/TSX Composite Index, and so represents a degree
of diversification. A well-diversified portfolio will reduce specific risk, which is the risk
attributable to a single company or sector. When you have a diversified portfolio, you
remain exposed to systematic risk, which is the risk inherent to the entire market. This
type of risk cannot be eliminated through diversification. Systemic risk is the risk that
one event may trigger a significant decline or collapse of a certain industry or the market
as a whole. If you choose to invest in a small number of stocks, or even a single stock,
you will be exposed to the risks of individual equities, which are significantly higher. The
chance that an individual company will suffer some irrecoverable damage is much
higher than the chance that the entire market will collapse.

Many investors choose to further increase diversification by investing in U.S. and

international equities in addition to Canadian equities.
The price of a preferred share will move in
response to changes in the prevailing interest
rates. As interest rates rise, the value of the
preferred share will fall.
Common versus preferred shares
In the event a company does have financial difficulties, common shareholders are in a
relatively weak position, because senior creditors, bondholders and preferred
shareholders of a company all have prior claims on the company’s earnings and assets.
While interest payments are guaranteed to bondholders (unless the company finds itself
financially incapable of payment), dividends are payable to shareholders at the
discretion of the directors of the company.

There are also risks associated with investing in preferred shares. The price of a
preferred share will move in response to changes in the prevailing interest rates. As
interest rates rise, the value of the preferred share will fall. There is also the risk that the
issuing company will default on its preferred dividend payments. Even if the company
does not default, a decline in its creditworthiness can reduce the price of its preferred
shares and could lead to a rating downgrade.

Liquidity
Both common shares and preferred shares entail liquidity risk. If there are few potential
buyers for a security, it can be difficult or costly to sell, which means you will not be able
to easily realize the value of your investment. This is especially true for stocks that do
not trade often or in large volumes.

Margin
If you choose to invest on margin, you are borrowing the money you are investing from
RBC Direct Investing and using your investments as the collateral. Borrowing to invest
is known as leverage because it increases both your potential gains and your potential
losses. If your equity positions fall, you could be faced with a margin call that would
require you to add cash to your account or sell assets in order to maintain the collateral
in your account. In essence, margin magnifies portfolio volatility. Also, investments on
margin are exposed to interest rate risk. If rates increase, the cost of borrowing will be
greater, making it harder to earn positive returns. The opposite is also true.

Foreign Exchange Risk

Investors holding non Canadian dollar denominated equities face the risk that the value
of the foreign currency may change. This may result in a gain or loss, no matter the
performance of the specific stock.

Country/Political Risk
Equities may have increased risk in regards to the political stability and financial
strength of a country in which the issuing company operates. Changes in country
legislation and policies may also be a cause of increased risk. This type of risk is most
important in developing countries.