Young readers often ask for investing tips and wonder how to get started. My typical response is that once you have a good handle on your finances – no credit card debt, student loans fully paid (or close to it), some cash saved up for emergencies, short-term goals are funded (or on the way) – then it’s probably a good time to start your investing journey.
Finding the right investing approach can be tricky for beginners. There are plenty of options available, from GIC’s and bonds to mutual funds, stocks and ETFs. Then you need to consider your age and risk tolerance. Do you have the stomach to handle stock market fluctuations of 25 percent or more, or would you prefer to see returns that are lower, yet less volatile?
If you’re serious about saving for retirement, you need an investing guide. Here are a few ideas to get you started:
First time investors: Building your portfolio
The best way to build up your investment portfolio is to start small and make it automatic. Determine what you can afford to contribute to your investments each month and set-up automatic transfers from your bank account on the days when you get paid.
Most people go to their bank branch to talk to an advisor about their investment options. Beware though; your financial advisor may be a mutual fund salesperson in disguise. More often than not a bank advisor will push their in-house mutual funds, which may come with some of the highest management expense ratios (MER) in the industry.
A good place to start is with a portfolio of index mutual funds. The cheapest and most widely publicized set of index funds is TD’s e-Series, which can be set-up for as little as $25 a month. Best of all, you won’t pay any commission or trading fees when you buy e-Series funds, which makes them the perfect vehicle for small, frequent contributions.
When it comes to asset allocation, I recommend using these three funds to get exposure to Canadian, U.S. and International stock markets, plus a Canadian bond fund to help lower volatility and lesson the impact of a market correction or crash:
|Fund type||Fund name||Allocation||Expense Ratio|
|Canadian Equity||TD Canadian Index – e||25%||0.32%|
|US Equity||TD US Index – e||25%||0.34%|
|International Equity||TD International Index – e||25%||0.49%|
|Canadian Bonds||TD Canadian Bond Index – e||25%||0.49%|
Note that you’ll need to open an account with TD, as you cannot access their e-Series funds from other banks or brokerages.
What to do when your portfolio reaches $25,000+
Once you’ve built up $25,000 or more in your TD e-series portfolio, it’s worth opening up a discount brokerage account where you can trade ETFs and individual stocks.
The $25,000 threshold is important because once your portfolio surpasses $25,000 then most discount brokerages waive their annual administration fee, saving you around $100 a year.
Exchange Traded Funds are worth a look at this point if you’d like to get more sophisticated with your investments; diversify into broader or more specific sectors, and lower your overall portfolio costs.
ETFs are securities that trade on a stock exchange and generally track the performance of an index. ETFs usually have much lower fees than mutual funds, but you might pay a commission every time you buy and sell.
Here’s a look at a model ETF portfolio that gives you exposure to different markets and asset classes for a fraction of the cost:
|ETF type||ETF name||Allocation||Expense ratio|
|Canadian Equity||Vanguard FTSE Canada All Cap Index (VCN)||20%||0.06%|
|Global Equity||Vanguard FTSE Global All Cap ex Canada Index (VXC)||40%||0.27%|
|Canadian Bonds||Vanguard Canadian Aggregate Bond Index ETF (VAB)||40%||0.13%|
Vanguard has also recently introduced a suite of balanced ETFs where investors can get exposure to all of the above with just one ETF. These all-in-one ETF solutions include a conservative blend of 40 percent stocks and 60 percent fixed income (VCNS), a traditional balanced blend of 60 percent stocks and 40 percent fixed income (VBAL), and a growth blend of 80 percent stocks and 20 percent fixed income (VGRO). DIY investing has literally never been so easy.
If you start using ETFs rather than index mutual funds, I’d recommend contributing new money just a few times per year rather than bi-weekly or monthly. This way you avoid paying a lot of commissions for your smaller transactions.
Consider a robo-advisor
At this point you might also consider using a robo-advisor to manage your investments. A robo-advisor provides portfolio management online with minimal human contact.
You fill out a risk assessment form online and then receive a personalized model portfolio built with low cost ETFs. The robo-firm takes a small fee to manage your funds, then monitors your portfolio daily and automatically rebalances it for you whenever it drifts beyond certain thresholds.
One compelling reason to have a robo-advisor manage your portfolio is that you automate the process and then get out of the way. Humans have a number of behavioural flaws when it comes to investing and our tendency to tinker (or dither) often leads to worse outcomes than if we were to just leave things alone (or follow a rules-based formula).
Using a robo-advisor is a good approach for those who don’t have the time or skill to manage their own portfolio, but who are savvy enough to understand that high-fee bank mutual funds are harmful to your wealth.
What about individual stocks?
I am a big fan of index funds and ETFs because they’re easy to use and they cost much less than the mutual funds sold by your bank or advisor. That said there’s a good argument to be made for investing in dividend stocks – particularly the type of companies that regularly increase their dividends.
Dividends can account for as much as one-third of market returns and the steady income comforts investors during volatile periods. Beware of high-yield stocks, and investing in companies with high or unsustainable dividend payout ratios. Avoid the temptation to chase the latest fad stocks and IPOs.
Discount brokerages such as the ones offered by the big banks can give investors free access to market research and stock screeners to help you track and build your investment portfolio.
The downside of a discount brokerage is the cost per trade, which can cost $9.99 anytime you buy or sell. A good rule of thumb is to limit the cost of your transaction to no more than 1 percent of the amount of stock you’re buying. For example if a trade costs $9.99 to execute you should buy at least $1,000 worth of stock.
Universal investing truths
Understand that there are two investing truths that have become more widely accepted today, but didn’t exist when your parents started investing.
One: The best predictor of a mutual fund’s future investment return is not the number of Morningstar stars it receives, but how low its expense ratio is.
Russell Kinnel, who works at Morningstar, had this to say about predicting future success:
“If there’s anything in the whole world of mutual funds that you can take to the bank, it’s that expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds.”
Two: Trying to beat the market is a fool’s errand. For decades, mutual fund managers attempted to win over clients with impressive research and statistics showing how they can make investors wealthy by outperforming the market (and their peers).
But active managers fail to beat their benchmarks more often than not. According to the SPIVA Canada scorecard, less than 20 percent of active Canadian equity funds outperformed the TSX over a five-year period ending December 29, 2017. That percentage dropped to 8.14 percent over a 10-year period.
The numbers are even worse for active U.S. equity funds, where just 2.2 percent of fund managers beat their benchmark over a five-year period and 1.67 percent beat it over a 10-year period.
The underlying point is that the odds of identifying successful fund managers in advance are vanishingly small. And if you happen to find a good fund manager, the likelihood that he or she will consistently outperforming their benchmark, after fees, is close to zero.
One key message for beginner investors is to try and build good habits early on. Pay yourself first through automatic contributions and you’ll never miss the money.
Start with what you can afford, but remember to increase the size of your contributions often – once a year or more – and match it to the amount of your salary increase.
For example, if you get a 4 percent raise next year, bump up your contributions by 4 percent as well. On $50 a month, that’s just $2. It doesn’t sound like much, but it’ll make a huge difference over time.
Finally, as important it is to keep your investment costs low and your portfolio broadly diversified, keep in mind that it’s often our own behaviour that leads to bad investment decisions and poor outcomes. Know yourself and what makes you tick, and try to limit situations where you might act on emotion and divert from your strategy.