Investing for the Beginner
Investing is a key part of personal finance. Being financially literate will require you to know the basics of investing – when to do it, how to get started and what you need to consider.
So why should you invest your money? The core principle of investing is the time value of money, the idea that money available now is worth more than the same amount at anytime in the future due to its potential earning capacity. This is what is usually referred to as “making your money work for you”. This principle also means that any cash that you are holding that is not invested or earning interest of some kind is actually becoming less valuable as time passes.
Initial considerations for the average investor:
- Are your personal finances in order? You should have at least a rough idea of your monthly cash flow and budget. You should focus on paying down any high interest debt. You should ensure you have an adequate emergency fund in short term savings. All of these things take priority over investing.
- Goals, time horizon for investment and risk tolerance. All three of these factors will affect what type of investments you will make. If you are saving for retirement, in general, the older you are the more risk averse you need to be. If you have even shorter term saving goals, say 5 years or less, you need to be even more risk averse.
- Expectations. It’s important to have realistic expectations and to know what good investment performance is. No average investor should be expecting to find a miracle stock that will triple their money in just a few months. Instead, you should expect to perform nearly as good as the market. Over the last 10 years the S&P 500 has returned an average of 7% so this should be the upper limit of your expectations.
So how do you actually start investing? The first step is to open the proper account. In Canada there are 3 primary account types that most people will use; RRSP, TFSA and brokerage accounts. For a beginning investor, you should only be considering 2 of these – the RRSP and TFSA. If you work for an employer then it is likely you have the option to contribute to an RRSP. In general these accounts are very “hands off” and you will likely only have minimal control over what type of investment strategy is employed. The younger you are the longer the time horizon for your RRSP investments are and therefor you can choose riskier investments.
Your RRSP plan provider will typically label the riskier option “growth”. Due to your limited ability to customize these investments I won’t spend anymore time on them here. Also note that you may have the option to open a self-directed RRSP. If that is the case for you then all of the following advice for TFSA investments can be applied here as well.
The Self-Directed TFSA is by far the best account option for a well-informed beginning investor. For anyone who turned 18 in 2009 or earlier the cumulative contribution limit is $52,000 as of 2017. Because of the advantages of a TFSA you should only consider other investment accounts once you have maximized your contributions to your TFSA for each year. There are many online calculators available to find your TFSA contribution limit but it is best to log on to you CRA account to see your exact limit for the year.
The primary advantage of the TFSA is that you will not be taxed on any gains or income generated by holdings in the account. Another important advantage is that you will not be paying fees or commission for the account, other than trading fees. Finally, it is very easy to track your account holdings and performance, this can usually be done through your standard online banking setup.
While the above advice only just scratches the surface, it should be sufficient for a beginning investor to get started. Below are 2 portfolio options that are widely recommended for novice investors with somewhere in the range of $50k or less to invest.
Novice Investor Portfolio 1:
The one fund portfolio is not a joke. As the name suggests, this fund is a mix of equities (60%) and bonds (40%) which gives it a balance of long term growth and short-term income. What separates this fund from other mutual funds is the low MER of 1.07% and the fact that Tangerine accounts have no fees. In the world of mutual funds it is not uncommon to pay 2% or higher management fees which is a primary reason why mutual funds have fallen out of favor in recent years.
- Simplest solution – single fund, no re-balancing necessary, automatic contributions possible
- Very low cost for its simplicity – 1.07% MER
- Tangerine is in general a very good banking option – no fees!
- Lower cost options are available for added complexity
- Must open a Tangerine account – however there are no fees associated with this
Novice Investor Portfolio 2:
This is a typical balanced ETF portfolio constructed entirely out of Canadian Vanguard funds that has an equity to bond ratio of 60%-40%. To build this portfolio you will have to open a self-directed TFSA with your bank of choice, such as CIBCs Investors’ Edge account.
- Extremely low-cost portfolio – 0.20% MER
- Ability to rebalance or buy/sell any holdings in real time
- Likely available through your current bank
- Higher complexity – you will have to calculate how many units of each fund to purchase
- Only ideal for infrequent, lump-sum contributions – must keep trading to a minimum due to fees
Both of the above portfolios are great choices for novice investors. However, I definitely recommend that you do additional research and learning before investing your money. Your interest in investing will also likely dictate which portfolio appeals to you more. If you are interested in investing and are leaning towards portfolio 2 then I would highly encourage you to learn as much as you can about index investing and ETFs in general. Also, watch out for a future post of mine dedicated to ETF index investing.
Check out my post on Tips for Saving More Money for additional information!