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Have you ever wondered how you can learn the art of investing money? Whether it’s for your retirement account or building up some cash flow to pay down your mortgage, investing is one thing that everyone should learn how to do. Why? Because learning how to invest money is not as complicated as most people think it is. By instructing you learn-by-doing, I will teach you the basics of investing money.
Why start investing
Why do we even invest in the first place?
Valid question! Usually, it’s because we have specific goals to achieve and investing helps us get there.
The obvious one is retirement. We need to save a bunch of money to support ourselves when we’re no longer collecting a paycheque.
But we’re also concerned about inflation. As the cost of living rises, it decreases the purchasing power of a dollar. As a recent example, the annual inflation rate in Canada was 2.2% in March 2021. So if you keep your cash stashed under the mattress for 20 years, it will lose value over time.
Investing our money today helps us beat inflation and prevent it from watering down the potency of the dollar. It lets you take advantage of the magic of compound interest, and thereby grow your savings so your future self can enjoy the same (or better) purchasing power tomorrow.
Choose the right investing style
Before you jump into investing with both feet, it’s important to take a step back and establish your goals and priorities. Here are a few things to consider.
Know what you’re investing for
How you invest depends on what exactly you’re investing for. You might be investing money to help your 14 year old with her upcoming university tuition. You might want to invest money to live off when you retire in 30 years or so. The time horizons on each of these investments are very different. Because you’ll need access to some of them sooner than others. Those with shorter horizons should invest more conservatively. Those investing money they don’t need for a long time can choose riskier investments.
Understand the risk you are taking
Before deciding where to invest, you’ll need to first assess your personal risk tolerance. This is a fancy way of saying how much of your investment you can really afford to lose. If you need money for next month’s rent, you have a very low-risk tolerance. If your life wouldn’t be materially affected in any way, if rather than investing money, you set fire to it, your risk tolerance is through the roof. Risk tolerance is often dictated by your so-called “time horizon”. This may sound like something you’d hear on the bridge of the Starship Enterprise, but instead, it’s just a term that means the length of time you’ll hold a particular investment.
Savings accounts are typically seen as low risk. They are appropriate for holding your emergency fund, rainy day money, or this month rent. Investing is much more suited to money you don’t need in the short term, for example your retirement savings, or a fund for your child’s university education.
Decide how much to invest
Deciding how much to invest isn’t simple, but your age is a good place to start.
A Fidelity study estimates that you need 10x your pre-retirement income saved by age 67 to maintain your lifestyle in retirement. Here’s a breakdown by age:
| Age milestone | Amount saved for retirement |
|---|---|
| 30 | 1x your income |
| 40 | 3x your income |
| 50 | 6x your income |
| 60 | 8x your income |
A general rule is to invest 10% of your gross income per year for retirement. But this depends on your income, too. Young investors living on a budget may only be able to afford to invest 3-5% of their gross income. Whereas late starters with higher incomes can more aggressive, investing 15-25% of their salary to make up for lost time.
Obviously, if you start investing early, your money will have more time to compound and grow. If you’re in your 20s, you have time on your side and can start investing with very little money. For instance, an initial investment of $4,000 at age 23 may balloon to as much as $522,576.11 in 30 years’ time (assuming 8% growth compounded monthly).
Determine Your Risk Tolerance
Here’s the million-dollar question: how much risk are you willing to take?
Every type of investment comes with a certain level of risk, which is often linked to the potential return. Generally speaking, the more risk you’re willing to take, the greater the return. A few examples:
- GICs are considered the safest investments in Canada, but the best GIC rates usually range between 1 to 3%, depending on the term.
- Bonds are considered a low-risk option that helps balance out your portfolio from tumultuous times.
- Stocks are more volatile, going through “bear” and “bull” markets where the market rides a rollercoaster of ups and downs. We saw this most recently during the stock market crash during the COVID crisis. As a result, on average, the stock market returns around 9-10% per year.
- Cryptocurrency is one of the most volatile investments you can make. Case in point: the value of Bitcoin increased by more than 90% during the COVID-19 crisis. But in May 2021, the Bitcoin price plummeted 40% simply because China decided to crack down on crypto.
Investing is a balancing act: the goal is to build a “risk-appropriate portfolio” — meaning a set of investments that match your risk tolerance. But how do you determine your risk tolerance?
Do some self-reflecting. Do market ups and downs make you feel pukey and panicked? Do you sleep better at night with a bond buffer in your portfolio? Or are you game to go “all-in” and build a portfolio of 100% stocks? Be realistic!
Consider your financial goals and your timeline to take risks. A recent university graduate’s portfolio will look different from a person who is close to retiring. In your 20s, you have decades to recover from a market crash, whereas a retiree could stand to lose their livelihood.
Diversify your investments
Rather than zero-in on some stock you think will perform well, diversify your investments. In doing this, if one part of your investment doesn’t do well you haven’t lost everything. Michael Allen, a Portfolio Manager at Wealthsimple explains that diversifying your portfolio means investing in many different geographies, industries, and asset classes (stocks, bonds, real estate etc).
To potentially smooth out your investment returns over time you could put your money in many investments that are uncorrelated with one another.
Allen explains that fluctuations aren’t necessarily the biggest risk for investors in it for the long haul. A potentially bigger risk is how you react to the fluctuations. Many investors find it difficult to stick to their investing plan—particularly during market movements. A diversified portfolio that’s prone to less market movements can come in useful to help manage your emotions.
If all this portfolio diversification talk sounds like hard work — that’s because it is. Automated investing is a good alternative for someone who wants to diversify their portfolio but doesn’t want to go to the effort of buying multiple assets such as stocks, bonds and real estate by themselves.
Determine Your Asset Allocation
Once you’ve figured out how much loss you can stomach and afford, it will shape the make-up of your investment portfolio. Specifically, how much of it to allocate towards stocks and how much to allocate towards bonds. Here are some examples:
- Low risk: Typically contains 40% stocks and 60% bonds or other fixed-income securities.
- Medium risk: Typically contains 60% stocks and 40% bonds.
- High risk: Typically contains as much as 100% stocks.
When constructing and rebalancing your portfolio, always remember that diversification is key. Never let your portfolio rely too heavily on a particular industry or bond type. A well-diversified portfolio is more sustainable and hedges you against unforeseen changes in the economy.
If you have no clue or your eyes are glazing over, don’t worry. There’s an easy solution. Just hand over the task to a robo advisor.
A robo advisor is a digital investment platform that can build a balanced investment portfolio to match your risk tolerance and goals. With a robo advisor like Wealthsimple, all you have to do is answer an online questionnaire, and it will put together a risk-appropriate, diversified investment portfolio. It also does the work of managing your portfolio.
Invest for the long-term
If you can, invest for the long term. Many studies demonstrate that investors who hold onto stocks for more than 10 years will be rewarded with higher returns that offset short-term risks. That’s not to say this trend will continue, or that risk is ever totally eliminated. Risk never disappears, but you might say it mellows with age.
If you can put money away for a long time period, then you can afford to have investments that are typically more susceptible to rising and falling. Your portfolio can contain a mix of stocks and equities that are typically more volatile compared to bonds.
Regardless of how long you’re investing for, diversifying your portfolio is an absolute must. One thing is also for sure — if you invest for a long time period you benefit from the power of compounding. This is the process by which the money you make earns interest on itself over time. The earlier you start investing, the more you benefit from compounding over time.
Choose Between Active vs. Passive Investing
Next question: how hands-on do you want to be with investing?
With a passive investing approach, you’re buying the entire stock market, which will deliver average market returns minus a small fee charged by the index funds or ETFs. It’s the “set it and forget it” approach: you’re stashing your cash into an investment portfolio and leaving it there for the long term.
An active investing approach means hiring a fund manager (in a mutual fund or ETF) to actively manage your portfolio and try to beat a benchmark, but it means paying more in fees. Alternatively, you can act as your own fund manager and pick your own individual stocks or ETFs using an online brokerage.
| Passive investing | Active investing |
|---|---|
| Simple, hands-off, evidence-based, and reliable way to earn market returns minus a small fee | Complex, expensive, hands-on, emotion-driven, strong possibility of underperforming a broad market index |
| Tracks broad market indexes by owning the underlying stocks in the index | Build your own portfolio of stocks and/or ETFs, or invest with an active fund manager |
| Rules-based approach to allocation and rebalancing | Goal is to outperform a benchmark index (beat the market) |
| Little to no effort or research required | Higher fees typically lead to underperformance |
But which approach performs better?
The jury is out: research strongly supports that passive investing outperforms active investing. While active investing can outperform the market over shorter periods of time, it is impossible to pick winning stocks with any long-term consistency and reliability. Unless you’re psychic, that is.
The bottom line: taking a “lazy” approach to investing pays off and timing the market usually doesn’t work. Building a risk-appropriate portfolio of low-cost, globally diversified, index funds or ETFs is the best and most reliable way to achieve long-term investment returns.
It may seem boring, but “getting rich the slow way” does work. 80-95% of active investment strategies fail to outperform their benchmark over the long term. Plus, active funds cost more than passive funds, which eats into your returns.
But we don’t want to be a total buzzkill. You might get excited by the opportunities presented by a hot new IPO or the thrills that come with trading cryptocurrency. That’s okay!
One way to enjoy the best of both worlds is to take a “core and explore” approach. Keep 90-95% of your portfolio invested in low-cost passive index funds (core) and use the remaining 5-10% of your portfolio to scratch your stock picking itch (explore). Just do your research and use value investing as an approach.
Watch out for high fees
Fees are the money you put into someone’s pocket rather than your own. Regardless of how you invest, you’re going to pay fees. What you need to watch out for is high fees. They’ll have a significant drag on your returns. You need to consider the value you’re getting in exchange for paying fees.
Here’s how fees impact gains on a $10,000 initial investment with a $300 monthly contribution for thirty years (assumes a return of 5.48%).
| Investment Type | Average Mutual Fund (2.08% fee) | Automated Investing (0.5% fee) |
|---|---|---|
| Starting Amount | $10,000 | $10,000 |
| Year 10 | $56,311 | $62,508 |
| Year 20 | $120,471 | $147,851 |
| Year 30 | $209,265 | $286,563 |
Source: Wealthsimple. For illustration purposes only. Actual rates of return may vary. Illustrative returns do not account for taxes and other expenses.
It’s well worth paying a fee for a professionally designed investment portfolio that can be adjusted as your life changes. It’s also handy to have features like automatic rebalancing — this makes sure your portfolio always contains the correct mix of assets. Some online investment platforms have a great combination of these services as well as low fees.
The last thing you want to do is overpay fees. If you are paying 1-2% in fees, you could lose up to 40% of your expected investment returns over time. Because fees are so consequential, you should make sure that you aren’t overpaying for the service you are getting.
Decide what to invest in
Once you decide on an investing style, how do you know what to invest in?
You’ve got a buffet of options: from individual stocks, index funds, ETFs, mutual funds, bonds, GICs, and alternatives such as cryptocurrency or gold. Take a look at the best investments in Canada, as well as a brief overview of the options:
Stocks
Stocks are the shares (parts) of a company listed on a stock market for people to purchase. Buying shares in a company means owning a small share of the company’s future earnings. With ownership come voting rights and a portion of the profits earned by the company.
Most stocks today are available as common stocks. Common stocks give the holder the right to vote and elect the board members of a company, (i.e. the individuals in charge of major decision-making). Common stocks also represent a portion of profits distributed by the company in the form of dividends. Payment of these dividends takes place annually or semi-annually, depending on the company’s policy.
Owning individual stocks is risky since there’s a chance the company loses money and even goes out of business in the future. That’s why it’s important for investors to diversify their portfolios by holding many different stocks.
Risk level: Medium to high
First, the risk depends on the stock. Mature, profitable businesses with distinct competitive advantages are less risky than a small start-up that has yet to establish its profitability.
Think of Tesla: it’s one of the most valuable companies in the world, even though it sells fewer cars than most if not all other automakers. Tesla would be considered a risky “growth stock,” with big potential for gains but also a strong chance of losing money. On the flip side, a blue-chip company like Microsoft has been around for decades and established itself as a profit-generating machine. Microsoft’s future earnings are much more predictable than Tesla’s and so investors can expect to earn steady and reliable returns.
Risk also depends on your asset allocation. For instance, investing in a single stock and nothing else leaves you with little to buffer the blow from a market crash.
Average return: 9-10% per year
Index Funds
Speaking of diversification, an index fund is a mutual fund that holds all of the stocks in a particular market index (like the S&P 500). That’s right, an index fund tracking the S&P 500 would hold all 500 stocks in proportion to their size and track their performance. The index fund’s performance would mirror the S&P 500’s performance, minus the small fee charged by the index fund manager.
Index funds can track all kinds of markets, from Canadian stocks, U.S. stocks, international stocks, and emerging markets. You can even buy bond index funds that hold thousands of government and corporate bonds.
Risk level: Low to medium
It depends on your portfolio allocation. An index fund that is 100% invested in stocks will still be inherently riskier than a balanced portfolio that contains bonds and/or cash. But an index fund can still lose money in a short period of time, such as during the coronavirus market crash.
But index investors buffer this risk through diversification. Instead of betting on a few companies, they spread out their investments and own all of the companies in a particular index.
Average returns: 6.2% and 7.8% per year
ETFs
An exchange-traded fund (or ETF) is an investment fund that lets you buy a large pool of individual stocks or bonds in one purchase. It can track stock indexes like the S&P 500, different commodities, bonds or a bunch of assets grouped together. ETFs trade like a standard stock on the stock market with price fluctuations being observed as they’re traded. It distributes ownership of the whole pool of assets into a single share ready to be traded like a common stock.
Besides making capital gains on ETFs, investors also benefit from profits distributed in the underlying ETF asset pool, such as dividends and interest.
ETFs are a good option for people looking to invest in a low-cost, diversified portfolio. Such folks can invest in well-known stock indexes without worrying about individual company stock prices or performance.
Risk level: Low to medium
ETFs hold baskets of stocks and/or bonds just like index funds. So they help diversify your portfolio and balance the risk of owning too few securities in your portfolio. Again, this doesn’t mean that ETFs are less risky than stocks when it comes to short-term performance. ETFs can lose money over the short-term if the market they are tracking falls in price.
Average returns: 6.2% and 7.8% per year, depending on which market(s) they are tracking.
Mutual funds
A mutual fund is a pool of various stocks and bonds grouped together in a single investment portfolio. The managers of the fund assimilate the different assets into shares and calculate the share price daily under the price fluctuations of each asset within the pool.
Investing in a mutual fund differs from stocks or bonds as the pool represents a collection of various assets. Investors earn money when the stocks within the pool generate dividends and on interest payments from the bonds. Assets sold by the fund at a higher price also create a capital gain distributed by the fund to its shareholders.
Mutual funds can be active or passive. An actively managed mutual fund has a manager at the helm making investing decisions and trying to beat a benchmark (i.e. “the market”). A passively managed mutual fund, also known as an index fund can track all kinds of markets, from Canadian stocks, U.S. stocks, international stocks, and emerging markets.
Canadian investors have nearly $2 trillion invested in mutual funds as their investment of choice. Unfortunately, Canadians pay some of the highest mutual fund fees in the world, with costs ranging from 2-3%.
Risk level: Low to medium
Mutual funds typically hold a wide variety of stocks and/or bonds. So from a diversification standpoint, they are less risky than owning a few individual stocks.
However, like with ETFs, the risk of a particular mutual fund depends on the underlying holdings (or what’s in the basket). A 100% stock mutual fund is riskier than a balanced fund with a mix of stocks and bonds. But a bond mutual fund is considered a low risk investment.
Average returns: 6.2% to 7.8% per year without fees. If a Canadian equity mutual fund charges a MER of 2.2%, then expect between 4% and 5.6% per year (net of fees).
Bonds
Bonds are issued mainly by companies, governments, and municipalities (provinces/cities) to raise cash in exchange for timely payment of interest on a fixed rate. Bonds are a form of debt, and as an investor, you are lending money to a government or corporation in exchange for a fixed interest rate (or coupon). Investors can purchase federal government bonds (the safest), provincial government bonds, corporate bonds, and “junk” bonds issued by riskier companies.
Bonds are generally considered a safer option than the stock market and act as the ballast that steadies the investing ship when waters get rough. People who don’t want to take risks or have heavily invested in the stock market can consider diversifying their portfolio with the purchase of bonds. You can also diversify your bond holdings by purchasing a bond mutual fund or bond ETF, which will hold many hundreds of individual bonds in one basket.
A downside: since bonds are considered less risky, their returns are also significantly lower than the stock market.
Risk level: Low
A bondholder is a loaner, not an owner, and should expect to receive interest payments plus the return of their principal investment when the bond matures. Federal government bonds are among the safest investments, followed by provincial bonds, high-quality corporate bonds, then lower quality corporate bonds.
Bonds are also sensitive to interest rate movements. When interest rates rise, bond prices fall (and vice versa). Bonds with a longer duration, such as long-term federal government bonds, are more sensitive to rate movements than short-term bonds.
Average returns: 2.7% per year
GICs
A Guaranteed Investment Certificate (GIC) is a type of investment that pays you a guaranteed interest rate. In exchange for your principal investment, a GIC pays a fixed annual interest rate for the duration of a fixed-term (often 1-5 years).
GICs offer the safest form of investing, albeit with the lowest expected return. GICs are best used for short-term goals – a way to keep your principal investment safe while earning enough interest to hopefully keep pace with inflation.
Risk level: Very Low
GICs offer guaranteed returns, making them a safe haven for short-term investing needs.
Cryptocurrency
Cryptocurrency is a digital, alternative form of currency not regulated by any central bank. Instead, it’s managed by the people who use it and buy it. Cryptocurrency trading is gaining more attention as an alternative to traditional investments, with Bitcoin and Ethereum being among the largest and most popular cryptocurrencies to invest in.
The good news: it’s never been easier to invest in crypto. There are crypto exchanges and indexes popping up, and you can even invest your TFSA or RRSP in the Bitcoin ETF. FinTech giant Wealthsimple even launched Canada’s first regulated cryptocurrency trading platform called Wealthsimple Crypto, an online platform that allows investors to buy and sell crypto for free.
The bad news: the world of cryptocurrency is largely unregulated and highly volatile. There are no perfect indicators for predicting the price of cryptocurrencies. It’s purely based on individual demand and supply speculation. For instance, the value of Bitcoin has increased by more than 90% during the COVID-19 crisis. But in May 2021, the Bitcoin price plummeted over 40% after China banned Bitcoin.
The bottom line: expect extreme ups and downs and dedicate a small percentage of your portfolio to crypto investing rather than your entire life’s savings. Otherwise, you risk losing some – or all – of your money.
If you have the stomach to play a higher-stakes game, investing in cryptocurrency could be for you. Just reduce your risk by trading on a reputable cryptocurrency exchange and diversifying your investments.
Risk level: Very high
Cryptocurrency offers casino-like odds where investors can lose most (if not all) of their money in a short period of time.
On the other hand, we’ve seen incredible returns in the 1000%+ range, depending on how long you HODL.
If you buy and hold for the long term, your patience and grit may pay off.
Average returns: N/A — investing in cryptocurrency is pure speculation.
Conclusion
Many of the people who want to start investing hope that there is some kind of magic way to instantly make money with little effort. While this may be slightly true, it is not guaranteed that you will encounter such situations. There are ways that can help you achieve those goals but those would require you to prepare and do your research first. For you to know and understand more things about investment and the way on how to start it for beginners, we need to first define some terminologies. A person who invests his or her money is called as the investor. This is because investors make an investment in any form of business or activities with the help of their money.