We have a sneaking suspicion you already know what investing is, but just in case, let’s define investing terms. Then we'll tell you how to do it.
That is the super concise investing definition that comes courtesy of Merriam-Webster. Regardless of where you invest your money, you're essentially giving your money to a company, government, or other entity in the hope they provide you with more money in the future. People generally invest money with a specific goal in mind, for example, retirement, their children's education, a house — the list goes on.
Investing is different from saving or trading. Generally investing is associated with putting money away for a long period of time rather than trading stocks on a more regular basis. Investing is riskier than saving money. Savings are sometimes guaranteed but investments are not. If you were to keep your money under the mattress and not invest — you'd never have more money than what you've put away yourself.
That's why many people choose to invest their money. There are many things you can put money into. Here are just a few of those things.
Now we know you're eager to learn the investing basics given that you're reading this article. But let's hold for a second and figure out if you should be investing in the first place.
THINGS TO CONSIDER BEFORE INVESTING
First things first. Before you start investing in anything, you should ask yourself a couple important questions. These questions determine whether you’re in good enough financial shape to start investing right now.
HERE ARE THE BASICS:
1. Do you have a lot of credit card debt?
If the answer is yes, you’re probably not in a position to invest quite yet. First, do everything you can do to erase that debt, because no investment you’ll find will consistently outperform the 14% or so APR that you’re likely forking over to a credit card company to service your debt. Here’s a good place to start plotting your debt’s annihilation.
2. Do you have an emergency fund?
In polite terms, poop happens. Layoffs, natural disasters, sicknesses — let us count the ways in which your life can be turned upside down. Any financial advisor will tell you that in order to avoid total ruin you should have between six months and a year of total living expenses in cash, or in a savings account should the unthinkable happen. If you don’t, bookmark this article, start saving, and come back just as soon as you’ve got that emergency fund squared away.
Beginners investing tips
Before we go over the specifics of what you should consider investing in, be it stocks, bonds, or your cousin Brian’s yakalo farm — let’s first go over the basics of how one invests.
Investing is what happens when at the end of the month, after the bills are paid, you’ve got a few dollars left over to put towards your future. No investing happens without putting money away. How are you supposed to find those elusive extra dollars to save?
Avoid lifestyle creep
In all likelihood, you’ll earn more in your thirties than you did in your twenties, and even more than that in your forties. The key to saving is to do your absolute best to avoid what’s called “lifestyle creep”. If you haven't heard of this before, let us explain.
Lifestyle creep means that as you make more money, what once seemed like luxuries become necessities. Whole roasted pigeon and oyster concassé may be sublime and all but just because you have the $626 in your checking account to cover the tasting menu at Guy Savoy doesn’t mean you should. Instead, you should do your very best to live the same way you’ve always lived. Then put away the extra money you’re making from your raises rather than increase your spending. Skip the pigeon, get yourself a croque monsieur, and invest the 600 bucks you saved!
Start investing — even a little at a time
Once you’ve got savings, you’ll absolutely want to invest. Inflation will almost outspace the interest rate that you’ll be able to get on a savings account. You’ll be effectively be saving and losing money at the same time. This is why you should start investing as soon as you can.
Investing is not just for the Warren Buffet's of the world. If you are finding it tough to put away some investing money each month, try using a spare change app. These services round-up your purchases, allowing you to invest small amounts of money that you'd hardly miss. For example, if you spent $3.39 on a coffee then $0.61 would be invested.
Investing small amounts of money is a great habit to get into and your money will add up over time. If you're looking for more easy ways to invest with little money, here they are.
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.
Saving 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.
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 investingis 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.
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.
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%).
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.
Consider how much time you can put into investing
Managing your investments can take a little time or a long time. Before you invest a dollar consider how much time you can put into managing your investments. A DIY approach will require making regular trades and ensuring sure your investments stay on track (re-balancing). A robo-advisor (automated investing) will cost a little more than doing things yourself but it won't be as time-intensive. The platform manages your investments saving you time. Christopher Liew a Certified Financial Advisor and the founder of Wealth Awesome explains this is always something to keep in mind.
"I always carefully consider how much time making an investment will take. Some investments will require much more work than others, and I don't want to spend too much of my precious time on investing."
Make an investing plan and stick to it
One of the biggest reasons many investors have low returns is because they sell at the wrong time. They often base decisions on recent performance. They look at what has been doing well or not so well recently. Many investors tend to buy things that have appreciated in value and sell things that have declined in value.
Rather than do this, you should create a plan you will think will help you reach your goals over the time period you have to invest. Don't stop investing because of bad performance. Stick to your plan without buying or selling based on your opinion of what will happen in the near future.
If you're ready to put all these beginners investing tips to good use, find an investment platform. If you're wondering which one to choose, we can help with that.
Types of investments
There are many different types of investments including real estate, bonds, stocks and automated investments.
Basics of investing in stocks
Now that you have some quick investing tips — it's time to learn the basics of investing in stocks. Chances are, at some family get-together, a drunk uncle informed you that the stock market is “rigged.” Of course, that's not true.
Risk vs. reward
The stock market is premised on the fact that investors will only invest if they’re compensated for taking the risk of buying stock. Think about it. Nobody would invest in any stock that they expected to rise 1.5% annually. You could potentially get the same or better returns from something like a smart saving investment account to any number of other investments that don’t carry as much risk as stocks do. They’d be insane to take more risk in order to collect an identical return.
One way of looking at the risk vs. reward tradeoff is through a concept known as the “equity risk premium” (ERP). This is an estimate of the expected return you gain from stocks. The percentage you can expect to earn on a stock over the so-called “risk-free rate,” the current interest rate you could get by putting your money in almost zero-risk government bonds. Without the potential for robust gains, all stocks would head straight to the basement.
You’d be mistaken if you thought that picking one stock is the way to benefit from this phenomenon. Warren Buffett, who will probably be remembered in history books as the world’s best stock picker, consistently advises anyone who’ll listen not to try to pick individual stocks, but rather diversify in order to benefit from the growth of the broader market. Once quoth Buffett, the Omaha oracle:
The goal of the non-professional should not be to pick winners — neither he nor his 'helpers' can do that — but should rather be to own a cross-section of businesses that in aggregate are bound to do well.
Why probably won't you win picking stocks? You may be very smart, but when you buy a stock at a particular price, you’re buying it from someone who also may be very smart and has access to all the same information that you do. You're betting it goes up while she’s betting it goes down. Are you really so sure you’re smarter than she is? Stock picking is exceedingly difficult and those who do it should be prepared to lose a big percentage of their investment.
If what we told you about diversification has resonated, you'll probably want to invest in real estate, bonds, and a number of stocks. This is one way of spreading out your risk.
Let's say you decide Netflix stock will give you the best return over time. And if history is any judge, it might. But what if Amazon figures out a way to eat Netflix’s lunch? What if tastes change, and people decide they’d rather watch YouTube videos of funnu cats instead of expensive dramas? The stock would be toast, and so would your investment.
For this reason, you should not only diversify your investment by investing in many stocks, but many different stock sectors (as well as bonds, real estate and other things).
This means that if one single sector suffers a big setback, it won’t drown your entire portfolio. In the dotcom crash of 2000 many tech stock prices plummeted. Had you invested everything you had in tech companies you would have made a very big loss.
Investing in stocks via ETFs
The most effective way to diversify a portfolio is by investing in mutual funds or ETFs that act as a wrapper for hundreds of different stocks or bonds; many of these will mirror the composition of well-known indices like the S&P 500. You can find a number ofinvestment providers that allow you to invest your money in market tracking index ETFs.
Investors not only need to consider diversification, they must also consider what their investments are costing them. “Fees” they’re called, and they’re like the termites of investing — always eating and never satisfied. Actively managed mutual funds have what’s called a management expense ratio, or MER, which is the percentage of the entire fund that the mutual fund company assesses annually to pay its managers, support staff, for advertising, rent, and about anything else you could think of.
In the U.S., a 1% MER is not uncommon, and it’s more likely to be closer to 2% in Canada. Whether the fund value increases by 15% or loses 5% over the course of a year, that percentage will always be lopped right off the top.
Though it might not even sound like that much, this financial advisor demonstrated how a mere 2% MER could decrease investment gains by half over a 25-year investment. But surely these fund managers must be so great at picking stocks that their fees are justified? Au contraire! Recent research reveals that over a 15 year period, 82.2% of managed stock funds have been bested by the overall market. For this reason, many investors have jettisoned the old mutual fund strategies of their parents in favor of low-fee, passive ETFs that seek to mirror the market rather than beat it, since MERs of passive investments are generally a fraction of those of actively managed funds.
Real estate investing basics
There’s an entire genre of TV shows that make it appear as though buying and flipping real estate is the modern equivalent of alchemy. You'd think just about everyone has the amazing ability to turn drywall and vinyl siding into gold. Those who buy property hoping to get rich quick should understand the dangers.
Real estate is a business that comes with huge, expensive complications, ones that can potentially ruin unsavvy speculators. Any back of the envelope calculation of investment return must take into account expenses such as property taxes, insurance, and maintenance.
Canadian business guru Joe Canavan, founder of GT Global (Canada) and Synergy Asset Management, looked at the numbers and realized, that over the last 25 years, the S&P TSX Composite Index was up by about 325%, while during that same period, the average home price across Canada increased about 200%. That said, buying a house has been for generations a kind of forced saving plan for undisciplined investors; it might not be the absolute best investment, but without that monthly mortgage payment, they might not have saved anything at all.
Those seeking diversification in their portfolio in addition to stocks and bonds can invest in real estate without any of the headaches that come with actually owning a house or apartment. Real estate investment trusts, or REITs, are companies that sell shares in their various real estate investments. Just as diversification is important in stock holdings, REIT investors can spread their risk among dozens — or even hundreds — of REITs through REIT ETFs, of which there are literally hundreds to choose from. REITs also offer some major tax benefits that neither home ownership, nor investments in stocks or bonds, offer.
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J. Michael Dennis, ll.l., ll.m.,
King Global Earth and Environmental Sciences Corporation
King Global Earth & Environmental Sciences Corporation is part of the Management, Scientific, and Technical Consulting Services Industry and the Professional, Scientific, and Technical Services sector.