Investing can be intimidating, partly because there is an entire industry working to make it seem that way. But it doesn’t have to be.
First, you need to think about your goals. Are you putting money aside for an emergency fund? A down payment for a house? Then you need a product that is safe and that can be accessed at any time, which means that stocks and bonds are not appropriate. Your only option is a high-interest savings account. It won’t earn very much interest – 1% or less at a big bank, maybe 2% or more at a credit union, but that is the price of safety.
If you know exactly when you will need the money, and it is within the next five years, then you might want to consider Guaranteed Investment Certificates (GICs). GICs are similar to high-interest savings accounts, except your money is locked (you will not be able to withdraw it) for a set amount of time, generally 1 to 5 years. Because the funds are locked in, GICs often earn better rates than high-interest savings accounts.
Are you saving for retirement? This is where stocks come into play. A stock is essentially a piece of a company. These investments are not guaranteed as businesses can fall in value and even disappear. But because of this risk, stocks earn higher rates of return than savings accounts and GICs. These higher rates of return are important because they allow you to reach your retirement savings goals faster.
A key risk with investing in stocks is if the company associated with a stock permanently falls in value or even goes out of business. If your entire retirement savings were invested in the one company and that company went out of business, your stocks would be worth nothing. That is something you want to avoid. Fortunately, you can eliminate this risk by owning a very small piece of virtually every publicly traded company in the world. If every company in the world were to become worthless, I’m guessing that you would have bigger problems than your retirement savings.
Even if the world doesn’t end, there are global stock market crashes, where the total value of all stocks falls temporarily. This could be an issue if you were retired and needed to sell some of these stocks in order to buy groceries.
This is where bonds come in. A bond is essentially a loan to a company or government that provides you with monthly interest payments. Bonds from companies and governments with strong credit ratings are almost guaranteed to make these interest payments. And their values tend to be much less volatile than stocks. In fact, during stock market crashes, frightened investors often sell their stocks and buy bonds, which increases the value of bonds. This means that adding some bonds to a portfolio of stocks will reduce its volatility.
Adding bonds also reduces the expected long-term returns of a portfolio. So, if you are young and saving for a retirement that is many decades away, you may want to choose a mostly or even all-stock portfolio. If you are close to, or in, retirement you may want to choose a portfolio that has more bonds.
You should expect that at any moment the value of a diversified portfolio of stocks could fall by 50%, while the value of a portfolio of bonds would remain largely unchanged. A 50% stock/50% bond portfolio would only fall by 25% or less (because bonds typically rise in value when stocks fall). If that still scares you, you probably want more bonds. Just remember that if you can handle the short-term volatility of a stock-heavy portfolio, you should benefit from higher long-term returns.
But how do you actually buy a diversified portfolio of stocks and bonds? The easiest way is through products called index mutual funds and index exchange-traded funds (ETFs). These are diversified portfolios that you can buy into. And because they stick to simply buying every stock or bond associated with a particular index, they charge very low fees.
The best index mutual funds and ETFs hold thousands of different stocks and bonds while having fees – also known as Management Expense Ratios (MERs) – of less than 0.5% per year. The typical mutual fund your bank advisor/salesperson will try to sell you changes 2% or more per year. For every $100,000 you have invested, that’s a difference of $1,500 per year or $125 per month.
If you have a portfolio of $500,000 or more, you can likely find a good wealth manager that will invest in low-cost mutual funds or ETFs for you. But for most Canadians, especially those just starting to save for retirement, your best option will be to open a direct investing account. This type of account allows you to buy stocks, bonds, GICs, mutual funds and ETFs without having to deal with a bank advisor/salesperson.
Any direct investing account should give you access to a number of index mutual fund and ETF options. All you are looking for is lots of diversification and low fees. Here are some ETF examples:
- Vanguard Growth ETF Portfolio (VGRO) – 80% stocks, 20% bonds
- Vanguard Balanced ETF Portfolio (VBAL) – 60% stocks, 40% bonds
Many investors would be well served by picking just one of these funds. All you need to do is decide the stock/bond ratio that is appropriate for your situation. One of these ETFs allows you to own around 4000 different stocks and 1000 bonds, with MERs of only 0.25%.
Now, ETFs can be a bit complicated for a new investor. You have to calculate how many units you can buy with the money you have to invest. And many direct investing providers charge $10 for every transaction, so they are not great for small accounts. Also, if held outside a registered account (e.g., RRSP, TFSA, RESP, RRIF), you need to do a bit of tracking for tax purposes.
All of this is manageable, but there is a simpler option: index mutual funds. Units of these are divisible, so you only need to know how much you want to invest. There are generally no fees to buy or sell, and they do the tax tracking for you, so are less of a hassle if held outside a registered account. The best index mutual funds in Canada are the TD e-Series Funds:
- TD Canadian Index Fund – e-Series (TDB900) – 0.33% MER
- TD U.S. Index Fund e-Series (TDB902) -0.34% MER
- TD International Index Fund – e-Series (TDB911) – 0.49% MER
- TD Canadian Bond Index Fund -e-Series (TDB909) – 0.51% MER
The one downside of these is that they do not come as one-fund portfolios. You will have to build your portfolio using these four funds. For example, a balanced portfolio similar to VBAL above would have 20% TDB900, 20% TDB902, 20%TDB911 and 40% TDB909. And it would have an average MER of around 0.4%.
Now, if all of this seems overly complicated, you might want to look into a robo advisor. These services will put together a portfolio of ETFs that is appropriate for your situtation and take all of the complexity out of it. The tade-off is that they will charge an additional fee on top of the ETF MERs, often around 0.4% or more.
Whichever option you choose, the important thing is that you are putting your savings to work in way that works for you. Happy investing!