Question from Ellen in Vancouver: I've been working hard to save a chunk of money and I know I need to invest. I'm long overdue and embarrassed about it. I have some time on my side and I want to take advantage of that. Problem is, I don't know where to start and the clock is ticking. I've dabbled lightly in investing but spooked myself out of it, unsure about what the right investment mix might look like for me. I've recently been attracted to groups like WealthSimple, where I can "set-it-and–forget-it" invest, but I'm not sure if that's the wisest thing to do.
How would you recommend I break up my $30,000 TFSA? As a Vancouverite without a million dollars, I will not be buying a home any time soon but I would like fairly accessible funds in case I get into business school or graduate program in the next three to five years. Otherwise, I'm happy to store at least half of this away ($15,000) and never look at it until I'm grey.
Here are my facts:
- 27 years old
- $30,000 in TFSA savings account
- $5,000 in RRSP in a “comfort growth” mutual fund
- Income of $75,000/year
- No debt
- Rent approximately $700/month
- Moderate-risk-level investment style
Ben Felix is an associate portfolio manager with PWL Capital in Ottawa and a CFA charterholder.
Ben's answer: It's not uncommon to get spooked when you're starting out with investing, but getting a handle on a few things can give you a big confidence boost.
Have an emergency fund
It's a good idea to keep between three and six months of living expenses in an easily accessible account for emergencies. The last thing that you want to do is take money out of your investments to cover the cost of fixing your car or bridging your income between jobs.
Get a grasp on risk
Risk is part of investing, but it's important to understand the kind of risk that you are taking. When you invest in one stock, there is a risk of losing all of your money if that company goes bust – that is called company-specific risk. If you invest in thousands of stocks across different countries, company specific-risk has less of an impact, and you are left with the risk of the overall market. It is very unlikely that the whole market will go bust all at once, and it will likely increase in value over time. Long-term investors should generally seek to minimize company-specific risk in favour of market risk by diversifying broadly.
Understand how much risk you are able to take
The $15,000 that you don't plan on looking at until you're grey might have a time horizon of 30 years, more than enough to recover from a market downturn. On the other hand, if the money pegged for shorter-term goals is invested in the market, a downturn can be a major setback. Money for short-term goals should be stored in a high-interest savings account or guaranteed investment certificate. It's the money set aside for long-term goals that you can invest in the financial markets. You can control the amount of risk that you are exposed to by adding some safer investments to the mix. Those safer investments are called bonds. Bonds have lower expected returns than stocks, so there is a clear tradeoff. More risk equates to more expected return. The following table is a general guideline for how much risk you can afford to take based on your time horizon.
Decide how much risk you want to take
A short-time horizon is a constraint on how much risk you are able to take. When that constraint is removed, you can decide how much risk you want to take. The following table is a general guideline for how much risk you might want to take, based on how much of a loss you think you could handle emotionally in a given year.
If you like evidence, don't be active
You will almost always be sold an actively-managed mutual fund when you go to the bank looking for investments. An actively-managed fund has a fund manager who is looking at the many stocks and bonds that exist in the market, and deciding which ones to invest your money in. The sales pitch will be that the fund manager is going to pick the right stocks and bonds for you, but the data simply do not support their ability to do so. When you also take into account the higher fees that you pay for actively-managed products, the odds of outperforming a benchmark index are stacked against you. The alternative is buying low-cost index funds. Rather than having a manager attempt to pick the right stocks, an index fund aims to passively own all of the stocks that represent a market.
Watch your fees
Regardless of how you choose to invest, you should understand the fees that you are paying. It has been proven consistently that fees are the best predictor of future performance, where higher fees predict lower performance. With a quick Google search you should be able to find any fund that is being offered to you. Look for the MER, or management expense ratio, which tells you how much of your investment the fund manager will take per year to manage the money. Canadian mutual funds have MERs well over 2 per cent, on average, while you can invest in index funds for less than a quarter of that cost.
Set it and forget it (mostly)
There are a handful of ways that you can get your hands on a globally diversified portfolio of low-cost index funds, and many of them are completely hands-off. The Canadian Couch Potato has an excellent guide to help you decide between three approaches to index investing. In recent years, Canada has seen a rise in online firms that keep their fees relatively low and use mostly low-cost index funds to build portfolios. Once you have a plan in place to invest in a globally-diversified portfolio of low-cost index funds, you really can set it and forget it. News headlines about impending market crashes or hot stock picks are meaningless to you. I'd check in on your portfolio at least once a year to make sure things are as they should be.
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