Ah, investing. That big, scary monster. The cause of countless cases of analysis paralysis.
There is so much information available about investing, you would assume it’s now easier than ever to get started. In fact, it’s quite the opposite. There is so much information out there, it’s overwhelming. Since some of the information can be so contradictory, many will simply give up before they even started.
Does that sound familiar? I’ve been there.
So exactly where do we start?
This article will be littered with links and references. There is a lot of information to consider on the subject and I don’t want to bore you (or scare you). Rather than rehash information, I’d rather send you to excellent sources. 🙂
First, let’s get some things straight. I’m not a financial advisor. I am not licensed to make financial recommendations. This article will not provide financial advice, but will rather provide my personal opinions. I will only try, to the best of my knowledge, to explain how important investing your savings as early as possible is. I prefer to simply refer you to some of the best resources. The goal is to help you avoid analysis paralysis and take action.
Compound Interest, the Eighth Wonder
In my last post, I postponed the importance of return until later. When starting to save, you have to focus on maximizing the savings rate first. This is what really makes the difference when starting to accumulate wealth.
Eventually, return will become your best friend.
One of the best metaphors I’ve read so far to illustrate the power of compound interest is from Robert R. Brown’s excellent book Wealthing Like Rabbits. I can’t recommend this personal finance book enough. It is loaded with pop culture references (including Star Trek!), and manages to make personal finance really accessible to millennials.
In the book, you may have guessed by its title, compound interest is compared to rabbits doing, well, what they do best:
Imagine you’re on a great big island. […] Now imagine that some farmer decides it would be fun to go hunting rabbits on his farm on the great big island. So, he obtains twenty-four rabbits from a distant and foreign land and releases them onto his farm on the great big island. The rabbits then proceed to do what rabbits do best every chance they get.
Here’s my question:
Approximately how many rabbits do you think would be on the great big island after about sixty years?
Would you believe about ten billion? Yes, you read that right. Ten billion rabbits. Amazing, isn’t it?
Well, compound interest is like that. The money you invest will make money, which will also make more money, and so on and so forth, exponentially. The most important factor in favour of compound interest is time. The more time you have to invest, the longer compound interest will work its magic. Hence the importance of starting as soon as possible.
To learn more about compound interest, in addition to reading Wealthing Like Rabbits, check out these articles:
Financial Independence Core Principle #2: Start Early to Realize the Power Of Compound Interest by TheYoungRetireeBy33
- What is Compound Interest by Wealthsimple
These articles provide concrete examples with numbers to illustrate the power of compound interest. Enough to make you want to invest right away, right? 😉
Risk and Return
Of course, to get return worthy of rabbits doing it like, well, rabbits, you have to be prepared to live with the ups and downs of the stock market.
As the 62nd Rule of Acquisition states: The riskier the road, the greater the profit.
If you turn your back on risk, you turn your back on a decent return.
To learn more about the link between risk and return, I invite you to look at these L’indice McSween segments (French only):
It all comes back to the riskier the road, the greater the profit. The more risk you are willing to take, the more compound interest will operate.
Another nice rule to remember to help you visualize the power of return (and why you should take more risk), is the Rule of 72. Dividing 72 by the expected return equals the number of years needed to double the value of an investment. For example:
- A 10% return will take 7.2 years to double your initial investment.
- On the other hand, if you settle for a 1% Guaranteed Investment Certificate (GIC), let’s say, your initial investment will take 72 years to double.
That GIC is suddenly much less attractive, isn’t it?
Wealthsimple made it the subject of an entire article, if you want to learn more about it.
In short, because risk and return are so closely linked, you need to have an idea of your risk tolerance. That will tell you what kind of return you can expect. Fortunately, several online questionnaires are available to help you figure it out. Among others, the Autorité des marchés financiers (AMF) offers a tool to help determine your investor profile.
Once our risk tolerance is figures out, we can look at our future portfolio’s asset allocation.
There are two main classes of assets to consider for your portfolio:
- Stocks are volatile, somewhat risky (depending on diversification, of course), but there is long-term high return.
- Bonds, on the other hand, provide stability at the expense of return.
Thus, we can modulate our desired return and risk by adjusting the stocks to bonds ratio.
A fairly common rule of thumb is to use your age as your percentage of bonds, and invest the difference in stocks. So a 20 year-old would have 20% bonds and 80% stocks. A young investor can afford more volatility, since they have a longer investment horizon than, let’s say, someone in their 50s. A 50-year-old should aim for a 50/50 ratio.
Another more aggressive rule of thumb is to subtract your age from 120 to get your percentage of stocks. Accordingly, the same 20-year-old would have 100% stocks, while the 50-year-old would have 70%.
Of course, these are simple rules of thumb. Your asset allocation always comes down to your risk tolerance. An aggressive 70-year-old investor might opt for a 100% stocks, while a (overly) cautious 20-year-old might choose to put his savings into a GIC (remember what I said earlier about GICs?) To each their own tolerance.
However, I am 100 % sure that risk aversion can be cured with a great deal of financial education. 😉
RRSP or TFSA?
This is the kind of question that comes up very often. Anyone thinking about retirement investing will consider the RRSP. However, most people do not even know that it is possible to invest in a TFSA. With a name like the Tax-Free Savings Account, people seem to assume that’s just that: a boring savings account offering 0.10% interest. The government is in no hurry to correct those assumptions, since the TFSA is, in Pierre-Yves McSween’s words, a weapon of mass tax destruction.
Any income from a TFSA is tax-free. If part of your portfolio’s passive income is non-taxable, that means less money to the taxman and more money for you. For more details on this real tax gift, I invite you to take a look at this very comprehensive article from Tawcan.com.
So, knowing this, RRSP or TFSA?
You may find me predictable, but…
No matter how much you need to cover your retirement expenses according to the 4% Rule (25 times your expenses), I suspect it is at least a few hundred thousand dollars.
To reach such an amount, you’ll need to save a lot. And while RRSPs and TFSAs are nice tax gifts, all good things come to an end. There is, of course, a maximum of contributions established for each account. You can find your personal contribution limits in your CRA Account.
Knowing this, your savings will inevitably reach the contribution limits for these two registered accounts. Once both accounts are maxed out, you’ll move on to non-registered accounts.
However, maxing out these accounts is better done in that order:
- It is preferable to invest in a TFSA when earning a smaller income in a lower tax bracket. The rule of thumb here would be to invest in a TFSA, and once it’s maxed out, switch to the RRSP.
- Conversely, it is preferable to invest in a RRSP when already earning a higher income in a higher tax bracket. This helps reduce the tax bill. Once the RRSP is maxed out, switch to the TFSA.
But remember that to achieve FI, both accounts will inevitably be maxed out. No need to overthink which one is best.
Beating the Market Is a Myth
You may be thinking that since you don’t know what to invest in, it’d be better to let a portfolio manager take care of it. Plus, since they’re professionals, they’ll beat the market, right?
Do you know how many portfolio managers outperform the market?
You understand, as I do, that the remaining 89% fails. And they’re professionals! How are we supposed to do any better?
When you think about it, is it really talent, or just sheer luck that makes anyone beat the market? To add insult to injury, these so-called professionals will charge you outrageous fees for their disappointing results! Even if their return is already negative! Thieves!
So why not settle for market returns, instead of trying to beat it?
Take a look at the S&P 500 index (based on the 500 largest U.S. companies). Or at the S&P/TSX index (based on the 60 largest companies listed on the Toronto Stock Exchange).
Not bad at all, is it? It’s pretty obvious that there is an upward trend in the long-term return. Good thing our investment horizon is long-term too!
Knowing this, isn’t it great to learn that there are index funds (which hold the same assets as an index), which aim to replicate those returns. And since it’s a boring passive investment method, the fees are lower than actively managed funds. Fantastic, isn’t it?
Long story short, trying to beat the market is futile and expensive (isn’t it ironic?). Instead, own the market. Choose low-cost index funds.
You’re wondering which index funds to choose? There are models out there for you! Notably, you can take a look at those index fund portfolio models presented by the excellent website Canadian Couch Potato.
My First Investments
My first investments date back to 2014. My then employer encouraged us to contribute to FTQ and Fondaction RRSPs, in addition to one of their own mutual funds. I knew next to nothing about investing at the time, but the meagre pay deduction required to generate a juicy tax refund was enough to convince me.
After that, I started looking into personal finance and reading (obsessively) on the subject in early 2017. Everywhere I looked, the importance of investing as early as possible kept coming up. I understood that I had to take advantage of compound interests over the next few decades, but I wasn’t too sure how to proceed. I read all about stocks, bonds, ETFs, mutual funds, but I could not make heads or tails of it.
After reading Andrew Hallam’s Millionaire Teacher, I was finally able to take action. He managed to make investing accessible to me. While he mostly emphasized on buying index ETFs through online brokers (for lower fees), he also recognized that Tangerine offered affordable and accessible investment funds. As most of my banking was already done with Tangerine, it did not fall on deaf ears.
Shortly after, I opened my first individual RRSP and I started investing with regular automated deposits in their most aggressive fund (100% stocks). Considering my age (26) and my Defined Benefit Pension Plan (DBPP), I could handle the most aggressive portfolio possible.
After that, I continued learning on investing and gained confidence. Just a few weeks later, I decided to invest in a Wealthsimple RRSP, out of curiosity. Their fees were lower than Tangerine’s (0.50% vs. 1.07%). However, they didn’t have a 100% stock portfolio. At the time, from memory, the most aggressive they offered was 80/20.
It was about a year later that I decided to open an account with Questrade. I was then able to start investing in index ETFs, here and there, with a few thousand dollars. I was learning as I went along.
It was in November 2018 that I had to take the DIY investing more seriously. A few months earlier, I started a new job for another company. I decided to take my old job’s DBPP commuted value over to Questrade. A portion (approximately $29K) had to go into a Locked-In Retirement Account (LIRA) and the surplus (approximately $13K) would go into my RRSP.
I suddenly felt like I had a fortune to invest, all by own self. I learned everything I possibly could and proceeded to invest my money.
Since then, I have transferred all other RRSPs to Questrade, except for my worker’s funds. These are not reputed to be easy to transfer or withdraw, let me tell you that. I also started investing in a TFSA, once my RRSP was maxed out (thanks to the DBPP commuted value surplus). Once I max out my TFSA, I’ll have to open a non-registered account, also offered by Questrade. I still have $49,000 in contributions to make up for, so that’s definitely not a problem for today. 😉
My Current Portfolio
I’ve had different strategies during my few years as an investor, but I’ve switched things around last July. Currently, my portfolio is made up of 94% stocks (XEQT) and 6% bonds (ZAG). It’s a pretty simple, borderline boring, portfolio, but it’s all I really need. On top of that, the fees are about 0.19%. That’s a long way from actively managed mutual funds. 🙂
Why a 94/6 ratio? Because it was actually 90/10, but during the stock markets little hiccups in September and October, I sold some bonds to buy stocks at a discount. 🙂
Ultimately, I plan to sell all bonds to have a portfolio consisting solely of stocks. I want to maximize my return during the accumulation phase. I’m playing with the idea for now. The next stock market dip might convince me to make a move, who knows!
Which Platform to Use
As you noticed, I now do all my investing through Questrade. If you are interested in opening an account, please use my QPass Key 665709686438830 and we will both get $25.
However, there are multiple other options available to you. If you prefer to work with an advisor, go right ahead! However, make sure that the professional in question is there to advise you, not to sell you investments that will benefit him more than to you.
And as there is a ton of platforms, Hardbacon offers excellent comparators, both for Robo-Advisors and for Online Brokers, which could possibly help you make a pick.
Keep in mind that it is always best to go for the lowest possible fees. One percent fees can make a huge difference on your return. This Get Smarter About Money calculator shows the impact fees can have on your investments. Don’t let the bank take away your return.
Another interesting alternative for people who want to start investing, without too much thought: Tangerine’s investment funds. Management fees are a bit high (1.07%) compared to online brokers or robo-advisors, but reasonable compared to big banks’ mutual funds (usually more than 2%).
Personally, I think it’s a great way to start investing without having to think too hard about it. Tangerine keeps it rather simple with only 5 different index funds, modelled according to the client’s risk tolerance (which is assessed by answering a questionnaire). Automate your savings and don’t think about it again!
If you don’t already have an account with Tangerine and you’re interested in opening one, feel free to use my Orange Key 45955399S1 and we’ll both get $50.
That’s how I started investing, and I’m really grateful to have had this easy option when everything else seemed impossibly complex. It gave me the opportunity to put my small savings to work, while I didn’t feel confident yet for more complex alternatives.
Now Will Never Come Again
Remember that the best time to start investing was yesterday, the second-best time is today, and the worst time is to wait until tomorrow. Whichever path you choose, start investing now.
Live now; make now always the most precious time. Now will never come again.
– Captain Jean-Luc Picard
The worst thing that can happen to you is analysis paralysis, and end up doing nothing. It’s terrifying to make decisions on a subject you barely know. I’m very aware of that. I can only tell you that the important thing is to start. Take the easiest option to begin with, then learn more on the subject as needed, and then make adjustments. Or keep it simple forever. It can’t be worse than sticking your money under the mattress. 🙂
Thank you for reading my article, which turned out quite lengthy despite all my best efforts. What can I say, I really like investing! 😉
Don’t hesitate to comment. I look forward to reading and answering, especially if you feel lost and would like to brainstorm. If you prefer a little more discretion to talk about investing, you can write to me directly on my Contact page or with Messenger through my Facebook page.
See you next week!
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