Pensions are a thing of the past. The young professionals of today are truly responsible for establishing their own long-term savings plans. When pension plans were commonplace, the money you put away was managed for you. The reality of today is that not only are we in charge of being disciplined savers, we are also responsible for making our own investment decisions. As a young investor entering the market for the first time, what should you do?
Don’t try to beat the market
An index is a grouping of stocks that has been designed to represent a market. The S&P/TSX Composite is the major index used to represent the Canadian market. Beating the market is the action of selecting a grouping of stocks that is different from the index with the intention of having better returns than the index. One of the biggest mistakes that young investors make is using intuition, tips from the media, and other predictive methods to try and beat the market. Very few people (professionals included) have been able to consistently beat the market throughout history, and trying to do so tends to lead to poor performance. Instead of trying to beat the market, you can buy the market using inexpensive tools like Exchange Traded Funds and index funds.
Watch your fees
A large portion of Canadian investment vehicles are actively managed mutual funds. These are mutual funds with a professional money manager and team of analysts deciding how to invest your money in an effort to beat the market. In Canada, these types of funds charge an average fee of 2.5%. That fee comes right out of your investment no matter how the fund performs. It would make sense if this fee could be justified by superior performance, but actively managed funds tend to underperform the index over the long term. Exchange Traded Funds that hold the market index can be bought for as little as .05%. You can pay 2.5% for something that hopes to beat the market, or buy the market for .05%.
It’s easy to be attracted to investing in companies that you know in the country that you live in, but there is a world of opportunity out there. We can’t predict the future to determine which types of stocks in a given country will be strong performers, but holding a diverse basket of different types of stocks in multiple countries allows you to capture the performance of markets around the world while reducing the potential impact of any single market performing poorly.
Understand risk and return
Portfolios usually contain both stocks and bonds. A stock is a piece of ownership of a company, and a bond is a piece of debt that a company owes you and pays you interest on. Stocks are riskier than bonds, but they also produce greater long term returns – more risk means more return in the long run. Not everyone can stomach a large drop in their investments, so managing your own behaviour starts with allocating the appropriate amounts to stocks and bonds.
Set allocations and rebalance
When a diversified portfolio is initially constructed there is a decision around how the portfolio will be split between stocks and bonds, and between domestic and foreign content. Once these allocations are set, it is important to rebalance the portfolio. If US stocks perform better than Canadian stocks the US allocation will grow; rebalancing is selling some of the US portion and buying more Canadian to get the allocations back to their original state. Rebalancing is done between the different types of stocks, but also between stocks and bonds, and it serves to decrease the overall volatility in the portfolio while removing emotions from the decision to buy or sell.
Don’t pay for advice unless you need it
Whether the costs are obvious or not, you are paying for financial advice when you meet with an advisor. Unless you have a large amount to invest or have an otherwise complex situation, you can save on the cost of advice until your assets have grown and your situation has become more complicated.
A simple way of implementing these steps can be elusive in Canada because neither financial advisors nor financial institutions stand to make the juicy profits that they are accustomed to when you invest this way. Currently, the two simplest ways to implement this in Canada are Tangerine Investment Funds and TD e-series funds. TD e-series are less expensive at about .45% for an equal mix of US, Canada, and International funds, but rebalancing and diversifying is left up to you. Tangerine will cost you 1.07%, but they take care of the rebalancing and diversification. Both of these options are index based, low fee, don’t have the cost of advice built in.
Full disclosure: I am in no way compensated by TD or Tangerine
Original post at theyoungprofessionaltimes.com