So You Want To Start Investing...
I’ve always been interested in investing but it felt like some sort of complex lottery that took years to master. Although this is somewhat true, I have found simple ways that are approchable for anyone to grasp and really wish I learned this sooner.
*Disclaimer: I am not a professional investment specialist or financial planner and am simply sharing my approach to personal investing. Before you start investing it is recommended to seek professional guidance on the best approach for you.*
Long term goals
First things first, long term goals are your best friend. I don’t have advice on day trading or investing in the next biggest tech company. My approach (and a lot of very successful investors) follow the strategy of investing in Index Funds which essentially means you’re investing in a whole industry or currency. For example, you can buy an index fund of the Toronto Stock Exchange (TSX), S&P 500 (the top 500 companies) or whole U.S. Economy. This is massive diversification where you’re not betting on a single companies stock, you’re betting on every company in a national economy. Therefore, even if some do poorly, most will probably do well and your money will grow. Index funds have grown 7% on average for the last 40 years. That’s a lot higher than the 0.5% the bank is currently paying to your savings account. This is a fairly conservative strategy, but it will give you piece of mind that you’ll grow your investments in the long run.
compound interest
Compound interest is your best friend. This essentially means the longer you keep your money in investments, the more it will grow. Looking at an online compound interest calculator online shows with an initial investment of $100 and an addition of $100 every month, you’ll have around $264,000 by retirement. You have only put in $48,000 of payments, and received $216,000 of interest. Now I’d recommend putting away much more than that per month but those numbers alone are pretty impressive. The thing to remember with compound interest is the longer it compounds, the more money you’ll make in interest. If you're able to put $100 a month away starting today, this could be a nice start to a retirement account.
What about Inflation?
Luckily for us, the Bank of Canada is constantly monitoring and adjusting interest rates to keep inflation fairly predictable around 2% increase each year. Financial planners assume that inflation will always be around 2% going forward. Therefore, the value of our current money will be 2% less next year which is why it is important to start investing your money to earn at least a 2% interest rate to counteract inflation. Currently, chequing and savings accounts aren’t paying interest rates this high so our best option is to invest in some of those Index Funds that average 7% interest per year.
7% interest - 2% inflation = net gains of 5% on average per year
Longterm investing will help protect the value of your money while also allowing you to create a nice stash of money savings.
How do I actually start investing?
Three main ways:
Investment Specialist/Financial Planner
Personal Brokerage Account
Robo-Investor
Investment Specialist: The traditional approach is to open a mutual funds account through your bank and work with an Investment specialist to allow them to manage your money on your behalf. The downside to this is the high cost of commissions: they take around 2% in commission fees which can add up over the 40 - 60 years you hope to be investing.
Personal Brokerage Accounts: are great since they have the lowest fees however they require the most knowledge of actual stocks, index funds, and ETFs to buy and sell. Therefore this is best for an investment enthusiast who is interested in keeping an eye on the market and adjusting their portfolio accordingly.
Robo-Investors: Finally, my personal favourite approach at this point is Robo-Investors. WealthSimple, NestWealth, and Mylo are some notable companies to check out. They have algorithms that monitor the market on your behalf and try to create an optimal balanced portfolio that adjusts automatically. It is virtually no work on your part and allows you to leave this up to the experts. Their commission fees are 0.5% which is much lower than a human advisor. They all basically share the same Modern Portfolio Theory of investing in low-cost index funds and ETFs for longterm growth.
Not my account…
My Process
I use WealthSimple and like the ease of use, modern app, and customer service. You can do a quick survey which then determines your risk tolerance level and will build a personalized portfolio for you. I have a biweekly automated withdrawal from my bank account into my TFSA. Automated withdrawals can be setup on the same day as your paycheque so you don’t feel the pain of it leaving your account - out of sight, out of mind. This is sort of a forced savings that reaps huge benefits in the future.
Since we’re focusing on longterm investing, it’s best to not check on the account too often (maybe once a month or so) as the market can highly fluctuate in the short term. Your account may be down $30 one day and up $70 the next all depending on the market so it’s best to forget about this account and not get discouraged. This approach allows you to invest the same amount every month whether the market is high or low, the long term gains will be seen in the future.
This is my approach and it certainly works for me, I like the hands-off approach so I don’t have to be constantly thinking about rebalancing my portfolio. Below is a referral link to my WealthSimple account, it simply gives both of us a certain amount of money managed for free for the first year.
https://wealthsimple.com/invite/USMWQQ
TFSA vs RRSP
Okay, so now you understand the principles of index funds, compound interest, and have chosen your investment platform. Now to decide whether to open a TFSA or RRSP. There’s pro’s and cons to both so I’ll briefly discuss each one.
TFSA
Tax Free Savings Accounts are fairly new in Canada and basically allow you to add a certain amount of money each year into the account and take it out at any point in your life, tax free. That means if you put $1000 in today, didn’t touch it for 40 years, it could become $16,000 due to compound interest. We could take out the $16,000 tax free and wouldn’t be counted towards our annual income for that year.
These accounts are great for when you’re young and still in the lowest tax bracket as you’re only paying 15% income tax on the $1000 when it goes into the account.
RRSP
Registered Retirement Savings Plans are different as whatever money you put into the account is deducted from your gross annual income and therefore you pay less taxes that year. However, if you take that money out in another year, you will have to pay taxes in it that year instead. So maybe we didn’t pay taxes on that $1000 this year, but in 40 years we’ll be paying taxes on the $16,000 it turned into.
The benefits to these accounts are if you’re in a higher tax bracket currently, you can offset your income by contributing more to your RRSP and paying less taxes in that income bracket. You instead wait until you are retired and are in a much lower income tax bracket to pay taxes at that point. Another added benefit is that many companies will match your contributions to an RRSP so if this is the case, it is beneficial to try and max out your payments to capitalize on the free money from your employer.
Pay Yourself First
This is an important lesson to remember: always pay yourself first. Every time you receive a paycheque, put some of it aside for future you. Anywhere from 10% - 25% is usually recommended. Just put it into your investment account and forget it ever existed, your 45 year old future self who was able to retire early due to compounding interest will thank you.
Personally, I take 25% of everything I make and invest it. This allows me to have piece of mind being a freelancer that there is always money available just in case I have a dry month or two of work. Once you start seeing this account increase month-over-month, you really don’t feel like taking it out again.
Thoughts
In closing, investing has been a game changer for me in how I think about my freelance career and my ability to semi-retire when I’m in my 40’s. It allows you to see the potential of compound interest and the effects of saving a little now to live comfortably tomorrow. Let me know if you have any questions, this post is barely scratching the surface.
References:
https://www.getsmarteraboutmoney.ca/calculators/compound-interest-calculator/
https://www.investopedia.com/ask/answers/042415/what-average-annual-return-sp-500.asp