Your grandparents had a stockbroker. Your parents had a mutual fund advisor. You have robo-advisors, online brokers, and newfangled investing apps. Thanks to technology and the democratization of investing, it has never been easier for Canadians to start investing today and avoid the many mistakes made by previous generations of investors.
If you’re new to investing, you’ve come to the right place. This article will teach you how to invest in Canada and build a low-cost, globally diversified, and risk-appropriate portfolio. You’ll learn the best investing approach for long-term, reliable outcomes.
Why do we even invest in the first place?
Valid question! Usually, it’s because we have specific goals to achieve, and investing helps us get there.
The obvious one is retirement. We need to save a bunch of money to support ourselves when we’re no longer collecting a paycheque.
But we’re also concerned about inflation. As the cost of living rises, it decreases the purchasing power of a dollar. As a recent example, the annual inflation rate in Canada was 3.4% as of May 2023. So if you keep your cash stashed under the mattress for 20 years, it will lose value over time.
Investing our money today helps us beat inflation and prevent it from watering down the potency of the dollar. It lets you take advantage of the magic of compound interest and thereby grow your savings so your future self can enjoy the same (or better) purchasing power tomorrow.
Before you jump into investing with both feet, it’s important to take a step back and establish your goals and priorities. Here are a few things to consider.
Deciding how much to invest isn’t simple, but your age is a good place to start.
A Fidelity study estimates that you need 10x your pre-retirement income saved by age 67 to maintain your lifestyle in retirement. Here’s a breakdown by age:
A general rule is to invest 10% of your gross income per year for retirement. But this depends on your income, too. Young investors living on a budget may only be able to afford to invest 3% to 5% of their gross income. Whereas late starters with higher incomes can be more aggressive, investing 15% to 25% of their salary to make up for lost time.
Obviously, if you start investing early, your money will have more time to compound and grow. If you’re in your 20s, you have time on your side and can start investing with very little money. For instance, an initial investment of $4,000 at age 23 may balloon to as much as $522,576.11 in 30 years (assuming 8% growth compounded monthly).
Here’s the million-dollar question: how much risk are you willing to take?
Every type of investment comes with a certain level of risk, which is often linked to the potential return. Generally speaking, the more risk you’re willing to take, the greater the return. A few examples:
Investing is a balancing act. The goal is to build a “risk-appropriate portfolio,” meaning a set of investments that match your risk tolerance. But how do you determine your risk tolerance?
Do some self-reflecting. Do market ups and downs make you feel pukey and panicked? Do you sleep better at night with a bond buffer in your portfolio? Or are you game to go “all-in” and build a portfolio of 100% stocks? Be realistic!
Consider your financial goals and your timeline to take risks. A recent university graduate’s portfolio will look different from a person close to retiring. In your 20s, you have decades to recover from a market crash, whereas a retiree could stand to lose their livelihood.
Once you’ve figured out how much loss you can stomach and afford, it will shape the makeup of your investment portfolio. Specifically, how much of it to allocate towards stocks and bonds. Here are some examples:
When constructing and rebalancing your portfolio, always remember that diversification is key. Never let your portfolio rely too heavily on a particular industry or bond type. A well-diversified portfolio is more sustainable and hedges you against unforeseen changes in the economy.
If you have no clue or your eyes are glazing over, don’t worry. There’s an easy solution. Just hand over the task to a robo-advisor.
A robo-advisor is a digital investment platform that can build a balanced investment portfolio to match your risk tolerance and goals. With a robo-advisor like Wealthsimple, all you have to do is answer an online questionnaire, and it will put together a risk-appropriate, diversified investment portfolio. It also does the work of managing your portfolio.
The jury is out: Research strongly supports that passive investing outperforms active investing over the long term. While active investing can sometimes outperform the market over shorter periods, consistently picking winning stocks is extremely difficult.
The bottom line: Taking a passive investing approach is typically more reliable and less costly than active investing. Building a risk-appropriate portfolio of low-cost, globally diversified index funds or ETFs is considered the best way to achieve long-term investment returns.
However, if you’re interested in exploring active investing, you can allocate a small portion of your portfolio (around 5% to 10%) for stock-picking or exploring other investment opportunities. Just be sure to do thorough research and consider value investing principles.
Once you’ve chosen your investing style, the next step is deciding what to invest in. Here’s a brief overview of some common investment options:
An exchange-traded fund (ETF) is an investment fund that allows investors to buy a diverse portfolio of individual stocks or bonds in one purchase.
ETFs trade on stock exchanges like individual stocks, with prices fluctuating throughout the trading day.
Investors benefit from capital gains on ETFs as well as profits distributed from the underlying assets, such as dividends and interest.
ETFs offer a low-cost, diversified investment option, making them suitable for various investment goals.
Risk level: Low to medium, depending on the underlying assets and market conditions.
Average returns: Typically align with the market they track, ranging from 6.2% to 7.8% per year.
Mutual funds pool investors’ money to invest in a diversified portfolio of stocks and/or bonds.
Managed by professional fund managers, mutual funds aim to generate returns through dividends, interest, and capital gains.
Mutual funds can be actively managed or passively managed (index funds).
Canadian investors often choose mutual funds, although they can have high fees ranging from 2% to 3%.
Risk level: Low to medium, depending on the fund’s asset allocation.
Average returns: Vary based on the fund’s performance and fees, typically ranging from 6.2% to 7.8% per year before fees.
Bonds are debt securities issued by governments, municipalities, or corporations, offering fixed interest payments over a specified term.
Considered safer than stocks, bonds provide stability to investment portfolios, especially during market downturns.
Investors can purchase individual bonds or invest in bond mutual funds or ETFs for diversification.
Risk level: Low, although sensitive to interest rate movements.
Average returns: Around 2.7% per year, offering lower returns compared to stocks.
GICs (Guaranteed Investment Certificates):
GICs offer a guaranteed interest rate over a fixed term, providing a secure investment option with predictable returns.
Ideal for short-term investing goals, GICs offer very low risk but also lower returns compared to other investments.
GICs are suitable for investors prioritizing capital preservation and steady income.
Risk level: Very low, with guaranteed returns.
Average returns: Typically around 2% or less per year.
Cryptocurrency is a digital, decentralized form of currency traded on various platforms.
Highly volatile and speculative, cryptocurrency investments offer potential for significant gains but also carry substantial risks.
Investors can trade cryptocurrencies like Bitcoin and Ethereum on exchanges or through investment platforms.
Cryptocurrency investing requires careful research and risk management due to its unpredictable nature.
Risk level: Very high, with potential for extreme ups and downs.
Average returns: Highly variable and speculative, with no guaranteed returns.
In summary, investors should consider their risk tolerance, investment goals, and time horizon when choosing between these investment options. Diversification across asset classes can help mitigate risk and optimize returns over the long term.
When deciding which account to invest in, consider factors such as your financial goals, income level, and tax considerations. Here’s a breakdown of popular investment accounts in Canada:
With careful planning and informed decision-making, you can build a strong investment portfolio to achieve your financial objectives.
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