The Canadian Money Roadmap

Tips For A Beginner Investor

August 30, 2023 Evan Neufeld, CFP® Episode 96
The Canadian Money Roadmap
Tips For A Beginner Investor
Show Notes Transcript Chapter Markers

I receive lots of emails from listeners asking questions but I rarely receive emails from 17 year olds trying to get a jump on their investing knowledge before turning 18! This episode goes over some of the amazing questions I received from a person completely new to investing and I hope it is valuable to anyone else getting started on their investing journey. 


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Speaker 1:

Hello and welcome back to the Canadian Money Roadmap Podcast. I'm your host, evan Newfield. On today's episode, I'm going to be answering a few questions that I've received recently. Most of them are applicable for new investors or people that have asked the same questions about different things like rates of return and understanding some of the basics and fundamental elements of investing. So if you're new to investing or if you had some questions that maybe you're too scared to ask, this episode is going to be great for you. Welcome back to the show. If you've never listened to my podcast before, welcome here. This episode is going to be great for people that are new to investing, but also those of you that have been investing for a long time. I'm going to go through a few questions that I received and a great email just this past week, and I thought it was so good that I needed to make an entire episode about it, because if one person is asking these questions, I suspect there are many of you who perhaps aren't so brave that are asking the same things, and so this email came from someone named Tessa, and Tessa is still in school and she wants to get a head start on understanding her money and understanding investing so that when she's in university and eventually earning an income, that she'll be a few steps ahead and able to make some good decisions with her money. So I emailed Tessa back and saying hey, I'm going to answer all your questions in the next episode of the podcast, and so I was actually really impressed that, tessa, if you're listening to this one, I was really impressed that you put together this very well worded and thoughtful email and, even though you're new to finance and investing, these are very well thought out questions and they're good ones to ask. So I'm going to get into the first one here. First question says first in the podcast and she's referencing my TFSA millionaire podcast from a few episodes ago she says you mentioned rates of return. I've come to understand that these rates of return only apply if you're using the TFSA to make some sort of alternative investment, such as index funds. Is this correct? Yes, so the TFSA, to clarify, is not an investment itself. It is just like a bucket that can have investments in it and, typically speaking, the general rule of thumb that you can use is that an investment usually has a component of risk to it, which means that it might not work out in your favor, at least perhaps in the short term. And so, just like anything in life, if it's not hard, it's not worth doing. If your money is just going to sit there in cash, it's probably not going to earn you anything. No risk, no reward, that whole kind of thing. So to get any sort of rate of return, typically some measure of risk has to be applied to that investment, and so that means that in any given year, your investment might be worth more, it might be worth less, and that could be true from day to day as well as year to year. And so, yes, if you're using a TFSA to invest, to get any sort of rate of return you'll have to be invested in something you mentioned index funds, that would be one, but any other sort of investment strategies. So an index fund is a specific investment strategy, so that can be an ETF or a mutual fund, but that is just an investment strategy that takes a look at an index, which is just a group of stocks. So the S&P 500, for example, it's essentially the 500 largest stocks in the United States. That is an index, and a fund or an ETF that tracks that index will just own all of those stocks. So Apple, microsoft, nvidia, coca-cola, walmart, home Depot, all those kind of Nike, all these big companies in the US that you have heard of before would be part of that, and so that's an index fund. But there's many other investment strategies that you could use. I'm not going to specifically advocate for one type of investing or not on in this context, but, yes, to get a rate of return, your money needs to be invested. So her second question says if one becomes a millionaire by investing 6,500 a year for 20 plus years, is the average 6% return synonymous with the quote compounding interest term that I hear so often? Lots to unpack here and so in that episode, unfortunately, I'll have to clarify, test the detail there. If you're doing 6,500 a year, it's going to take more, like 40 years. This is not a get rich quick podcast by any means. This is kind of a tried and true pick away at it, grow it over time kind of approach. If you get 6% a year and you invest 6500, it'll take you about 40 years to be able to get to a million bucks in the TFSA. But that is the typical working life of the average Canadian. So I don't think it's completely outrageous to talk about that. But if you're looking to get rich quick, yeah, that's not it and this probably isn't your podcast. But yes, the 6% rate of return is just a number I pulled out of the air. This is not any sort of guarantee or anything like that. That's just an assumption that we use to do simple calculations. But if you use that rate of return, the idea that you're mentioning of compound interest is what we're referring to there. Now, one clarification that is like a huge bugaboo of mine is that the term compound interest interest is the word there that I'm that I have a problem with, because when you're investing in the stock market, you don't earn interest from that. Interest is a specific thing. Interest is a payment received. Okay, so when you have money in the bank, the bank pays you interest. If you are taking out a loan, you pay the bank interest. If you own a bond, you get interest. However, if you're in the stock market, there's no interest involved. The payments that you can receive in the stock world are dividends, and those are different. Okay, so the term compound interest is not applicable unless you're a GIC investor, essentially because when bonds pay interest, they don't compound. They're called coupons, and if your bond pays a certain rate, it'll pay that same amount for the entire duration of the bond. It doesn't compound on itself. So compound interest is this goofy term that should never have been ubiquitous like it is now. Should we compound growth right? Because when we invest in the stock market, typically the way that you make money is on a price appreciation, meaning the price of your investment increasing. That has nothing to do with interest and this isn't a silly question. This is probably the most common thing that people get wrong when it comes to terminology of investing. Compound growth makes much more sense because there's no interest involved in the stock market and when the price goes up by 6% per year hypothetically it's never going to happen, but say it did there's no interest involved. So this would be compound growth. But yes, the idea that compounding is involved here just means that when something grows the next year, there's growth on top of the growth, on top of the growth on top of the growth. That's the compounding principle at play here. But I thought it was worth clarifying that interest is a specific payment. So my former colleague here at the office we live in the in the prairies here, so there's a few more people in agriculture that would maybe get this reference. I'm the last person that can make a great farming reference, but anyways, here we go. He says that interest is kind of like if you've got a big bin full of wheat. Receiving interest is like adding more wheat in the bin Capital gains or price appreciation. So value increasing is if the price of wheat increased, the amount of wheat in your bin doesn't change but the value of it goes up because the price went up. Okay, so when you're investing in the stock market you might receive some dividends. That's a little bit more wheat in the bin but has nothing to do with the price. In reality, when you receive a dividend, the price actually goes down. So you end up with about the same net net amount anyways. But when you're a long-term investor, getting a regular return on your money will compound, meaning the growth that you had last year will grow on top of this one, and some years it'll go down for sure. But the principle applies over a long period of time. So I've kind of been skirting around the next question here. But the next question says furthermore, if this is true, can you rely on this rate to always be positive? And I will say that with another always statement. It's like actually, you can rely on it to always be variable and you will not always have a positive rate of return when you're investing in the stock market. It's just not true. It won't happen. Even if you get an average rate of return of 6%, that means you cannot rely on it being 6% every year. It's almost never 6% per year in the truth be told here. So let me give you an example. So a really popular ETF that it invests in a variety of indexes as the Vanguard Growth ETF portfolio, or VGRO VGRO Again, this is not advocating for it, just explaining what it is and some characteristics here. Over the last five years, it has averaged almost exactly 6%. Yes, I cherry picked this so I could use that number of 5.94% per year over the last five years. Again, that's compounded rate of return. But the way to get that 5.94% over the last five years came along with something like this. I don't have data for 2018 here because it launched partway through 2018, so I don't have full your data on that, but it was about flat to negative in 2018. And then in 2019, it was 17.77%, 2020, 10.88%, 2021, 14.82% and last year it was down, so negative 11.17%. And then it's back up about 8.25% so far this year. This is as of August 25th, and so the first year. If you put your money in the first day that this fund launched, you lost money and then you made way more than 6% for the next three years and then lost 11% last year and then you're back up a little bit more than that this year. So you average about 6, but it comes along with some spikes and dips along the way. Now, the unique thing too is that those are just end of year or like full year numbers and in reality, like a January to December 31st time period is completely random, right? Like if we did a June to June, those numbers would look very, very different, right? Because the price moves every single day and there will be periods of time that, even though the full year ends up being positive, in the middle of the year it might be quite negative. For example, last year, even though the year ended down 11% for this specific ETF, from January 1st of last year to September 30th. So in the nine month period it was down 16%, right? So there are going to be periods of time where things do not look like this great 6% per year, just chugging along kind of thing. By no means. That is the risk and reward tradeoff that comes along with investing. So, because there are periods of time where it is not positive, that leads to what we call the equity premium. Meaning the benefit of investing in equities or stocks in the first place is that you have to be along for the ride, and the ride involves a few bumps. For sure, the longer you invest, the less the bumps matter as much in terms of your total returns, but that might be a different topic. Okay, that's another question here from from Teza's email. Does it matter if one invests monthly or could they put in a lump sum of, say, 6500? This is current TFSA max rules 6500 at the beginning of the year and get it off their plate? Yes, both options are totally possible. So the first option that you suggest as monthly is very, very common, mostly because people get paid every month and they're not just sitting on cash waiting to dump it into an investment or something like that. So people usually invest monthly just because that's when they get paid. But theoretically, if you had money to invest all at once, there's a lot of research and data that's out there on this idea Investing on a regular basis is called dollar cost averaging. That's a bit of a mumbo jumbo language here, but the more often you invest, even if it goes up and it goes down, you'll end up getting the average price over that term. The data says more often than not, if you have the money to invest, you'd be better off investing it all in a lump sum up front, because the data also says that the stock market is positive more often than it is negative. So it is definitely possible to get the timing wrong by doing that. However, the odds would say that you're more likely to make more money by investing it all in a lump sum. So there's no right answer here, because you can only know the right answer in hindsight. If you want to play the odds, invest your money as soon as you have it, but if you're playing for something that's a little bit more comfortable, or you're investing through cash flow meaning when you get paid investing on a regular basis might be a nicer way to smooth out that investing experience over time. It definitely decreases your risk of getting your timing wrong, but the odds are better than a coin toss of you coming out ahead by getting your money in the market longer. So I'm not an advocate for timing the market, for thinking like, oh, it's going to crash tomorrow. I shouldn't. You know, whatever, no one does that. No one gets it right. Don't bother doing that. Just pick a lane either decide you're going to invest as soon as you have it or invest on a systematic way on a regular basis. Both of them you'll probably be just fine, but you'll decrease some of your volatility by investing regularly, even if you end up with a little bit less statistically over time. Next question is it possible or what? If an index fund fails and one is at the age of retirement, would all of their invested money be gone? Good question. I won't get into all the different levels of insurance or things like that, the parties at play here. I will just highlight the concept of an ETF and a mutual fund and investing in the stock market as a reminder of what it actually is. It's so easy to just see this as blips and blobs and numbers on a screen these days, but when you invest in the stock market that's either if you own individual stocks or if you buy ETFs or mutual funds what you're actually doing is owning a piece of business In the case of ETFs and mutual funds. You're owning a piece of many businesses. So back to my example of the S&P 500, apple is the largest company in there. It's the largest company in the world by quite a bit. When you buy the S&P 500, you're not buying some esoteric financial product. What you're doing is actually owning a piece of Apple. You're owning a piece of Microsoft. You're owning a piece of Tesla. Those are the businesses that you are actually owning. So an index fund failing in your example, where you're left with nothing, that means every single company in your fund, in the index or whatever you're doing, every single one of those companies has to be with the zero at the same time, and if that's happening, we've got bigger problems than you having a retirement. So this is the idea of specific company risk and diversification. So this is not the question you're asking, but when you do this, the odds of all of those companies being worth absolutely zero on the same day is statistically impossible. And so, essentially, by diversifying, by owning a bunch of stocks all at the same time through index funds, even active strategies, doesn't matter the chances of those being worth zero is statistically impossible. And so, by diversifying, you've diversified away any specific company risk and now you just have market risk. So I don't see this as a concern that you should have when you're investing in diversified investments, because you're buying real businesses that sell products and services that people actually buy, it's not some casino that you're just dropping money in, okay. So remember you're buying businesses when you're investing in the stock market. It's kind of cool, it's really neat, but it's also very easy to forget what you're actually doing. And so what's much more likely is that you get to the age of retirement and you get some particularly bad luck and you have one of those years where the stock market in general, or the index or whatever you're doing, is down at a really bad time, and say, you get to retirement and the stock market happens to be down 25% that year, and now you're living off your own investment, so you got to start withdrawing from it. Now the thing to remember there is that when you retire, you don't spend every dollar that you own on the day you retire. Right, you probably withdraw a few thousand bucks a month on a regular basis and kind of pick away at it. So no, it's not good to withdraw when the stock market is down, but that's part of the risk that you enter when you retire and you live off what you have. So that is a risk, and so what typically happens is that, especially if you work with a professional, they will typically start decreasing the amount of investment risk that you have in your portfolio the closer you get to retirement. This is a really common strategy that most workplace investment plans have, or target date investments if you've ever heard of that where things get more conservative over time. The reason for that is that if you're invested in 100% stocks, you could do really really well, and there's some people that really believe that you should be invested in stocks only. But you expose yourself to significant risks, potentially at really bad times. And so if you've, perhaps as a younger person, you have more of your money in stocks and then, as you get closer to retirement, you have a little bit more in bonds and you kind of keep going down that trajectory, over time the volatility of your portfolio will go down, so it decreases that risk of you retiring at a potentially bad time. I would work with a professional to set up an investment approach that works for you and what you need. So I'm not going to give any blanket advice here. But that is a risk for sure of retiring potentially at a bad time when your investments are down. I would pretty safely say that if you are invested in index funds as a strategy or any sort of diversified portfolio that the idea of those failing is so small a risk, it should not occupy a whole lot of mental capacity for you. I'm not going to say it's zero, but everything has a measure of risk, I guess. The last question here I'll kind of summarize essentially she's going to start going to university and has some expenses. It's going to be pretty expensive, it sounds like, but she's going to be working and earning some money. So she says should someone in my shoes invest in index funds at age 18 and which ones with this person be setting themselves up for failure? Would someone in my position be better off with a GIC? Unfortunately these are really specific to you as a person and I cannot give specific investment advice or securities that you should be buying on a podcast or outside of a professional engagement. But I will address the idea of investment purpose and investment timeline. So if you are looking to invest in a TFSA for the purpose of covering your expenses while you're in school, I would say please do not do that. I would also say please do not invest in a GIC, because that will lock up your money for that period of time. You can get something called a cashable GIC, but the rates of return on them aren't really that great. I would probably just use a high interest savings account or something like a money market mutual fund which pays a good amount of interest yes, interest, an actual payment that you receive. So that's more of a question of timeline than it is specific investment products. So if your timeline is short, meaning you're going to be spending that money on a known timeline, the less risk you should expose yourself to. An index fund definitely has risk. I kind of get this vibe a lot of the time from people that are learning investing that it's because it's recommended so wholeheartedly on the internet. Everybody should be invested in index funds. They're not safe, meaning they'll decrease in value along with the stock market. There's no guarantees that come along with them or anything like that. It diversified, which is great, but it's not risk-free in terms of the decline in value. So say you mentioned having $100,000 of cost over the whole of your school year. That's tuition, room and board, the whole thing. What if your invested money was worth 80,000? Oh crap. Now that's a pretty standard decline in investments, say 20%, but you can't afford that because now you have to come up with another $20,000. So if you are investing over a very short period of time, exposing yourself to any sort of price volatility or changes is not something I would recommend. So index funds or stock or bond investing at all would not be something that I would recommend in general over a short period of time. Over a longer period, if you want to start investing for retirement when you're 18 or a little bit older, that's just fine. Most people just don't have the cash to be able to do that. But if the purpose there and your intended timeline is much longer than the next four years, say maybe the next 40, then yeah, having some investment risk and investing in the stock market and that's where index funds can come into play for some people that would be a much better option, given that timeline Again, goal and timeline are really important to determine how you should be investing. So would someone in my position be better off with a GIC? I just GICs. I think they might have their place, but man, they're rarely a great deal because most people can't afford to lock up their money and have no flexibility on it. And if the rates are that attractive, you can probably get very similar rates in something that isn't locked in these days and it's probably representative of a situation where the potential future returns on the stock market are probably gonna be better. But that's a bit more of an advanced topic for another day. But a GIC, I guess, would be fine if you have a known amount of money that you need over a known amount of time. So you say, okay, well, I've got 20 grand today and I need that same 20 grand, or maybe a little bit more, in three years, and I just wanna get out of my own way. Sure, gic might be a good option there, but historically speaking, the rates on GICs haven't been that great compared to any sort of alternative that has what we call liquidity, meaning the ability to spend it. So, yeah, if you're saving up money to cover off your cost to school, I would say you want more flexibility and worrying about a rate of return on that money, that shouldn't be the main focus. So, anyways, that was a lot to cover off here, but a lot of questions that I have received from other new investors and I've received a lot of emails lately from people that are beginner investors, and I had a little poll on Spotify recently asking about what content you would like to see, and the responses were pretty even across the board, except for more content on TFSAs and investing for beginners. Those were the two winners. So I hope I'm scratching the edge for any of you that were asking for more of that. If you are a new investor or you're new to Canada, I've got a few of those questions recently. If you're a new Canadian and you've got specific questions, send me an email at hello at evannewfieldcom. I'd love to add those to another episode coming up in the future. I appreciate all the emails that I've received lately lots of them. I've got some great episodes coming up. I've got a few other guests that I think are gonna be a big hit coming up in the very near future and a very special episode that I've recorded a while ago but I wanted to save it for my 100th episode. So that's coming up at the end of September. So if you're new to the podcast, subscribe to hear more episodes just like this going forward. I'd love to get feedback from you, so send me that email. Send me your questions and I'll be sure to add them to the lineup for future episodes. Thanks again for listening and we'll see you next week. Thanks for listening to this episode of the Canadian Money Roadmap Podcast. Any rates of return or investments discussed are historical or hypothetical and are intended to be used for educational purposes only. You should always consult with your financial, legal and tax advisors before making changes to your financial plan. Evan Neufeld is a certified financial planner and registered investment fund advisor. Mutual funds and ETFs are provided by Sterling Mutuals Inc.

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