Investing Is Hard And I Don’t Have Any Money: Savings Basics For Young Canadians
Saving money for your future self, decades out in front of you, is harder than spending it on your present self. An extra cupcake, a new pair of jeans, or a week in Cuba, look a lot better than figuring out how much money you’ll need per year when you’re in your 60s so you can figure out how much you need to start saving now to get there. You see what I mean? Drudgery. It’s the difference between delight and feeling like you need to climb a mountain just to keep up.
The term, ‘investing’, carries heavy mathematical connotations that are repellent to a large number of people. None of that here, let me assure you. It also feels, somewhat counterintuitively, that investing is only something people relatively well-off can participate in. Let me settle it now: this is false. You can start with as little as $100. So no more of not bothering, figuring it’ll be OK if you get to it next year, or the one after. Because it won’t be. What we’re talking about is learning how to make your savings grow, all on their own, while you get on with your life. It’s what I hope to teach you by the end of this. This isn’t a con or a scam, it just takes a little effort, so many don’t end up taking advantage until they get jobs that offer retirement plans.
I’m going to keep it simple and divide sections into small, manageable parts. I’m also going to try and make all of this tangible for you, the benefits all up in your face so you can’t miss them. Prepare to have the daunting, mysterious, and complex subject of investing unwound into delightfully breezy prose. Here we go. Do not read it all at once.
What is investing?
Investing means buying shares, or ownership stakes, in things that have the potential to grow in value over time, i.e. assets. The two basic assets young people need to know about, besides their ability to educate themselves and earn more money, are stocks and bonds.
A stock or equity represents the value of a business so that people can buy and sell it. It is priced per share, and the total number of shares of stock equals the whole business. The more shares of stock you own, the greater the profits or losses you will be entitled to as the business grows or shrinks. If the business does well, the share price will go up. If the business loses money or experiences a change in reputation, investors will sell their shares and prices will go down. Moment to moment, the movement of the share price is simply the result of every buy order and every sell order as they come in.
Over 600,000 companies’ stocks are bought and sold electronically in public markets, or exchanges, like the Toronto Stock Exchange, the Johannesburg Stock Exchange, the Tokyo Stock Exchange, and so on around the globe. Because they’re public, that means anyone can go online and buy shares in them (more on how later). It’s by buying their bonds and shares that most people save for retirement. And no matter the country, you have loads of leading businesses to choose from. Here are three homegrown examples.
As of the time of writing, Canadian Tire’s stock sits at $137.71 per share, with 58,236,464 shares currently owned by investors.
Scotiabank’s stock is priced at $72.08 per share, with 1,220, 414, 624 shares currently owned by different investors.
Shopify, the e-commerce platform, sells for $501.70 per share, with 100, 282, 712 shares owned by investors.
A bond is a loan, or fixed income instrument, issued by a government or a business, and taken on by everyday investors, like you and me, or by institutions that invest on behalf of large numbers of people, like pensions, investment funds, and insurance companies.
There are no term limits on bonds, but they tend to be for 30 days up to 100 years if the borrower has reasons to believe they’ll still be around—which is likely if you’re a country. In exchange for the money bond buyers loan out, which they’ll get back at the end of the term, they’ll also receive an interest payment, usually monthly or quarterly, totalling yearly to a percentage of the bond price – right now, we’re talking 1% to 4% or so in Canada depending on the type of bond and the length of its term. The exact interest payment bond buyers receive depends, among other things, on how likely it is that the borrower can actually pay them back. The less likely, the higher the interest payment, and vice versa. For example, if you buy a $1000 Dollarama bond that pays 4% on a quarterly basis, you’ll receive $10 every 3 months for a total of $40 a year.
Stocks used to be issued in paper form. This one’s for one share of Disney.
Stocks are riskier—pose a greater possibility of permanent loss—than bonds for a slew of reasons, but the main two follow below.
- Developed governments rarely crumble, therefore their bonds tend to be more stable sources of income for those who hold them. Companies, on the other hand, go out of business all the time, and with them, their stocks and bonds;
- Yet, if a company does go out of business, its bondholders have first rights to the company’s assets to get their money back. Stockholders get what’s left after bondholders have been paid back.
Because they are riskier, a global portfolio of stocks offers a higher return on your money over the long term (think: minimum 10 yrs to your working lifetime), in the vicinity of 6% per year, compared to a global portfolio of bonds at 3% a year or so. Stocks are volatile savings instruments. You could lose money.
In the late 1920s to the early 1930s, the stock market in the United States lost over 80% of its value; in 1989 it lost 20% in a day; and in 2008-09, it halved. Yet, over the last 100 years, U.S. stocks still managed a return that flirts with 10% per year.
In the 1980s, Japan experienced tremendous economic growth, and stock prices tripled pretty much across the board. Then, in 1991-2, the market crashed with such ferocity that today it has yet to fully recover.
During the 2008-9 financial crisis that began in the United States, Canada’s stock market followed its neighbour straight down over 40%.
Bonds, on the other hand, aren’t likely to fluctuate more than a handful of percentage points over the long term. There are, of course, always exceptions, such as when inflation runs amok.
It takes willpower to ignore these price fluctuations, which can last for years, even if you know they’re coming, and that they’re a normal part of investing. Sometimes, when the world seems to be in more turmoil than usual, stock owners get spooked, sell their holdings, and move to bonds for safety, thinking they might lose it all because of Brexit or Trump or something else in the news. They forget that there has never been a meaningful time in human history when large-scale conflict or hardship has been absent. Mass selling, of course, causes prices to drop and investments to lose value.
This is why we diversify. The principle of spreading your investments around, across countries, industries, and asset classes, goes by the name of diversification. We put it into practice as a protective measure. If our developed international stocks (Europe, Japan, Australia) aren’t performing well, we still have ones in Canada, the US, and emerging markets (China, India, Brazil, Russia, etc.) to pick up the slack. If stocks are underperforming, bonds are likely going to do better as the two are uncorrelated. Having an asset class doing well in your portfolio can make a tangible difference in an investor’s life, for example if they retire during a bad year in the stock market, and need to live off their bonds for the next few years while stocks recover.
The key to being a successful long-term investor is noticing when people are afraid and selling, and meeting their fear with bravery, as you buy more shares at cheap prices, knowing full well that no war, or trade war, or your choice of catastrophe, short of an actual apocalypse, has ever stopped the development of humanity and technology along with it. Every stock and/or bond market crash has been followed by a subsequent recovery. That doesn’t mean every company or country—remember Japan from a few paragraphs ago—participates in that recovery, just that global markets as a whole return to fair value, or revert to the mean, over long periods of time. If only there were a way to buy shares in the stocks and bonds of every significant company in the world and ride the progress of industry toward heftier savings and a more comfortable retirement.
Because picking individual businesses and bonds to invest in is a full-time job, most people invest using funds. A fund groups together stocks, bonds, and/or other assets, according to a specific investment strategy. Investors pay a yearly fee, expressed as a percentage of the money they have invested, for the privilege of participating in the fund assets’ potential for rising in value. The strategy most apt for everyday investors like you and me is called indexing.
Indexing means creating a fund that mimics a group of assets, or index, chosen to represent something. That index could track, for example, the business operations of an entire country, the entire world, a specific industry within a country, or companies that fit into a certain investment strategy.
You can buy a Canadian index fund that tracks the Canadian stock market, owning stakes in established businesses like RBC, Bell, Suncor Energy, and Canadian National Railway, grouped according to their size in Canada’s economy. Whatever the Canadian industrial complex does, the fund will do, up or down. Example: FTSE Canada All Cap Index ETF(1). Don’t worry if some numbers and abbreviations don’t make sense yet. Just have a look around the page.
You can buy an index fund that only invests in the stocks of infrastructure projects like highways, bridges, and energy factories. Example: AGFiQ Enhanced Global Infrastructure ETF.
You could invest in an index fund that tracks companies with good records in the areas of environmentalism, societal contributions, and internal governance. Example: Fidelity Sustainable World ETF.
You could invest in a fund that owns small stakes in major businesses in every investable country on the planet. Example: Vanguard Growth ETF Portfolio.
It’s that last category we’re interested in here. Over the long term, we want to participate in the industrial progress of the world through a diversified set of index funds.
(1) The term ETF stands for Exchange-Traded Fund. Some funds, like ETFs, trade on a stock exchange, while others, like mutual funds, do not. Trading on exchanges makes ETFs cheaper and more efficient for reasons you can dive into here if you are so compelled.
Why should I invest?
The reasons abound. It’s helpful to lay them out: retirement, a vacation, a car, a house, to start a business, to pay for school, so your kids can have a cushion when it finally comes time to move out. There’s no wrong answer, you just need to know why you want to grow your money.
If you are reading this, and you are under 30 years old, you are one lucky person. You have most of your working life ahead of you to save and let your investments grow. To put that in perspective, if you start investing $100 a month at age 30 in a portfolio that charges a reasonable yearly fee of 0.25%(2) of money invested, and the money grows at 6% per year, and you keep it up until 65, you’d have a little over $157,000 by the end. If, instead, you started when you were 40, you’d only have $73,229. If you up contributions to $500 a month, the total at 65 is $690,338.46. Here’s the compound interest calculator I used to get these numbers. It shows you how investments grow over time. Play around with it and see how much you can afford to save.
(2) Investment fund fees are generally calculated daily and charged monthly.
How do I invest?
The reason(s) you choose determines how you should go about investing. It tells you your time horizon, or how long you have to invest, which guides you in terms of the appropriate amount of risk to take.
Remember that risk means probability of losing money. To give you a visual example, take a look at these model stock and bond portfolios by PWL Capital, a Canadian money management firm that works with millionaires but spends a lot of its time educating everyday investors through blogs and podcasts, like Canadian Couch Potato and Canadian Portfolio Manager. Pay special attention to the lowest one-year return toward the bottom, which is the most money the funds lost in a 12-month timeframe, expressed in percentage terms. This is a measure of a worst-case scenario for the funds, the worst bump on the road over the last two decades. This way you have an idea what to expect as you hold the fund until retirement. Also look at the annualized return projected(3) over 20 years, which is the money you made per year by holding the funds over that time, expressed as a percentage. This number represents why regular saving and investing is worth it over the very long term. All you have to do is compare the 5.82% yearly return from a portfolio of 80% stocks and 20% bonds to a chequing account from a major bank today, which gets you about a 0.01% return every single month.
Now, say you’re investing for retirement. Since you’re young, let’s suppose that’s 2-4 decades away. Which portfolio should you choose? One with more bonds, because it’s lowest one-year drawdown (i.e. loss) over the last 20 years of 3.87% is less painful, or one with more stock funds, because a 30.72% drawdown means you can buy more shares for cheaper, with decades left to save? It stands to reason that it’s the latter.
But, if you need your money in less than five years to pay for school or a trip, something shorter term, then anything but bonds could be too much of a risk. The risk of losing 3.87% of your investment in a year, which is what you open yourself up to by investing in a portfolio of 80% bonds and 20% stocks, is much easier to stomach in this case than going into all stocks, possibly losing a third or more of your investment in a year, and not having the luxury of time to wait for the markets to recover.
You also need to think about your own emotions. Would you be able to withstand a stock market crash, like the one in 2008 initiated by the US housing market—where mortgage issuers carelessly handed out mortgages to people of modest means, knowing full-well they wouldn’t be able to keep up with payments—and see your holdings cut by over 50% in 18 months? Would you be able to stay the course until the market recovered without getting spooked and selling? If not, you should minimize your percentage in stocks, and up your bonds, until that feeling goes away(4).
Rationally, you may know that the stock market sometimes crashes, your investments might drop substantially, and that the only way to get through this is by holding on, owning an appropriate percentage of bonds, and continuing to invest regularly. Emotionally, though, you might find yourself betraying your better judgement. Money enables survival, so when it’s at stake, we can’t always be trusted to think clearly. If the thought of losing money robs you of sleep at night, the low and comparatively steady returns of a bond fund may be where you max out on risk. And that’s OK if it’s the only way you’ll sleep at night; you will just have to save more. The percentage of stocks and bonds you decide on is called your asset allocation.
A helpful rule is that, if you’re investing for retirement, your allocation to bonds should increase the closer you get to not working. As we learned earlier, bonds are less risky. You’ll want the money you’ve saved over the years to be relatively safe as you spend it down, relishing your golden years as you see fit.
If you’re young, it’s likely that maximizing investment returns toward a certain goal is a top priority. That would entail a higher allocation to stocks. Something like 80% stocks and 20% bonds is a common allocation for a 30-year-old with decades to compound their money. You open yourself up to more risk that way—the value of your stock funds will move up and down a lot in the short term, but a diversified portfolio should compensate you over a decade or more.
Having decided on an asset allocation, you can now consider if indexing’s counterpart is of interest to you. Allow me to level with you. In Canada, most investors are not indexers. They put their money into funds that practice what is called active management, or the pursuit of better returns than an index, usually through strategically buying and selling assets that deviate from it. What I mean by ‘strategy’ here is timing of the stock and bond markets. Researching companies and economies enough that you think you can forecast their future with enough accuracy to put money on it.
The problem here is that, over decades, the vast majority of active managers can’t beat their chosen index benchmarks. This is due to their, on average, very high fees, with most sitting between 1% to 3% or so of total money invested, per year. Compare this to the average index fund that charges 0.2%. The problem is also due to human nature and how greed and fear are hard to remove from anyone’s focus as an investor.
Suppose you put $20,000 in a stock index fund that tracks the whole world and charges 0.25% a year, and you put another $20,000 in an active global stock fund, whose manager is able to pick any stocks they want to try to beat our index, but charges 1.5% a year. If we project those investments over the next 20 years and assign them a 6% annual return, here’s what occurs: you end up with $64,701 from the index fund, and $50,408 from the active fund. That’s a 71.5% difference in terms of the money that ends up in your pocket.
I’m not flatly dismissing activate managers, because a few are able to outperform their chosen indices; it’s simply that we, as young accumulators, tend to not have the hours to research and locate them consistently, or we don’t have access to them. We’d need a handful more zeroes at the end of our balances to earn a glance. But that’s OK. The returns of the public global stock and bond markets are more than enough to meet our big-picture goals.
When index funds became public in the 1970’s thanks to John Bogle, active managers rightly viewed them as a threat to their fees. They were so scared, they put out ads like this one.
If you’ve just discovered that you’re an active investor at heart, eager to analyze companies and buy shares in the ones you think will do well over time, I wish you more than luck. To those remaining, it’s time to decide the funds that best suit your needs.
Flip through selections from leading firms in low-cost indexing, such as Vanguard, RBC and Blackrock, Horizons (hover over the benchmark section) and BMO. You’ll find that some of these products are actively managed. Anything that says ‘plus’, ‘enhanced’ or ‘strategic’ is a giveaway. Sample at your peril. Each fund you click on will offer you stats in terms of historical returns, portfolio holdings, and fees. The indexes needed for a global portfolio go by specific names:
- S&P/TSX Composite Index or Canadian All Cap is the Canadian stock market: Vanguard, Ishares, BMO.
- US Total Market Index or S&P 500 Index denote broad US funds: Vanguard, Ishares, Horizons, BMO.
- EAFE (Europe, Asia, Far East) or Developed International countries refer to Europe, Australia and the UK: Vanguard, Ishares, Horizons, BMO.
- An Emerging Markets index tracks developing countries like Colombia, Saudi Arabia, and Thailand: Vanguard, Ishares, BMO.
- In terms of bond funds, what you’re looking for is a Canadian aggregate bond index fund or a global bond index fund: Vanguard, Ishares, Horizons, BMO.
There are lots of possible fund combinations, but the simpler the portfolio the better. You could go the Canadian Couch Potato way, choosing one Canadian index fund, like VCN, plus a World minus Canada stock fund, like XAW, and a Canadian bond fund, like ZAG. You could also buy shares of a fund that holds a set of funds that come pre-divided into your choice of asset allocation. Vanguard and BMO offer their own versions. For example, Vanguard’s Growth ETF Portfolio, which trades under the symbol VGRO, offers a portfolio of 80% stocks and 20% bonds. It reaches these numbers by holding six index funds equivalent to about 30% in the US stocks, 25% in Canadian stocks, 17% in developed international stocks, 6% in emerging markets, 5% in developed international bonds, 5% in US bonds, and 12% in Canadian bonds. Each time you buy a share of VGRO, you get a proportional percentage of each index fund.
There are no wrong answers to your asset allocation, so long as you get the proportions that suit your goals and risk tolerance. Here’s a quick run through global allocation strategy with a word on fees.
- The US has the safest and best regulated stock market in the world, while accounting for half of the world’s stock market activity. That’s why most model portfolios will be about 50% in the US. The cheapest US index funds charge 0.15% or so.
- Canadian stocks live in the 20% to 30% range because the Canadian dollar is the currency we most often transact in. The cheapest broad indices clock in at 0.05%.
- Developed international stocks tend to hover within 10%-20% of a portfolio. Fees for broad indices start at 0.20%.
- Emerging markets are stock markets that are only finding their way. Regulation can be poor and the number of investors small, but the potential for growth easily surpasses anywhere else. You see 5% to 15% in most model portfolios. Over the long term, given how India and China are barreling toward superpower status, there’s an argument that the percentage could be a lot higher. Fees for broad emerging market index funds are in the vicinity of 0.25%.
- Canadian aggregate bond funds cost around 0.1%-0.2%, while a global bond fund shouldn’t cost more than 0.5%. The percentage of bonds in your portfolio depends on your risk tolerance and investment time horizon.
How am I supposed to evaluate which funds are better? You may be asking. How are they different? Good questions. If you clicked on any of the fund names above, you may have noticed that fund companies supply information in terms of objective, performance, and which companies’ stocks are held in a given fund. This is a good place to start. Let me put it this way, though. Sure, there will be different indexing methods among funds that claim to cover the same section of the global stock market. Canadian Index Fund One and Canadian Index Fund Two may track different indices that exist for the same purpose and thus own different stocks. Investment companies do work according to their own internal rules and in-house experts. That being said, divergence among similar broad index funds isn’t worth losing sleep over, so long as they are chosen as a component of a globally diversified portfolio as discussed above. Over decades, differences in returns should average out.
In terms of index fund fees, cheaper is generally better, because all the funds are doing is buying the same assets in their respective indices. A Canadian index fund will own leading Canadian businesses as per the index it tracks. If Bell, for example, goes bankrupt, it will be removed from the TSX Index and replaced with another business. This means the fund that tracks the index will have to sell its Bell stock and buy the new company’s. Swaps don’t happen very often with country-wide indices, so replication is cheaper than, for example, an actively managed fund that tries to buy and sell assets to do better than an index.
There are a million model portfolios out there, and it’s easy to feel like you’re swimming in information without necessarily going anywhere. To sum it up, the purposes of asset allocation are: to make sure you can meet your financial goals; to make sure you can sleep soundly without worrying about surviving a market crash; and to diversify, because nobody knows, in the short term, what the world economy will do. All we can say, with the confidence of over 100 years of market history, is that a diversified stock portfolio averages mid-to-high single-digit growth per year.
(3) Please note that the funds in these portfolios are all under 10 years old. The returns data available for them has been averaged per year and projected into the future.
(4) This can be a nerve-wracking decision, one investment advisors and financial planners make their living helping people out with. Those that abide by a fiduciary standard, anyway.
How do I buy this stuff?
You purchase shares of your stock and bond funds by opening an online brokerage account, which every big bank in Canada offers through their respective self-directed investment subsidiaries. Some are more hip than others in terms of offering online applications, but the result is the same.
Because you’re young, and your tax bracket is probably lower than it will be in 10 years, it makes sense to choose the tax-free savings account, or TFSA option, when you get to opening your brokerage account.
TFSAs come in clutch in many ways. The investments in them grow tax free and it doesn’t cost anything to put money in or take it out. That said, there’s a limit to it. The government adds a dollar amount every year to the total Canadians are allowed to invest in their TFSAs. That total contribution room, which is open to all Canadians, whether or not they have opened an account, currently sits at $63,500. You can open as many TFSAs at as many financial institutions as you like, but you cannot contribute more than the total allowed amount without penalty. The penalty is 1% of the amount overcontributed per month until you withdraw it. You can get more information on opening TFSAs here: RBC, TD, BNS, CM, Questrade.
A note on commissions: brokerages, for providing a place for buyers and sellers of stocks to meet, will charge you $10, sometimes a little less, per sale/purchase in your account. The exceptions to this rule are Scotiabank’s iTrade and Questrade. Both allow you to buy funds, including broad indices, for free or a small fee of a few cents.
Go ahead and open an account. I’ll wait.
Welcome back. You’ve made your fund choices and at last it is time to buy. I shall throw it once more to PWL Capital and their advisor, Justin Bender, whose video series on buying shares on different brokerage platforms is an invaluable resource.
When should I add to my investments?
If you pay commissions on each purchase, investing one or two lump sums every six months is enough. The days don’t matter so long as you stick to them over the long term.
If you don’t pay commissions, or they are very little – Questrade’s work out to 0.01% of the purchase price – you can be more flexible and set a biweekly or monthly schedule. Purchases as low as $100 may make sense given your particular situation.
At least once a year, you must also rebalance your portfolio. You achieve this by selling some of your investments that have done well during the year, and adding that money to investments that have done the worst. The idea is to buy low, sell high, and return your portfolio to the asset allocation you want, which for the foreseeable future will be the same one you chose a few paragraphs ago. For example, suppose you invest in a portfolio of 80% stock funds and 20% bond funds. Imagine that, after a year, you sign in to your brokerage account to find that your bond fund now represents 30% of your portfolio, while your stocks have decreased to 70%. In this case, rebalancing would entail selling 10% of your bonds and putting that money into stocks to take advantage of their drop in price. If you have a lump sum to invest, you may be able to rebalance without having to sell and incur commissions.
Will I make any money?
- If you add money periodically over decades, according to a schedule you can afford and an asset allocation you can stomach—for perspective: $500 invested at a 6% yearly return over 20 years at a 0.25% yearly fee becomes $1,613.
- If you make sure to only add money you won’t need to dip into for any reasons other than an emergency and the reasons you are investing.
- If you don’t sell shares when stocks crash but instead hold on and buy more if you can.
- If the percentage of bonds you own always accurately reflects your risk tolerance — i.e. the safer money you’d want to keep around for peace of mind, knowing the stock market could halve next year, and the money you need within the next five years.
Then, yes. You’ll be fine.
If you have any questions, DM me on Instagram @Trevor Abes.
Disclaimer: This article is meant for general education purposes only. It does not constitute financial advice as I am unaware of your personal situation. Consult a professional who abides by a fiduciary standard before making any investment decisions.