Trevor Abes: Writer

Tag: Investing

Young Canadian Investor #19 — The Cons of Financial Independence

For the purposes of this article, I’ll say you reach financial independence when you have enough money and/or investments to cover your expenses without ever having to work again.

It’s an important goal for a lot of 9-5ers who work decently-paying jobs that don’t mesh with how they’d like to spend their time. Maybe they want to be with family 24/7, maybe they want to travel all the time, maybe they want to write short stories all day and submit them to literary journals. It’s whatever makes you feel like you’re living the life you want, with the caveat that you should be realistic and thoroughly assess how close you can get to it. Here’s why.

  1.  Financial independence can become an overwhelming, all-or-nothing proposition. One where you give up a disposable income and with it any prospect of having fun for its own sake so long as you can save more money. And maybe you’re genuinely interested in travelling down this frugal road, exchanging nights out for pasta and cheap wine at home because you know that in 5-10 years you’ll have saved enough to free yourself from the daily grind. You should know, though, that there’s no point in saving half or more of your income if you’ll have to do it for decades to reach financial independence. In this case, there’s something to be said for investing less and living a little now instead of waiting until you’re 50.
  2. You need to have a clear sense of what to do with your hard-earned independence. Once you hit your magic number and have enough to support yourself forever more, how are you going to spend your time? It’s easy to get caught up the the thrill of the journey without giving due consideration to what you need to do to look back proudly on your life. Would you paint a new canvas every day? Dive into research projects that’ve been on the backburner for too long? Would you open up a coffee shop, source all your ingredients in ethical ways, and serve your community in a way you can be proud of? Your answer can change, and often, you just need to get a handle on what gets you out of bed in the morning.
  3. It’s not impossible to be fulfilled while holding down a 9-to-5. This entails finding a job you don’t hate or merely tolerate, one where you still have energy at the end of the day to go out, see people, and live a well-rounded life. There is nothing wrong with working for the next 40 years so long as it adds value to your waking hours, so long as it gives you a sense of purpose that makes you feel alive. Under this scenario, investing your money is still a must, but you can feel free to put less of your paycheck away knowing you’re comfortable working into old age. What would this ideal job be for you?

In the end, financial independence is a lifestyle choice, one that mostly appeals to people who value the freedom to do as they please day to day. If you’ve been searching for a short book to help you invest your money so you can get closer to tasting that freedom, my new effort is for you. It’s called Nine Steps to Successful Investing: A Guide for Young Canadians. In no more than an afternoon, it’ll give you the tools you need to invest prudently in the world’s stock and bond markets through index funds and fulfill your long-term financial goals.

I’m also available to teach you 1-on-1 over Zoom if you prefer.

Feel free to drop your questions in the comments!

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 with a professional who abides by a fiduciary standard before making any investment decisions.

Young Canadian Investor #18 — Investment Safety Versus Investment Return

It can be tempting to think that the investment that offers you the highest potential return is where you always want to be. If you have enough time for the investment to realize its value, what’s the problem? Well, it really depends on your particular financial situation.

If you’re 65 and have a million and a half dollars sitting in the bank, putting 20% of your net worth in the hottest publicly-traded cryptocurrency mining company because it might grow 100X wouldn’t make much sense. That’s because you need that money to fund your retirement, you might live until you’re 100, and the price of bitcoin is incredibly volatile and may go to zero.

If you’re 27, healthy, and working a somewhat entry-level job that allows you to save a little bit of money, the whole bitcoin thing might work for you. Supposing you have an emergency fund in place, diversify your investments into stocks and bonds, and are well-read enough to feel comfortable about bitcoin’s future, there’s no reason not to go crypto with a small but significant percentage of your portfolio. Why? Because you understand the risks and believe in the prospects anyway. If bitcoin goes to zero, you like the story enough to follow it all the way down.

The takeaway here is that investors should aim for the return they need to fulfill their financial goals. At minimum, the 65-year-old needs to meet their yearly expenses until they pass away. Fulfilling that goal with 1.5 mil to draw on is really about preserving that money and growing it conservatively so it lasts for the next 40 years. Crypto is way too risky in this case. Even too high of a percentage in stocks may expose this retiree to a double-digit drawdown in the price of their shares from which they may not recover. Something like a 50/50 split between stocks and bonds would be a good starting point.

Now, consider the 27-year-old’s aspirations. While they may and probably should be putting some money away for retirement and investing it in the riskiest (aka highest-returning) assets they can stomach, they may have shorter-term goals they want to get to first. If you’re saving for a car, for example, it’s no good to put the money in stocks and experience a 25% drawdown the year you planned on making the purchase. Bonds, which give you a shot at keeping up with inflation, are more appropriate instruments here. While they may experience single-digit drawdowns year to year, bonds will do a much better job at preserving your capital over 3-5 years so it’s there when you need it. Any savings term shorter than that limits your investment options to cash and GICs, which won’t really grow much at all but they won’t lose anything either.

If you’ve been looking for a nudge to get invested in line with your personal needs, check out my new investing guide for young Canadians.

I’m also available to teach you 1-on-1 over Zoom if you prefer.

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 with a professional who abides by a fiduciary standard before making any investment decisions.

Young Canadian Investor #17 — Why I Write With Young People in Mind

It may or may not be obvious by now, but as a young person time is still capable of being very kind to you. It can still heal all your non-lethal wounds, just by letting it pass, because you have so much of it still to spend.

Go forth and get yours, lil cub.

When it comes to investing, having healthy time reserves is essential to actually making money. Stocks have a positive expected return only over very long periods—somewhere around 7% per year for a globally diversified stock portfolio over a couple decades—but they’ll go up and down unpredictably year to year. You’re in a fantastic situation here because, as a twenty- or thirty-something, you can simply keep investing and let those up and down years eventually add up to money in your pocket while you focus on living your life.

Another reason I’m interested in helping young people like myself invest is how boring all this stuff can get. I happen to be someone who’s blessed with an appreciation for economics, personal finance, and business analysis, but 90% of the people my age that I know can’t take more than a few minutes of investing talk without their eyes going glazy. I think it feels like work or grade school, something you’re obliged to partake in without particularly wanting to. My intention with Young Canadian Investor is to convey basic investment knowledge in accessible language to hopefully knock that 90% down in a meaningful way.

One more point worth mentioning is how nonurgent it can feel for a 27-year-old to put money away they’re only going to use 10-30 years from now. It’s much more enticing to splurge now than to delay gratification for your future self by investing 40 of those $60 in your wallet. And make no mistake, you should splurge to a degree. Life is short and it’s a gift meant to be savored. You just want to take steps to continue savoring comfortably well into your old age, and investing is one way to ensure that happens by minimizing your chances of going broke.

Being young is only full of advantages if you know how to recognize them. I’m just here to point one of them out for you. It’s the same reason I wrote my little book, Nine Steps to Successful Investing: A Guide for Young Canadians. I wanted to make it easier for people my age to cushion the expansive futures before them with more financial security, at least compared to not investing at all. Feel free to give it a shot and to ask any questions you may have in the comments.

And I do mean any, no matter how basic, because we all gotta start somewhere.

I’m also available to teach you 1-on-1 over Zoom if you prefer.

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 with a professional who abides by a fiduciary standard before making any investment decisions.

Young Canadian Investor #16 — The Costs of Not Investing

Why I Invest

I don’t know about you, fellow twenty or thirty-something, but my main goal right now is to have the freedom to do what I want with my time.

As a writer, I know that working alone isn’t going to get me that freedom—unless something I create takes off, catches loads of public attention, and grows to complement my history of barely livable wages and price-per-word rates. That means I need to be creative about the number and nature of income streams I put into place. That’s where investing comes in.

Here I am being writerly at Word Sound Power Open Mic in Toronto.

I’ve been diligently investing into a couple tax-free savings accounts for the past two years. I own mostly exchange-traded funds (ETFs) that hold the global stock and bond markets with about a fifth of my portfolio in individual stocks. As businesses improve and their stock prices rise over the long term, my investments will grow for me on their own while I focus on the rest of my life. It’s a small total right now—the entire portfolio provides me with about $1000 of dependable income per year— but it will eventually become enough to let me focus on putting words together full time. That’s why I do it.

Here are five more general reasons I invest and you should too.

  1. Inflation is the phenomenon of the prices of things going up over time. In Canada, it’s about 2 percent per year—about 3.3 percent when you factor taxes in. In other words, your cash buys you about 3 percent less stuff every year you hold on to it. Conversely, it’s reasonable to expect that owning the global stock and bond markets through ETFs will earn you around 7 percent per year over a couple decades. By simple addition, investing puts you 7-3.3=3.7 percent ahead.
  2. If you don’t invest, you may have to confront the reality of Unfulfilled Goals. And we’re talking big goals here, like a car, a down payment on a house, tuition for a degree, or the head start you need to start that family. It’s a lot easier to accumulate 20 thousand dollars over a handful of years if that money is invested and growing, as opposed to you putting it in a savings account that makes you 0.01 percent per year.
  3. The difference between peace of mind and Financial Insecurity is having enough money to meet your basic needs, say for six months, just in case you fall on hard times. This emergency fund is insurance against the ups and downs of life and everyone should work toward building one. But once you have that emergency fund sitting safely in cash, it’s important to start investing and building your nest egg for the future. The simple fact is this: when it’s time for a pivot in your professional or personal life, having tens of thousands of dollars around to help you achieve it will make a huge difference.
  4. Living paycheck to paycheck entails A Poorer Quality of Life. One where there isn’t a whole lot of breathing room at the end of the month after accounting for expenses. That said, a diligent investing plan is one way to generate more room for you to spend your time as you please. What would life be like if your investment portfolio provided you with even $200 of extra income per month? What kind of pressure would that relieve? If you start investing today, you can get there.
  5. The biggest consequence of not investing is the Inability to Retire. A good rule of thumb is to multiply your current salary by 25 to get a sense of how much you need to stop working at 65 years old. Whatever that number is for you, counting on investment growth to reach it is a lot easier than putting your cash in a savings account or under your mattress where it’ll lose money to inflation over time.

If you’re interested in learning the ins and outs of investing prudently to meet your financial goals, you can read my new investing guide for young Canadians. It’s short, to-the-point, and will set you up for making the most of your money regardless of how much you have. Feast your eyes on the luxuriously cheesy cover below.

 

I’m also available to teach you 1-on-1 over Zoom if you prefer.

Feel free to drop any questions in the comments!

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 with a professional who abides by a fiduciary standard before making any investment decisions.

Young Canadian Investor #15 – Trusted Financial Sources

You can’t infer trust from any random person dressed in formal wear eager to tell you where the stock market is headed. This is especially true in a world where financial television stations like CNBC, Bloomberg, and BNN bestow their airtime on experts who pull economic predictions out of their behinds and aren’t held accountable for being unreliable.

What you’re looking for are financial professionals who can be objective with you because they don’t have to choose between giving you useful advice, or selling you products and services, even if you don’t need them, to ensure that there’s food on the table.

It’s hard to comb through the media landscape to identify people who focus on the needs of everyday investors, the ones who never learned money management in school, and treat the financial field as they do the medical one—with unwavering trust—when most financial advisors in Canada are actually under no obligation to put your bottom line before theirs. In the interest of facilitating the process, get to know a handful of people who have shaped my investing mind with solid fundamentals for long-term success.

common sense investing

Ben Felix is a financial advisor who runs a YouTube channel called Common Sense Investing. It’s great for in-depth but digestible explanations of core investing concepts, plus a fair amount of content that will take you far into the investing weeds. I like Ben’s work because he backs his points up with academic research and isn’t afraid to call out active managers for lining their pockets with client money before bothering to grow what’s left over. He’s also very blunt, which I find refreshing. All he’s trying to “sell you on” is the upside of taking the reins of your financial future.

canadian couch potatoOne reason Ben can be so forthright about his peers is that he works for a firm that is way more transparent about its strategies and fees than the major Canadian banks. One of his colleagues there, Dan Bortolotti, is the creator of the Canadian Couch Potato, a pioneering blog and podcast dedicated to helping everyday Canadians understand the benefits of investing through index funds. Unlike picking individual stocks and relying on your research to ensure satisfactory returns, index funds allow you to own a piece of the global stock market for cheap, thus hitching your money for a ride on capitalism and human progress as you save more of it. Dan is one of the leading index fund proponents in Canada; a contrarian stance in a country where most advisors steer clear of index funds because they get paid the least for recommending them.

plain bagel

Richard Coffin, an investment analyst in Ottawa, operates a YouTube channel called The Plain Bagel. He uses his platform to run through basic investment concepts, much like Felix, but in a broader, more accessible style that emphasizes humor and entertainment. His Q&As and April Fools videos are prime examples of this. If you’re as new as it gets to stocks and bonds, I’d say start here.

money school canada

Preet Banerjee, a popular financial consultant and speaker known for his many media appearances, sits somewhere between Coffin and Felix when it comes to pedagogical use. On Money School Canada, he pairs his slow and measured approach to unraveling terminology with your favourite teacher’s enthusiasm and production value that helps break everything down into constituent elements.

Does anyone worthwhile come to mind to complement this post? Feel free to drop their name in the comments. Everyone’s journey to financial independence will have its own unique twists and turns and I’d love to know who’s been there to help you along the way.

If audio is more your thing, check out my favourite investing podcasts part one and part two.

If you’ve been searching for a short, no-nonsense guide to walk you through the process of index investing, you can pick up a copy of my new book, Nine Steps to Successful Investing: A Guide for Young Canadians.

I’m also available to teach you 1-on-1 over Zoom if you prefer.

Feel free to drop any questions in the comments!

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 with a professional who abides by a fiduciary standard before making any investment decisions.

Young Canadian Investor #13 — The Benefits of Delayed Gratification

Far be it from me to tell you to not indulge in the pleasures of youth, whatever those amount to for you. You need to fill your time with experiences now to be able to look back fondly on them later when energy, passion, and priorities have evolved you into a different person. Don’t worry, I’m not here to be a wet blanket.

What I’m here for is to illustrate how investing is the bridge between your horny, idealistic, sleep-deprived self to the person you’re going to become after you’ve lived your fair share. It may not be immediately worth it, but investing now can lead to opportunities that aren’t presently available to you.

“The answer is dreams” — Haruki Murakami, Sputnik Sweetheart.

If you follow through on some of my suggestions about saving money, invest in stocks for at least a decade, and stick to making regular contributions, that extra 40 or 50 grand just lying around, while unimaginable now, will be available for you to take the next major step in your life. That may be starting a business, starting over somewhere new, or putting a down payment on a house, really any fantasy turned into tangible reality due to the benefits of compound interest and living below your means.

If I may get a little heady and sentimental, what do you dream about? If I may get a little more to the point, you already know that time is an inexorable progression toward pushing daisies, so what are you waiting on to move closer to the life you want?

It’s really all about rustling up your first $1000, investing it in a TFSA, and contributing to it from there until you reach your target number. If you think this investing business is too complicated for you, I beg to differ. My new book, Nine Steps to Successful Investing: A Guide for Young Canadians, will walk you through the process in plain language in no more than an afternoon. Give it a go if you’re ready for your nest egg to grow at a considerably greater clip than the pennies your bank throws into your savings account every month.

Feel free to drop any questions in the comments!

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 with a professional who abides by a fiduciary standard before making any investment decisions.

Young Canadian Investor #12 – How to Save $1000

The smallest amount of money you can invest in Canada without having to pay a fee for the privilege—usually $25 per quarter—or commissions on transactions—$5-$10 a pop—is a grand at a brokerage house called Questrade. A brokerage house simply provides a platform where investment buyers and sellers can make their orders.

The problem here is that, if your investments fall below $1000 in any given quarter, Questrade will charge you the fee unless you make one trade in any amount. To avoid all this time wasted monitoring your balance, what you really need is to start investing with an amount that could fluctuate in value, due to the ups and downs of the stock market, without much of a risk that you’ll fall below the threshold. Seeing as 50% drops occur about once every decade or more, this post should be called How to Save $2000, stock market history considered.

If you have cable, you’ve probably seen Questrade’s commercials where young 20- or 30-somethings sass some sense into older, crustier financial advisors for their high fees. As the broker with the lowest minimum in the land, this is entirely by design. Compared to the big banks, where $5000, $10000, and $15000 minimums are prohibitively in place, youngins have nowhere else to turn. To be fair, you could invest in a TFSA at CIBC with no fee and a $500 minimum, but you’d still have to pay $7 per transaction. Question is, how do you get that two grand in your hand in the first place? Ponder my suggestions below.

  1. If you receive a regular paycheck, shift 5%-10% of it into a savings account each time. The amount should be small enough that you won’t feel like it’s missing.
  2. Think about the money you spend on personal entertainment like books, music, games, and eating out, and make small cuts such that you end up with a reasonable bit of cash, say $100, by the end of three months. Obviously up the amount if you are able.
  3. If you eat out as a matter of course, learn to cook. Seriously, be willing to mess up, experiment until you find your comfort zone, and it will pay off. When you cook from home, you don’t charge yourself extra to pay for rent and staff salaries. That means your fried chicken dinner will cost you $5 instead of $15.
  4. Remove brand influences from your life by shopping for generic brands and netting yourself the savings, which can be 25% or more.
  5. Consider subjecting yourself to ads and using the free version of Spotify for a good long stretch. You could also cancel your Netflix or Crave subscription and opt for your local library’s free streaming service. You’ll probably only get to stream a limited number of recordings per month, so complementing your viewing with creative YouTubing would become a must.
  6. Adopt a big-picture perspective and identify things you spend money on but don’t use and/or need. Beyond mere entertainment, this could include balance protection insurance on your bank account, a gym membership, or extra cellphone plan features bloating your monthly bill.
  7. Give yourself time to accomplish this goal, even if it’s a year or more. Your means are what they are and improving them requires you to simply begin.

While this list is by no means exhaustive, it should add up to meaningful savings over a reasonably short timeframe if you put it into practice as a whole.

If you’re curious about investing and have been searching for a short, no-nonsense guide to help you get started, have a look at my new e-book, Nine Steps to Successful Investing: A Guide for Young Canadians.

Feel free to drop any questions in the comments!

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 with a professional who abides by a fiduciary standard before making any investment decisions.

Young Canadian Investor #11 — My New Investing Guide for the Youngins (of Which I Am One)

Quite thrilled to announce that I have a new book out called Nine Steps to Successful Investing: A Guide for Young Canadians. Its purpose is to walk you through the investing process, from figuring out what you’re saving for, to opening an RRSP or TFSA, to putting your money to work in the world’s stock and bond markets through index funds.

I tried to be efficient with words and not wander down many rabbit holes to avoid trying your attention with subject matter that tends to put most youngins to sleep. Explanations are just as long as they need to be with links to digestible sources for anyone interested in learning more.

If you’ve been thinking about investing, have the sense that you’d like to approach it yourself—as opposed to hiring a financial advisor—and prefer a lean primer as opposed to 300 pages of fluff, this book will put you on the right track in no more than an afternoon.

You can find copies here.

 

Young Canadian Investor #10 – Common Investing Questions Answered

1. Don’t I need to already have a considerable amount of money to invest? Not anymore. It used to be commonplace for funds to have $1000 or $2500 minimums to invest, but you can now buy ETFs for free on Questrade without a commission, even if it’s one share at a time. And just for reference, the Vanguard FTSE All Cap Canada ETF, which invests in a basket of stocks meant to represent the entire Canadian stock market, currently trades for $26.03 per share.

2. What’s wrong with enjoying myself and my money now if life is short and you never know what could happen tomorrow? Nothing at all. In fact, another way to look at investing is as a way to prolong your enjoyment of life until the very end. It’s a trade-off, really, between putting a few dollars away without sacrificing too much in the now, and risking going broke when you can’t work anymore. Whether that means saving $100 a month or $10000, the point is that your future self will really appreciate it. 

3. This investing stuff is way too complicated for me. Has anyone put it all into plain language so I can educate myself at my own pace? Yes, indeed. Behold.

annie-spratt-hc7kZmrQPYU-unsplash

4. If investing in the stock market is so great over the long term, and helps set you up for a more comfy retirement, why do only about half of Canadians engage in it? Because holding stocks for decades requires a strong stomach. It isn’t easy to watch your globally diversified investment portfolio drop by 20% about every five years, and by a third to half or more every decade or so, on its way to providing you with an average 7% return.

5. What’s inflation? Inflation refers to the sustained rise in price that most goods experience over time. In Canada, it’s 2% a year or so, meaning that the 7% return mentioned above is actually 5% adjusted for inflation.

6. Isn’t a house a better investment than putting money in the stock market? No, because of the money it costs you to maintain and live in it. Here’s a detailed breakdown courtesy of Ben Felix, an investment and financial planning professional based in Ottawa.

7. Can’t I just save money instead of investing? Sure, so long as you’ll be able to give yourself the life you want when you’re older. If you save $300 a month for the next 20 years, you’ll have $72,372 by the end of it. If, instead, you invest that money, and earn a 7% return over the same period, you end up with $157,489. Give this compound interest calculator a whirl and figure out how much money you’ll need to lead your idea of a good life.

Feel free to drop any questions in the comments!

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 with a professional who abides by a fiduciary standard before making any investment decisions.

 

 

Young Canadian Investor #9 – Useful Investing Tidbits

1. Why own stocks? Because owning one is equivalent to buying into the productive power of that company’s employees to sell products/services and make money. The better they perform, the higher the stock’s price, the more wealthy you become, and the quicker you can do as you please with your time.

2. Talking heads on financial television always come with an agenda, whether that’s sugar-coating the strengths of an investment they already hold or plan to, or supporting federal or monetary policy they would end up benefiting from. The same goes for interviewees espousing the benefits of spending within your means and making regular contributions to a retirement portfolio of stocks and bonds. One avoids being whipsawed by conflicting advice by having a financial plan and sticking to it.

3. Anytime you hear anybody make a prediction about where the stock market will be in the future, you can be sure that they’re mistaken, or lucky if they turn out to be right, regardless of the credentials they hold. Consistently predicting the future isn’t within the purview of human intelligence.

tech meme 1

Technical analysis at work. Courtesy of wallstreetbets.

4. Unlike the USA, where buying stocks commission-free has been widely adopted, Canadians still pay anywhere between $5-$10 per buy or sell order. The best exception here is Questrade, where you can buy ETFs for free.

5. Much maligned for offering mostly super-expensive mutual funds, and fees for advice that only the gullible or misinformed should pay, Canada is slowly improving in terms of providing everyday people with access to fairly-priced investments and the information they need to understand them. Common Sense Investing and The Plain Bagel come to mind as two sources worth your eyeballs. If you’d rather read, MoneySense is a good place to start.

6. The worst thing you can do with your stocks is find yourself having to sell them when they’re down because you need the money. Another way to put this is that you should only invest money you don’t need to cover your expenses, including emergencies. That way, you’ll be able to hold on during good markets and bad and take advantage of compound interest.

7. Technical analysis, or investing based on the price movement of assets like stocks and commodities, is the financial equivalent of LARPing, or choosing to inhabit a world that runs by whatever principles you choose. Its basic premise, that you can predict buyers’ and sellers’ motives by studying price charts, refers directly back to numeral 3. 

8. If you’re interested in picking individual stocks as opposed to or in addition to owning index funds, you need to be willing to dig into companies’ financial statements. In Canada, you can find them on SEDAR, or the System for Electronic Document Analysis and Retrieval.

9. Canada’s economy is made up of roughly 35% Banks, 20% Oil and Gas, 10% Industrial Manufacturing, and 10% Basic Materials like lumber and metals. Technology is only around 4%, with Health Care bringing up the rear at 0.5%. In the USA, on the other hand, Technology represents about 20% of the economy, and Health Care is 15%, which demonstrates the benefits of diversifying your investments beyond your home country.

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 with a professional who abides by a fiduciary standard before making any investment decisions.

Young Canadian Investor #8 – The Downsides of Index Funds

Thanks to the efforts of the late, great, Jack Bogle, index funds have opened up the world of investing for everyday folks in a simple, cost-effective way.

Now, pretty much anyone can open a brokerage account, invest commission-free in a handful of index funds that own stocks all over the world, and thus piggy-back off humanity’s industrial might to improve their financial futures. 

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Tell em Queen.

That said, these funds are not panaceas. Even though they’re the best option around for %99 of people fortunate enough to have spare cash lying around to invest, they are not without their faults.

1. Most index funds that track the stock markets of entire countries are market-cap weighted, meaning that the more a company grows in value, the more of its stock the fund will have to hold. The problem here is that, since stock prices are not only based on company performance but also on investors’ expectations about how companies will perform, investors’ expectations can and do frequently lose sight of how well or poorly a company is doing. That means stocks are often cheaper or more expensive than company performance merits. But the market-cap weighted index is designed to ignore these discrepancies and simply buy or sell in line with investors’ expectations without stopping to question them. One workaround is to integrate valuation into your investing process by considering which countries are cheaper or more expensive than others at any given time.

2. Because indexing has become so popular over the last decade, the investment companies that offer these funds have become increasingly larger owners of the businesses held by the funds. Right now, Vanguard, BlackRock, and State Street (The Big Three) own a little over 20% of the S&P 500 (the 500 biggest companies in the USA). That’s an issue because shareholders get to vote at company meetings to choose boards of directors and have their say regarding future plans. If you invest in an S&P 500 index fund, it’s the fund provider and not yourself that gets to vote for the 500 companies. If three investment companies basically have the reins of the USA’s capitalist machine in their hands, that smells of antitrust, and government intervention can’t be too far off. The Big Three vote in line with company management, so there’s been no rocking of the boat, but the door is certainly open for them to. We’ll see how long that lasts.

3. Another flaw to be mindful of is that index funds concentrate investor behavior. If you’re a stock picker or active investor, you’re going to own a handful up to maybe a couple hundred stocks based on your analysis of what a business worth owning looks like. If you buy into broad indexes, on the other hand, you buy into entire stock markets, including the outstanding businesses, the mediocre, and the ugly. So if an index fund investor decides to buy or sell a portion of their globally diversified holdings, they are essentially buying or selling a tiny part of every stock in every major index in the world, whereas the stock picker would only be buying or selling the specific stocks they own. In times of market distress, such as the virus-induced stretch we’re currently living through, it’s easy to see that a wave of selling from index investors can have an outsized effect on the markets simply because they own all of them. The more people index, the more pronounced this effect will be, and the more important it becomes to brush up on your investing basics so you never let fear get the best of you, and you recognize that, when index fund prices drop, that means they’re on sale, so you should buy more shares if you can instead of running for the hills.

In spite of their flaws, index funds still guarantee you the returns of the markets they track minus very low fees. They’ll also beat the vast majority of stock pickers over the long term, so long as you maintain regular contributions, choose an appropriate time horizon and risk tolerance, and keep your emotions in check. There is no doubt that everyday investors like you and me would be way worse off without them.

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 with a professional who abides by a fiduciary standard before making any investment decisions.

 

Young Canadian Investor #7 — Some Context to Minimize Panic

Arguably, the hardest part of investing for the long term in individual stocks as well as broad stock index funds—this includes funds that track the Total US Market, Developed International Markets, Emerging Markets, or the Global Stock Market— is keeping your psychology in check during market extremes. 

When funds have been going up for a handful of years, most of us think the trend will continue and want to buy more shares. Even though we have to pay an increasingly high price to do so. 

When funds have been dropping for a long stretch, most of us figure it’ll get worse and feel we should sell. Even though prices haven gotten cheaper and thus more appealing.

Why do we act like this? Human nature.

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How do we fix it?

One. By setting a range for how high and low stock markets can go, as per the historical record, to get an idea of good lows to buy more of, and good highs to dollar-cost-average into until prices improve. Selling investments should be limited to the reason you invested in the first place. 

How much can markets rise before a recession knocks them down to fair value? Australia’s stock market went more than a quarter century without one.

How much can a country’s stock market drop, and how soon? Eighty percent is a reasonable worst-case scenario. This happened in the US over two years in the late 1920s and early 1930s with the market taking over 25 years to recover. It happened again, this time over a couple decades, during the double-digit inflation of the 1960s and 1970s. 

Historically speaking, though, any time a broad index is down double digits (over 10%) constitutes poor performance and thus a buying opportunity/sale/good deal. This with the knowledge that it could drop another 50% or more and get that much more affordable.

Two. By remembering that, excluding problems with the fund’s management or issuing company, a broad market index fund going to 0 would require the industrial complexes of the countries it tracks to go out of business too. And it’s next to impossible for that to happen, whether in Canada or Spain or South Africa. Barring an apocalypse or investment company bankruptcy, dips in your index funds’ prices per share will eventually recover. It may take many years, so it’s up to you to ensure an appropriate time horizon.

Three. By holding firm that, to benefit from investing in stocks over the long term, i.e. make money, you have to invest regularly and stay invested—continuously— in a globally diversified portfolio for a minimum of five years but ideally for a few decades or more.

That’s essentially how you watch your index funds drop in value without panic-selling to avoid the stress. Easier said than done? Perhaps. 

But when you compare how inflation currently cuts what you can buy with the money in your savings account by 2% per year, every year, with a globally diversified portfolio’s long-term expected return of 7% per year, giving into fear looks a lot like very slowly going broke.

You can learn more by reading my introduction to investing for young Canadians.

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 with a professional who abides by a fiduciary standard before making any investment decisions.

 

 

 

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