Investing Series – Stocks (Part 2)

So last week I detailed exactly why people should invest in the stock market, and why all the talk about “losing your shirt” or getting rich quick is equally overblown.  I just want to take the opportunity to encourage our readers to make sure and ask any questions or submit any comments they may have.  I love learning new things and exchanging ideas with others, so please feel free to engage us!

Amongst the rambling in my last article I promised that I would show you some specific ways where you could invest in the stock market as a whole and not have to worry about picking specific stocks against Ivy League PhDs.  The mechanics are fairly easy, and these options will almost certainly be available wherever you bank.

Mutual Funds

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Perhaps the most popular way to get into the stock market is through mutual funds.  Mutual funds basically consist of a group of people giving their money to an experienced and proven investment professional to invest it for them.  Most funds will have cute little titles like, “Global Equity Fund D,” or, “Dividend Income Class C.”  This usually means that they concentrate on one part of the market as opposed to others.  Mutual funds are fine products, they allow you to invest small amounts as often as you want and every bank has access to thousands of them.  That being said, I think there are much better options out there for one reason: FEES.  Canada specifically, has the highest mutual fund fees in the world.  The fees are basically how the investment company, and investment professionals make money.  Trust me, they make A LOT of money by taking it away from you!  There are a huge variety of ways companies can take money from you in the form of fees.  Some get taken from the original amount you invested, others get taken when you cash the fund in, but they all take a lot away.  When you see fees of 2.5+ this will often make a huge difference in your overall return.  Consider that right now bonds or GICs will barely return 2.5% overall!  This is why I would likely recommend one of the following two products instead.  There are some decent mutual funds out there, and if you can only afford to invest very small amounts they might be the best option, but please do yourself a favour and read the fine print before locking yourself into any fee-heavy fund.

Index Funds

There has recently been a huge push towards index funds within many financial circles.  Index funds basically try to invest in as broad a market as they can.  They require little management, and are usually controlled by a simple mathematical formula.  The idea is to try to have money in as much of the market as possible, while paying the lowest amount of fees.  Many index funds charge less than .4% on your investment compared to the 2%+ that we looked at with mutual funds.  The sad truth is that mutual funds almost never beat index funds over long periods of time, especially when the management fees are taken into consideration.  This basically means that investment professionals might beat the market for 1,2 or even 5 years, but they will likely lose out on average over time.  There are a rare few examples of mutual fund managers who consistently beat index averages.  They are usually known as geniuses and are pretty tough for the average person to invest with.  Index investing is just so much easier and is generally stress free.  Investing in index funds has recently been coined as “Couch Potato Investing” because it is so easy and uncomplicated.  I don’t know about you, but this sounds great to me!  I will likely write more on this topic in the future, but for more information just Google the term “Couch Potato Investing.”

ETFs

The final way that a person can get broad exposure to a large part of the overall stock market is through an investment product known as an Exchange Traded Fund (ETF).  This product is more or less a combination between a stock and a mutual fund.  It acts just like a stock does.  It is listed on the stock market, it moves up or down, and you can buy or sell it at anytime; however it is not a specific company.  It is a basket of companies just like an index fund or a mutual fund.  Much like an index fund, ETFs are generally comprised of stocks that were picked by a math formula to meet certain specifications.  ETFs can be centered on any type of stocks like Chinese companies, natural resource companies, gold, emerging markets, or a thousand others.  They can also be very broad based, just like index funds.  Many people like ETFs because they are very easy to buy and sell, while at the same time they are much less risky than specific stocks.  It makes sense when you logically think that while certain stocks might go down, the market as a whole will go up over time; therefore, owning a really small piece of a lot of companies makes more sense than one piece of a single company.

If you remember the principles of spreading out your risk, being committed for the long term, and paying attention to fees, getting the benefits of stock/equities really isn’t that difficult.

Next week we will begin wrapping up our investment series by showing what steps you need to take in order to physically get your money from your bank account and into an investment product of some kind.