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

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.

 

 

 

 

 

 

About Teacher Man

TM is a self-professed nerd about all things related to personal finance. He can be found writing for My University Money, Young and Thrifty, and Canadian Personal Finance Blog. TM blogs in order to continue his quest for lifelong learning and hopefully to help others along the way.

6 Responses to Investing Series – Stocks (Part 2)

  1. My plan is to get ahead of the game for once!
    I have more mortgage than house value.
    A large number of people lost jobs and houses in 2008 and 2009.
    Many had to declare bankruptcy.
    A portion of these people have been back to work for at least 1 year.
    They are in a good position to purchase a new home at discount prices.
    They will start qualifying for new mortgages 3 yrs after bankruptcy.
    That means these homes can get financed in 2012 and 2013.
    I’m getting on board with FNMA while it is a sleeper.
    It jumped up to $1.00 last Feb 2011, so it has potential now.
    I think it is going to go far past this level – to $35 within 10 years.
    By betting $200 for 1000 shares I could lose my little investment.
    But, when it goes to $2 I make 10x my money, or $10,000.
    It was at $70 in 2008.
    When it goes to 10% of that amount or $7 that’s 35x gain.
    For 1000 shares that’s $35,000.
    I will use this benefit from FNMA to pay my mortgage down.
    Then I will have more house value than mortgage.
    That is the way life should be.
    It is definitely worth risking $200.
    Happy Holidays!

    Shirl

    • Not exactly your stereotypical, “How to invest for the long term,” Shirley, but you’re right, a $200 lottery ticket isn’t the end of the world. Your overall reasoning appears sound. I would definitely caution against focusing solely on the stock. I would also remember that there is a huge housing glut in the market right now, so it will likely be soft for years to come. If you really want to get ahead of the game, have you looked at a strategic default, and maybe opening up a side business?

  2. Nice quick and dirty on investment options in the market! I found it quite helpful. I will be taking my firt plunge into stocks this week. I’m going to do it through my Questrade TFSA, and start with a small amount ($1100). I will be investing a similar amount every couple of months, and believe in diversifying. However, to save on trading fees, I will be buying only one stock each time, meaning this first dip into the market will involve buying shares in one company (looking to start off by investing in the energy sector HSE, FTS or SU). In a couple of months, I will buy shares in the finance sector (probably RY, TD or BNS) and so on.

    Don’t know if this is the best way to go, but it makes sense to me, unless I’m missing something.

    • You could do this MIT. The only problem is that your are definitely under diversified in the short-term. I would probably recommend looking seriously at a Canadian ETF. You could get the diversity you want for the same trading fees. Stay tuned for a certain eBook that might be coming out here soon…

  3. I agree with you. I will be grossly under-diversified in the short-term. However, I think the cost of owning 5 different companies will be about $25 in fees and since I will be diversifying every couple of months, the fees will add up. This is especially significant because I will only be investing an amount around $1000 each time, rather than a large sum.

    The ETF is appealing, but I wanted to get started with dividend paying stocks.

    • Dividend stocks aren’t a bad play. I still think, in terms of a percentage of your monthly investments, that you would be better off with ETFs. Right now BMO just started offering commission-free ETFs. I’m sure the others will follow suit. Once you have a decent-sized nest egg you could purchase a more diversified stock portfolio all at once. That’s how I would do it. But you know what, as long as you know your risk tolerance, are ready to ride out the rough times, and are a disciplined saver, you’ll probably be fine. Just by doing research you’re ahead of most people.

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