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Passive Investing in 2019

Passive_Investing_2019

Passive Investing for Beginners

Passive investing is a growing trend in the investment world. Because of the broad success of index funds, many investors are beginning to question the importance of active money management and whether it may even hurt returns in the long term. Due to the costs associated with actively managing investments, passive investing strategies have an inherent advantage that is difficult to overcome.

At its core, passive investing is a fancy way of saying buy and hold. It’s all about minimizing fees and hassle while striving to build wealth over time. Having to constantly research and make decisions is costly in terms of time and money. Then there’s cost of making an actual transaction, which can be substantial if you’re making a lot of them. When you buy and hold, you hitch your fortune to a wagon and let it ride. Buying and holding is the simplest form of passive investing, but there are also some strategies which can be used to manage risk.

Diversification

It’s important not to hold all your eggs in one basket. Companies and economies go bust all the time, but they generally don’t go bust all at once. If you buy lots of different things across different sectors, economies, and asset classes, you can effectively spread your risk and average out your returns.

These days it’s easier than ever to build a diversified portfolio. Instead of buying individual stocks, there are index funds and Exchange Traded Funds (ETFs) that represent just about anything you could invest in. The simplest strategies involve just a few broad market ETFs or index funds that can be adjusted for your risk tolerance.

Rebalancing

Once you’ve decided how to diversify your portfolio, you need to ensure that it stays diversified. Different asset classes have different rates of return, with the riskier classes generally having higher returns over time. Due to this, your holdings will tend to become skewed towards riskier assets over time, which makes your whole portfolio riskier than intended by your diversification plan.

This is where rebalancing comes in. In order to get your portfolio back into alignment with your target, you need to buy (and possibly sell) some of your holdings. If you are making frequent cash contributions, simply buying your most underweight assets is often sufficient to stay on target. However, if your portfolio eventually drifts too far, you may also need to sell some of your overweight holdings so that you can purchase more of the underweight. Due to the cost associated with buying and selling, it’s best to do full rebalancing only infrequently.

Discipline

Perhaps the most important aspect of passive investing is discipline. If you don’t have the fortitude to stick with your investment plan even in the midst of a recession, you may lose more than you ever gain on your investments.

Many investors panic during downturns and pull their investments out of the market once they’ve seen their investments drop in value. It can be physically painful to see your net worth drop by 30% or more. The key thing to remember is that in the long run, the market always recovers. If you sell at the bottom, you’re jumping off the wagon and locking in your losses. So remember – you’re in it for the long haul.

On the flip side, it’s important not to get greedy or chase high returns. It’s easy to be enticed by the media’s coverage of the latest investing craze or flashy stock that is “set to perform this year”. Always be skeptical of what the media says and remember that if it’s in the media, it’s probably too late. Often times, investors following trends just end up buying high and selling low. If for some reason you have the urge to follow the advice you hear in the media, then make sure you do your homework and most importantly ask yourself: Am I really a passive investor?

5 steps to passive investing for retirement

So you’re interested in becoming a passive investor? Well look no further, you’re in the right place. This article will help you get started in 5 simple steps. Before we get started with investing, you should have learned how to prioritize your money and cleared all of your high-interest debt, such as your credit card and student loan debts. The interest on these is a lot higher than the returns you’ll make with your passive investments. Also, the money you are investing will go solely towards your retirement nest egg, so you shouldn’t be investing with money that you will need in ten years or sooner.

Finally, this guide assumes that you will be investing in low-cost Exchange Traded Funds (ETFs). As discussed in our Primer on Passive Investing article, passive investing is all about minimizing fees, staying diversified and being in it for the long haul with the expectation of getting the market returns. Remember, 80-90% of active managers do not beat the market’s returns. With that said, let’s begin:

Step 1: Develop a plan based on how much you can afford to invest.

Let’s say you intend on retiring at the age of 65, under the assumption that you will live to the ripe young age of 100. After all, we have made great strides in the field of medicine and it is not unreasonable to expect to be around a bit longer. According to MoneySense, the typical middle-class couple can live comfortably on $42,000 to $72,000 a year, assuming no mortgage or child cost. That equates to between $1,470,000 and $2,520,000 over the course of 35 years.

Who wouldn’t want to have a nest egg valued at over $1,000,000? But the reality is, the amount of money you can afford to invest is determined by what your monthly expenses are. Before investing, you should pay off your monthly expenses, then determine how much of your disposable income can be allocated towards retirement. Don’t forget to take your lifestyle into account. Depending on your lifestyle, you may decide to scale back spending in order to save more towards retirement. The main point of this step is to have a plan that works for you. The truth is, there is no perfect plan and the fact that you have one is a good start. The right time to start investing for retirement is now.

Step 2: Determine your asset allocation

Consider asset allocation as the process of “splitting up your investments” into various asset types in order to find the right balance between potential returns and safety. When investing, there are 3 main asset types to consider: stocks, bonds and cash (or cash equivalents). Depending on your tolerance for risk, you may decide to hold more or less of a particular asset type. For the purpose of this guide, we will assume that you are only holding stocks and bonds because you are trying to build wealth. That being said, it is not uncommon for some investors to hold cash as an “emergency” fund or as an extra safe (though unprofitable) asset.

When determining your asset allocation, a common rule of thumb is to hold your age in bonds and the rest in stocks. For example, if you are 40 years old, your portfolio should comprise a 40% weighting in bonds and 60% weighting in stocks under this rule of thumb. Once you’ve determined your stock allocation, you can refine this further by selecting ETFs that give you exposure to a variety of markets such as Canadian, US, and International equities.

For example, your 60% stock allocation could be further split up into:

  • 5% Canadian Equities
  • 35% US Equities
  • 20% International Equities

When it comes to bonds, the Canadian Couch Potato blog recommends holding Canadian bonds as opposed to International bonds because of the currency risks. In keeping with our scenario above, the remaining 40% of your portfolio’s allocation could be held in indexes or ETFs that track the entire Canadian bond market. When determining your asset allocation, always remember to stay diversified. There is an online questionnaire from Vanguard may also be helpful to determine your asset allocation. If you’re still not sure or do not feel comfortable determining your allocation, speak with a registered fee-only independent financial advisor and let them know that you’re interested in DIY investing using low-cost ETFs.

Step 3: Open an account with a discount brokerage and build your portfolio

According to Young and Thrifty’s comparison of online brokers in Canada there are a few factors that you should consider when selecting a discount brokerage, these are:

  1. Free ETFs trades
  2. Low account fees
  3. Low trading fees
  4. Low account minimums
  5. Good customer service
  6. Reimbursed transfer fees
  7. Safety
  8. Compatibility with Cell Phones

For any passive investor, using a discount brokerage is a must! Why you ask? Because you want to minimize fees as much as possible. I opted to go with Questrade because of their free-ETF purchases, low account fees and they offered to pay the transfer fee when I moved the money in my bank’s mutual funds over to them.

Step 4: Stay the course and avoid speculation

So you’ve built a diversified ETF portfolio, now here comes the hard part: staying the course and avoiding speculation! It’s easy to be tempted to sell your investments when the markets are doing poorly. Keep in mind that, even if the market is doing poorly, it does not mean that you have lost money. The losses are only incurred if you sell a security for less than what you have paid for it.

Always remember that over the long term the market has always gone up. If you were to Google search the market indexes of the New York Stock Exchange, NASDAQ, S&P 500 (which is an index that tracks the 500 largest corporations in America) and Morgan Stanley Capital International (MSCI) world index you will observe one thing. That is, these indexes historically trend upward over a long period of time, even after global recessions. But don’t take my word for it, according to Investopedia:

Between 1928 and 2013, a broad index of U.S. stocks increased 2,000-fold. However, 20 times they actually lost at least 20% of their value in that period.

With this knowledge in mind, I’d like to share two rules that Warren Buffet — the world’s most successful investor — lives by:

Rule #1: Don’t Lose Money.

Rule #2: Never Forget Rule #1.

Another aspect of staying the course is contributing regularly. The best way to do this is to set up automatic payments to your brokerage account and make regular purchases. This reduces the likelihood of you spending the money before having the opportunity to invest it. Consider this as “paying yourself first”, which can go a long way towards establishing a comfortable nest egg.

Step 5: Rebalance your portfolio when needed

As time passes, your portfolio will drift from its initial asset allocation because of the variance in performance between the assets in your portfolio. Because of this, rebalancing will need to be done in order to bring your portfolio back into alignment with the target allocation. There is no set rule of thumb as to how often you should rebalance. Some investors rebalance based on a calendar schedule (monthly, quarterly, annually), whereas others opt to rebalance whenever their assets have grown in value beyond a certain threshold (for example, 5% or 10% out of target). Because you’re focusing on building wealth and contributing on a regular basis, you could rebalance by simply purchasing the underweight asset(s) in your portfolio. If you’ve signed up with a discount brokerage that offers free ETF purchases, this method would not incur any fees and would help to keep your portfolio balanced.

Most importantly, be sure to remember the rule of thumb in step #2. You never want to be bearing too much risk as you approach retirement. It is important to maintain an asset allocation that’s in keeping with your tolerance for risk and time horizon.

1 comment on “How to Buy Stocks: A Beginner’s Guide to Buying Stocks in 2019”

How to Buy Stocks: A Beginner’s Guide to Buying Stocks in 2019

How_to_buy_Stocks

Last Updated: 24th January, 2019

Have you always wanted to invest in the Canadian stock market, but had no idea where to start? You’ve come to the right place. In this article, I’ll show you everything you need to know about the basics of stock market investing in 2019.

Are you ready? Let’s dive in!

Unlocking The Mysteries Of Stock Market Investing

Too many people make stock market investing more complicated than it needs to be. It’s as though investing is a great mystery, one that can only be solved by those with special insight and knowledge.

Thankfully, buying stocks doesn’t have to be a complex process. In fact, just about anyone can learn how to buy stocks with a little time and effort.

Getting Started in 2019

The first step is to open a brokerage account. Yes, it’s true that you need a broker in order to buy stocks.

The good news is that in 2019, you don’t need to visit a stock broker in person, call someone on the phone, or become engaged in a complicated transaction.

You can buy and sell stocks from the comfort of your living room, through an online discount broker. You don’t need very much money, either.

In many cases, it’s possible to open a brokerage account and start investing with as little as $50. Look for a reputable account online, and then open your account. Once you do that, you will be able to start buying stocks.

Online brokerage accounts are fairly easy to find. In Canada, there are no fewer than 12 leading discount brokerages vying for your investment dollar.

While you can check all of them out in this recent review of Canadian Online Brokerages, my top choice for online brokerage in 2018 is Questrade.

How Do Stocks Work?

If you’re new to the world of stock market investing, you may be wondering what a stock is in the first place.

Stocks, also referred to as shares, represent ownership in a corporation. They give the owner of the stock, also known as the shareholder, a claim on company assets and earnings. They can also grant the shareholder other benefits, such as voting rights.

To use a basic example, if a company issued 1000 shares, and you purchased 100, you would hold a 10% ownership of that company.

Of course, large corporations such as Google, or Royal Bank, are worth billions of dollars, with outstanding shares numbered in the hundreds of millions, so 100 shares would be a drop in the bucket when it comes to your claim on ownership.

But 100 shares is significant inside an individual portfolio, and can provide an investor with an opportunity for strong growth over the long term.

Types Of Stock

Corporations issue two main types of stock: common and preferred. Each type can be divided into several different classes, but these are the main categories.

Common shares provide the owner with voting rights at shareholder meetings, while preferred shareholders have a preferred claim on earnings, such as dividends. Preferred shareholders also have priority if the corporation were to go bankrupt.

Common shares are, exactly as they sound, more common.

What Is An ETF?

Exchange Traded Funds (ETFs) have become incredibly popular in recent years, and just might be the best way to get started with stock investing.

ETFs are groups of stocks that track the performance of a particular stock market index. With ETFs, Instead of trying to pick individual stocks, you receive the benefit of several stocks.

The benefit to a novice investor is that you don’t have to try and learn how to buy stocks before you get started. A solid ETF, can be a great way to get started.

ETFs vs. Index Mutual Funds

At first glance, an ETF might seem similar to a mutual fund, in particular an index mutual fund, but there are some key differences.

While ETFs and index mutual funds both offer an indexable basket of securities, ETFs are more flexible than an index mutual fund, in that they can be traded just like an individual stock.

They also lack the management fees (MER’s) of a mutual fund, although most brokers do charge a trading fee on ETFs. Depending on your strategy, ETFs can be advantageous to index mutual funds.

Because of their simplicity, ETFs may also be the best way to get started with stock investing. Once you are more comfortable, you can move forward and learn how to buy individual stocks.

How To Choose Stocks

Choosing individual stocks for your portfolio begins with research, and lots of it.

To start, get as much information as you can on the companies you are interested in, learning about how they are run, as well as the potential they have for future growth.

Also, consider whether or not the stocks you choose are a good value. There are many different ways to evaluate stocks, and you can learn them and then apply them.

The important thing is to get started. An ETF can help you get started with investing, and start earning compounding returns, while you learn the ins and outs of how to buy individual stocks.

Make It Automatic

No matter how you choose to invest, or where you put your money, one of the best things you can do is to make it automatic.

You want to make sure that you invest regularly, since that is a good way to make sure that you are earning better returns over time.

Decide how much money you can invest each month, and have the money automatically withdrawn from your bank account and used to invest in shares of an ETF or a particular stock.

This investing technique is known as dollar cost averaging, and it’s used by investors of all experience levels not only for convenience, but to enhance investment returns over the long term. Here’s how it works.

What Is Dollar Cost Averaging?

Dollar Cost Averaging (DCA) involves the purchase of investments in smaller amounts on a regular schedule, ie. monthly, bi-weekly, rather than in lump sums, less frequently.

Automating the purchase of investments removes the need for an investor to try timing the market, as over the long term the investments will be purchased at a lower average price. This is where the true value of dollar cost averaging lies.

Example Of Dollar Cost Averaging

Let’s assume an investor decides to purchase $1,000 worth of XYZ Corp. at the same time every month for four months. In this example, we’ll also assume that the stock first declines in value, but then rallies strongly.

As you can see in the table above, using a dollar cost averaging strategy the investor would have purchased 272.22 shares for a total of $4,000. His/her average price per share for this period would have been just $14.69 (calculated as follows: $4000 / 272.22 = $14.69). With the stock ending at $18 at the end of this period, the investor’s total position would now be worth $4,900 (calculated as follows: 272.22 shares * $18 = $4,900). As a result, the investor would actually show a profit of $900 on his/her overall position despite the fact that the stock declined in value over the full four-month time period (dropping from $20 to $18).

By comparison, if the investor had decided to invest $4,000 in shares of XYZ Corp. all at once at the beginning of this period, then he/she would have purchased 200 shares at a price of $20 per share. With the stock finishing at $18 at the end of the four months, the investor would have shown a net loss of -$400 on the stock.

This example clearly illustrates the benefits of dollar cost averaging, especially during periods of volatile share prices.


With dollar cost averaging, you can start small. As you earn more money, and learn more about investing in stocks, you can increase your contributions, as well as start finding other stock investments that will help you reach your financial goals.