Every week, I get at least one message from a reader thanking me for my texts, but saying, basically, “What you’re talking about stock market investing goes 10 feet over my head.” Me, I’m starting and I just want to understand the basics. What should I do? »
That’s an excellent question. Our parents rarely answer them. School, even less. So you can go through your life without knowing how the greatest engine of enrichment in history works. I will explain it here trying not to make you cry with boredom.
Investing in the stock market takes time and money. No time in the sense that investing is complicated – when done well, investing takes less than an hour a year. No, rather in the sense that you have to be patient and think in years and especially in decades, not in weeks or months.
Investors become owners of a small part of companies by buying their shares. Over time, some of these companies will increase their revenues and profits, and therefore be worth more on the stock market. Stock owners get richer.
Which companies to buy? We mistakenly think that we must succeed in finding the next Amazon or the next Google to make money on the stock market.
This way of investing is called “stock picking” because one tries to select future winners. It may seem logical. Unfortunately, decades of studies show us that more than 9 out of 10 investors who invest this way (and that includes professionals who manage mutual funds) have long-term returns that are lower than the returns of the full stock market.
It’s counter-intuitive, but it usually pays more to buy the haystack (the market) than to reach for the needle (the next Apple).
So far, is that clear?
How do I buy the market? You can buy a fund that contains a small portion of each of the top 250 companies on the Toronto Stock Exchange. Or a fund that contains a portion of each of the 500 largest companies traded in the United States.
These funds are called exchange-traded funds (ETFs). As they reproduce the major stock market indices, they are called index funds. To buy these funds, all you need to do is open an online brokerage account. All major banks (and Desjardins) offer this service. We can also open a brokerage account TFSA, RRSP, RESP, etc., and hold our investments there. Companies like Questrade or Wealthsimple make buying ETFs even easier by offering automated platforms where investment portfolios are already assembled for us.
Are you still following?
How are stock market investments performing? Despite crashes, recessions, COVID-19, Silicon Valley Bank, Vladimir Putin, inflation and other nasty events, the Canadian market has enriched investors by an average of 9% per year for half a century. In the United States, the market has grown by an average of 11% per year for the past 50 years.
Many of you are startled when I mention these numbers. If few investors make 9% or 11% per year, it is because many are stock picking, with disappointing results. Another explanation is that few investors have all of their investments in stocks. Because while stocks have offered good long-term returns, they’ve had a painful habit of crashing 30% or 40% once or twice a decade for generations.
In a perfect world, we would let our investments fall in peace knowing that the market has historically always reached new highs. But most people are unable to see their investments lose 30% or 40% and stay calm.
That’s why a balanced portfolio contains at least one other component: bonds. Buying a bond fund is the equivalent of lending money to a government or a company, which agrees to repay us with interest.
An investor who had theoretically invested 60% of his money in Canadian, American and international equity ETFs and 40% in bonds would have had returns of 8.46% per year on average for 50 years. In its worst year, this portfolio would have lost about 25% of its value, according to calculations by Justin Bender of PWL Capital.
So $10,000 invested this way 50 years ago would be worth $580,000 today.
In 10 years, this portfolio could hypothetically be worth $1.3 million, based on historical returns. As I said, one of the ingredients of success in the stock market is time. More time, more dollars.
What funds can you buy? I’m getting there, but first, I want to talk about the mistakes made by investors.
One of the biggest mistakes is trying to time the markets. That is to say, to sell your investments or not to invest because you believe that a recession is coming and that the market will fall. This lowers returns since the markets are unpredictable in the short term.
In investing, our biggest enemies are not crashes or recessions, but the person you see when you look in the mirror every morning.
If the idea of watching your investments fall without doing anything gives you stress, I suggest you consult a financial advisor. This person can also motivate you to save and invest more. In return, it will charge an annual fee that can be around 2% of the size of your investments (compared to 0.25% or less for self-managed ETFs). But if it saves you from making costly mistakes, it’s worth it. It’s still rare, but some financial advisors and portfolio managers have started offering only index ETFs to their clients, and charging lower fees, around 1%.
Generally speaking, young investors, who have decades ahead of them and who should completely ignore short-term market ups and downs, often aim for an 80% stock, 20% bond portfolio. In their brokerage account, they can buy funds like XGRO from BlackRock, ZGRO from BMO or VGRO from Vanguard.
An older investor, who will have to sell his investments to live on them in the near future, can opt for a portfolio with 60% stocks and 40% bonds. For example, XBAL from BlackRock, ZBAL from BMO or VBAL from Vanguard. More “conservative” versions of these funds are also available with a 40% stock, 60% bond formula. These are XCNS, ZCON and VCNS.
It is also possible to separate all this and buy a Canadian equity fund, a US equity fund, an international equity fund and a bond fund. You’ll pay an even lower annual management fee (sometimes as low as 0.05%). For large sums, it may be worth it. But for most people, the simplicity of an all-in-one fund is hard to beat.
And, to be a true Michael Jordan of investing, you can schedule automated transfers from your checking account to your investment accounts. The best investors are the ones who put it all on autopilot, and then ignore it because they have a life.
This is how to invest. Does that help you? I know it’s not easy. I have written two books on the subject, and I continue to learn from it every day.
It’s easy to complicate everything. But it’s mostly not necessary.
The most important thing is to start.
