The Beginners Guide To Investing

When you hear the word ‘investing’, what’s the first thing that comes to mind? Maybe it’s money, the stock market, Warren Buffett, or maybe it’s nothing at all. If you feel like you don’t know a lot about investing, you’re not alone. I believe the majority of people don’t know as much about investing as they should. But if you’re looking to change that, you’re in the right place.

We aren’t taught anything about money, investing, or finance during grade school. It’s usually not until university where we even have the option to learn about it in the classroom (but you have to pay to take the class). Yet no matter what direction our lives take us, we all have to make a living, be financially responsible, and plan for our future.

Before coming into the financial industry, I went to college, received a diploma in Structural Engineering Technology, and worked as a Geotechnical Engineering Technician for almost five years. During my schooling I took a lot of math and physics courses, but while I was working, there was never a time that I had to do math I couldn’t either do in my head or on my iPhone calculator (and I’m not a genius). We’re not always taught what we should be, so we don’t always get the chance to learn things that can really help us. I believe that investing, is one of those things.

Key Takeaways:

• Investing is the best way to put your money in a position where it can work for you, with the potential to increase to incredible amounts over time.
• Although there can be risks associated with investing, there can also be risks associated with not investing.
• By understanding how investing works, we can make better informed decisions that can have a lifetime of benefit.

What Is Investing?

Investing is putting our money into the position where it can work for you, where it can earn money for you. Investing really utilizes three main things: contributions, annual return, and time. The more money you put into an account, the larger it will be (pretty simple). The higher an annual return you get, the more (and quicker) your money will grow. And the longer your money can invest, the larger the growth becomes. That’s because of compound interest. Let’s take a look at an example.

If you ‘saved’ $100 every paycheque, or every two-weeks, after 40 years you’d end up with $104,000 in the bank — it seems like a lot of money, but it has no growth. If instead of just saving it, you invest it and earn an annual return of 4%, you’d end up with $256,551.51 — even better. If you instead earned an 8% annual return, you’d have $760,899.67 — now we’re talking.

Just by investing rather than saving, you end up with over 7.3 times your contributions. The best part is, there is no extra work on you part. All you have to do, is take the initiative. That is the easiest $656,899.67 that you could ever make. No extra job, no budget restrictions, no sacrifices. And that’s with only $100 a paycheque, imagine what you could contribute could grow into.

Why We Invest

We all have our own reasons to invest, but there’s two main things that come to my mind when I think about why we invest: inflation, and growth.

I think we’ve all seen this picture (or something like it):

Every year the same $20 bill buys less and less groceries. It’s because of inflation. Inflation is the increase in the cost of goods, resulting in less purchasing power over time. People often think that there are a lot of risks involved with investing, but one could argue that there are risks involved with not investing, primarily, inflation risk.

Until recently, in Canada, a good estimate for inflation is about 2% a year. So something that costs $100 today, will cost $102 next year. Even though you could afford that thing today, if your $100 doesn’t grow, you won’t be able to in a year. Inflation seems very small, but in 20 years that $100 item will be $148.59, and in 40 years it’ll cost $220.80. By investing, we are giving our money a chance to keep up with, and even out perform inflation. Ensuring our money isn’t losing purchasing power.

As we saw from our compound interest example above, we were able to turn $104,000 into $760,899.67 over 40 years. Increasing the contributions by more than 7.3 times, or by $656,899.67. Introducing the second main reason to invest: growth. If you retire and expect to live another 20 years, with $104,000 you’re looking at being able to withdraw $5,200 a year, where a balance of $760,899.67 gives you a $38,044.98 yearly budget. This difference in income is literally life changing.

This growth is passive, meaning you’re not working to earn it like you would a regular job. If you were working to make that money, you’d need to make an additional $16,422.49 a year (before tax), which turns into a serious part time job (you’d have to work 821 hours at $20/hour). Passive income works when you’re working, when you’re busy, or even when you completely forget about it, in other words: always. There is nothing else that matches the reward for the required effort. So much reward, for almost no work at all.

Volatility And Reward

Stock markets are volatile, meaning they fluctuate, sometimes significantly. In 2020, we saw a lot of market fluctuation due to the COVID-19 pandemic. When markets are down, it can be tough to look at and see your investments are down. But even with the short term volatility, stocks markets consistently produce positive long term returns for investors. Below is a chart of the S&P 500 monthly performance for the year 2020. The S&P 500 is a group of 500 publicly traded American based companies, so it’s a great representation of how stock markets behave.

Stocks offer the most potential reward, but also come with the most volatility. Bonds (or fixed income) are less volatile than stocks are, and therefore offer a lower reward (but a reward nonetheless). Vanguard has compiled some amazing data on the performance of stocks and bonds, it can be found here. In summary, over the past 96 years US bonds have averaged a 6.3% annual return, while over the same period US stocks have averaged a 12.3% annual return (as of 2023).

Volatility is important to understand and consider because it plays a big part in planning. The longer funds are invested, the higher the chance of the investment having a positive overall return. If you have a short term goal, investing too aggressively can increase the chance of having a negative return when you need the money, as seen in the chart below.

Aligning our goals with realistic timelines is important. Taking on too much risk, or not enough risk, in their own ways, can be equally destructive to our investment plans.

How To Invest (Properly)

There’s a big difference between investing, and what I’d consider to be gambling. Investing is geared towards stable, long term, steady annual returns to grow your money. Gambling is taking unnecessary risks on an unstable, uncertain investment — like betting on a ‘hot stock’, or trend. Warren Buffett said that no one invests like him because it’s boring. He was right, but it works. Investing properly, is based on sound fundamentals, and decades of proven concepts. By investing properly, we can’t eliminate all risk, but we can certainly reduce and manage it appropriately.

You’ve heard the phrase ‘don’t put all of your eggs in one basket’. In the world of investing, it means don’t put all of your money into one company. The key is to diversify. Diversifying means to invest in a lot of different companies, a lot of different industries, a lot of different areas. There is safety in numbers. It’s like instead of betting everything on one team to win the Super Bowl, you bet a little on every team. That way if a company has a bad quarter, or an industry or area is impacted negatively by something, it minimizes the short term loss on your portfolio.

Another way to provide safety is through asset allocation. Asset allocation is like diversifying, but instead of looking at different companies or industries, you’re looking at your percentages of stocks and bonds. If you have a lower risk tolerance, or a shorter goal timeline, being in a conservative portfolio (bond weighted) could be ideal. If on the other hand you have a higher risk tolerance, or a longer timeline, being in a growth portfolio (stock weighted) would allow you to capture the most growth potential that markets offer. Asset allocation is the single most important factor in portfolio performance, more important than timing or even picking the best performing stocks.

The primary goal of any financial plan should be to protect your money, and then to grow it. In that order. Taking on too much risk can be disastrous to your goals, while not taking enough risk for longterm goals could diminish your growth potential. Risk shouldn’t be something to be intimidated by. It’s easy to be scared of something when you don’t know anything about it. But by learning how investing works, you can see that investing isn’t scary.

Prepare To Get Started

Investing requires money, you have to fund it. It almost becomes a rewarding expense, and should be treated like one. To be successful you have to be committed to it. There are things you should take care of before beginning to invest. Not only to give yourself the best chance to succeed, but also to ensure your money is working as efficiently as possible for you, for as long as possible.

Credit card companies typically charge 20% interest or more on outstanding balances. Meaning over an entire year, for every $100 of credit card debt you carry, you’d pay $20 in interest. As we saw from the Vanguard data, 100% stocks portfolios have averaged 12.3% annual return over the past 96 years. If you’re earning 12.3% while paying 20%, your net rate is -7.7%. As far as interest rates go, it’s better to pay off the highest interest rates first. Otherwise you’re paying more than you’re earning, so your money is working for you, but not as efficiently as it could. If your debt has a similar or lower interest rate to what you’d expect to earn, then it comes down to what you prefer. Is being debt free more important, or is investing?

COVID-19 has been a test on financial plans, especially on emergency funds. Having an emergency fund is a short term fall back in case of the unexpected. An emergency fund can take a lot of different forms: savings account, investment account, line of credit or credit card to name a few. Each has their own advantages and disadvantages. Savings accounts are stable but offer little to no return. Investment accounts can grow your money, but fluctuate. Line of credits don’t cost anything if you don’t use them, but have medium rates if you do need to borrow. Credit cards can also be free as long as you don’t use them, but have high rates of interest when you do. It's important to understand the pros and cons of each, to determine what will work best for you.

Often one of the best ways to get started is right in front of us. A lot of employers offer matching plans for group RRSP’s, yet a lot of people don’t take advantage of it. Every time you’re paid, a small percentage of your pay goes into an investment account, and your employer matches contributions to a point. Meaning that right from the start you’re getting free money, plus it’s being invested. If you have a plan through work, or a pension plan, make sure you’re making the most of it.

Budgeting is a balance of living your lifestyle today, while thinking about future you. Having even a basic budget in place, or knowing how much you can freely put towards your investments can make everything just a little simpler. It also ensures you’re not short on cash and forced to skip or stop making contributions. As long as you can contribute regularly your money will have the chance to work for you. It’s only when you get derailed that your plan faces issues.

How To Start

The earlier you start, the more time your money has to work for you, so it's positive impact is much more felt. If you look at the line graph above comparing the performance of 0%, 4%, and 8% interest rates, every year the gains get bigger and bigger.

The early we are in a good financial position, the better we are, because we have so much longer to reap the rewards of it. If you're waiting to start investing when you're older, please don't. The most common thing I hear in meetings with new client is: "I wish I knew this earlier", "I wish I started years ago".

Whether you decide to use a self-directed account, or you use an Advisor, I think it’s important to do your own research. Doing it on your own requires a high level of understanding, discipline and time to do it successfully. Using an Advisor can seem straightforward, but it requires trust, and due diligence on your part. Not every Advisor is built the same, not all companies offer you your best option. An Advisor should be someone you trust, someone who shares your vision, and someone who helps you get there — every step of the way.

Keep doing things your future self will thank you for.