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Beginning to invest can be overwhelming. There are so many acronyms thrown around such as TFSA, RRSP, ETF. Not to mention everyone, whether it be your bank or your roommate, seems to think they know how you should invest. To tackle this, we created a quick guide to help Canadians understand investing and how to get started.
For most Canadians, especially beginning investors, we recommend using a Robo-Advisor. This is a relatively stress-free and affordable service that diversifies and manages your investments. Check out our picks for the Best Robo-Advisors in Canada.
First Off: What Are Stocks and Bonds?
Buying a stock (also often called equity) is essentially like buying a tiny fraction of a company. There exist different types of stocks, but generally speaking, owning a stock often gives you (but does not guarantee) some share of the companies profits (called dividends when they are sent to shareholders).
Bonds, on the other hand, are created by governments or companies and are a way for them to generate cash by taking on debt. For example, if a municipality needed money for a construction project, they might sell bonds for $100, which guarantees they'll pay bondholders $105 in 2 years. Both stock and bond prices are dictated by what other people are willing to pay for them, and hence fluctuate with buyers' confidence in the asset. Generally speaking, bonds are considered a safer investment than stocks as they are less likely to lose a lot of value (like stocks often can), but they also are unlikely to gain a lot of value (like stocks often can).
Should I Pick Stocks?
When many novice investors think of investing, they think it's is just picking stocks. However, the majority of Canadians don't pick stocks when they invest. Instead, they typically purchase mutual funds, or more recently Exchange-Traded Funds (ETFs). Both mutual funds and ETFs essentially are baskets of a ton of stocks and/or bonds. When you buy a share of an ETF or mutual fund, you are buying a portion of all the shares and bonds in the basket. We highly recommend most Canadians invest in these funds instead of stock picking, as it is generally less risky. For example, if you pick stocks and $100,000 invest in 4 companies and one of them goes bankrupt, you could be out $25,000. On the other hand, it is unlikely that 25% of the many companies in a fund will go bankrupt at once. Finally, stock picking can incur extra stress and be very time-consuming, especially when it provides similar returns to just purchasing a fund.
So What is a TFSA or RRSP?
Many people believe that a Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) are investments themselves and that you just put your money in one and start making money. But that simply isn't true. The TFSA and RRSP are just TYPES of investment accounts. That would be like saying that any clothes you throw in a washer are automatically being cleaned. You have to first choose your washing settings (investments) and turn on the washer (buy your investments). With both your RRSP and TFSA, you have to select what investments you want to purchase in each, whether that be stocks, bonds, ETFs, or mutual funds (don't worry, we these all are).
A TFSA is just a tax shelter Canadians can use to avoid taxes on their gains. Normally, if you invest in something and it appreciates (the price goes up) and you sell it, you will be taxed by what's called a capital gains tax. If you invest in something using the money in your TFSA and it goes up, you won't be taxed by the capital gains tax when you sell it. There are contribution limits and other restrictions for this account that are explained fully on the CRA's website.
Similar to a TFSA, and RRSP is simply a different tax shelter, focused on retirement. However, an RRSP is taxed at withdrawal and functions very differently than a TFSA, including the ability to convert them to a Registered Retirement Income Fund (RRIF) when you retire. Generally speaking, we only recommend contributing to an RRSP when you are saving for retirement and maximizing your TFSA contributions first. If you are unsure, speaking with a financial planner may help you to decide which account type (or both) works best for your situation.
Mutual Funds vs. ETFs
I know we just recommended mutual funds and ETFs, however, we will be going back on our word here. We generally actually don't recommend mutual funds, although they still more recommended than stock picking. If you're unsure what investments you invested in, but you had an advisor set up your investments for you at a major bank, they likely have you invested in mutual funds. Most mutual funds have high management fees (called the Management Expense Ration, or MER) that come with owning them, often above 2%. That means you could be automatically losing over 2% of your investment value every year (whether the investments are gaining or losing money this fee is taken off). With a 2% MER, if you invest just $5,000 a year into your portfolio for 25 years, you could lose over $50,000 to mutual fund's MER during that time.
ETFs on the other hand, have much lower fees. The Vanguard Growth Portfolio ETF (VGRO) for example, is a diversified worldwide ETF made to be a complete investment portfolio. Its performance is nearly identical to most similar mutual fund options, but its MER is just 0.25%. That is about 88% less in fees than most mutual fund options.
How Do I Buy ETFs?
The most affordable way to buy an ETF is to open an account with an online brokerage. Your bank likely offers this, although Questrade is another great choice as they allow you to buy ETFs for free. Click here to get $50 in free trades when you sign up for Questrade. Using this account you can purchase ETFs that meet your requirements, risk level, during hours when the market is open. We generally recommend the Vanguard Asset Allocation ETFs summarized here. This is a great way to invest (and the cheapest), but many people still find it overwhelming to find the right ETF or even trading ETFs. That is why for most Canadians I recommend a Robo-Advisor!
What is a Robo-Advisor?
A Robo-Advisor is simply an investing platform that asks you questions about your goals and generates a portfolio of ETFs that helps you meet these goals. You put money onto the platform, and it automatically buys these ETFs for you in the right proportions that match your risk levels. The MER is higher than just buying ETFs but much lower than mutual funds. It generally ranges between 0.25-0.7% depending on the service. Many Robo-Advisors even offer access to financial planners if you are looking for personal service (namely WealthBar).
Even if you already have mutual funds set up, switching over to a Robo-Advisor is straightforward as they will manage the switch and often pay any fees incurred. Check out our picks for the Best Robo-Advisors in Canada.