I'm sure not a lot of people enjoy having their savings just sit in a pile earning 1% interest in their savings account. But unfortunately, basic financial investing was not something many of us really learned in school.
It's such an amazingly important and useful tool, but it's up to us to learn how to invest. Unfortunately buying stocks can be intimidating and a bit complex, as well as time and knowledge intensive. Mutual Funds are okay, but know that you are paying someone a fee to manage your money (regardless if your mutual funds do well or not) which significantly reduces your profits. Fixed income like GIC's and bonds are excellent for the risk averse but rarely pay much more than your savings account these days, and are usually locked in for a given time period.
So what's the best option for someone who doesn't want to spend a ton of time researching, and worrying, and wants something simple, stress free and relatively low-risk that also gets reasonable gains?
This is where I talk about the magical concept called the The Couch Potato Portfolio- a simple answer to the complicated question of investing. But first, I need to explain a couple key terms:
MUTUAL FUNDS and ETF'S
An ETF stands for 'Exchange Traded Fund." This means it is like a Mutual Fund, but you buy it just like you'd buy a stock on an exchange like the Toronto or New York Stock Exchange. In comparison, you buy a Mutual Fund from a bank or other financial institution. Aside from these differences, Mutual Funds and ETF's are very similar in how they work.
Here’s the basic principle behind a Mutual Fund: you, along with a bunch of other investors give your money to a professional investment manager and he/she invests that money over a wide range of stocks or bonds. In doing so, you reduce the risk of losing all your cash on one bad bet. (This is known as diversifying)
An ETF is the same, except you purchase the fund on the stock market rather than at a bank. There are MANY different ETF's out there (check out ishares.ca for a comprehensive list). You can get a Health Care ETF that has hundreds of health care companies within it, or a bond ETF, an oil and gas ETF, or one with all high-dividend paying Canadian companies.
The other difference with an ETF (and why they're gaining so much popularity) is that they charge a very low fee compared to most mutual funds. With both Mutual Funds and ETF's you'll pay what's called a 'Management Expense Ratio (MER).' A typical actively-managed mutual fund (meaning some full-time financial guy is constantly fine-tuning the investments in the fund) could charge you as much as 2-4% of your investment each year. Whereas a passively-managed ETF (not constantly changing the investments, little work involved) usually charges only around 0.2%. This is a huge difference when you're making around 4-5% on your funds but 3% is being skimmed off the top!
THE COUCH POTATO PORTFOLIO
So now that those terms are explained, I can tell you about the wondrous 'Couch Potato Portfolio.' All you need to do to have an extremely well-diversified, safe and dependable investment portfolio is to do the following. Invest:
- 1/4 of your money in a Canadian Stock Index ETF
- 1/4 in a U.S. Stock Index ETF
- 1/4 in a World Stock Index ETF
- and the remaining 1/4 in a Universal Bond Index ETF
There are different variations on this strategy (check them out here) but they are essentially the same concept. This investment strategy is a powerful tool as it allows you to be EXTREMELY well diversified as you are essentially spreading your money across hundreds of well-established companies and bonds all around the world. You don't spend much in terms of management fees, and it's called the Couch Potato portfolio because you don't really have to do much with it once it's set up! Just re-balance it once a year so you keep that 1/4 balance and let it do it's thing. All these ETF's should pay dividends too, so you can just collect a nice paycheck while you let your investments grow!!
If you're interested in a more detailed description of ETF's and Mutual Funds, head over to my investment website, oneyounginvestor.com/mutual-funds--etfs.
And if you'd like to buy ETF's, you'll need what's called a trading or brokerage account. Check out Questrade.com for a discount broker (cheap rates and simple!), or TD Waterhouse (full blown trading account, kinda expensive!)