Ready to invest and invest your money, but unsure where to start and overwhelmed with all there is to learn about investing?
It is very understandable and there is no reason not to start investing while you learn all the details and nuances of investing. I know it’s a lot to work with, but it can be very easy to get started with. My children do, so can you.
Before you start building the ETF portfolio, you need to make an assumption: you have 15 to 30 years to invest and let your money do the work for you.
Risk tolerance & emotions
If you’re starting out and new to investing, you’ll come across a lot of different financial guidelines, all of which are designed to help manage your emotions.
Investment risk is tied to your emotional response to depreciation. How are you going to deal with it? Sell everything when it’s down? This is a bad move and the chart below shows you how the markets are rebounding and making new highs.
As you can see, there is no need to panic. You have to be patient
Building an ETF portfolio
Throughout my entire experience as an investor, returns are important – be sure to track your returns. Why? Because it can make up for lower contributions over time and / or shorten your years of work.
As such, market returns around the world are not really attractive. Not to mention, as a Canadian, understanding the economies and business practices of North America is easier, and I like to invest in what I can understand.
Now you might be tempted to focus on the Canadian stock market, but I find it very limited. They are mostly financials and energy / raw materials. On the other hand, the US stock market has really good coverage of all sectors.
The first ETF to build a strong ETF portfolio uses an ETF that tracks the S&P500. You invest in the top 500 US companies that operate around the world. The companies take over globalization for you. My ETF is the Vanguard S&P 500 Index ETF or VFV ETF.
Since inception, VFV has had a return of 18.53%. It fluctuates, but over time there is a potential return. Imagine what your TFSA can grow with such a return and that is why VFV is also in my portfolio.
|1||2009||5,000||5,000||5,250||5,500||Not pursued||Not started|
|2||2010||5,000||10,000||10,762||11,550||Not pursued||Not started|
|3rd||2011||5,000||15,000||16,550||18.205||Not pursued||Not started|
|4th||2012||5,000||20,000||22,628||25,525||Not pursued||Not started|
|5||2013||5,500||25,500||29,534||34,128||$ 41,742||Not started|
|6th||2014||5,500||31,000||36,786||43,590||$ 52,820||Not started|
|7th||2015||10,000||41,000||49.125||58.949||$ 56,307||Not started|
|8th||2016||5,500||46,500||57,356||70,984||$ 70,200||Not started|
|9||2017||5,500||52,000||65,999||84.034||$ 78,900||$ 13,308|
|10||2018||5,500||57,500||75,074||98,487||$ 96,937||$ 58,818|
For the first $ 50,000 or $ 100,000, consider the following: Guidelines. In this phase you define and refine your investment strategy – it is the learning phase. Take it slow and invest once a month or quarterly.
Find a discount broker with free ETFs and low transaction fees. Personally, I try to limit my stock trading costs to a maximum of 1% – I’m investing $ 1,000 for a $ 9.95 transaction fee. Questrade now has free ETFs and no maintenance fees.
When you have all of your $ 50,000 ready, spread your purchases out over weeks to avoid dropping your beginner portfolio and not being able to drop the average. There’s nothing like seeing your money drop right after you buy it and waiting for months to come back.
If you’re just starting to save, put away $ 50 or $ 100 a week and buy VFV’s shares when you have enough cash to cover the price of a stock or two. Over time, it will build up and grow.
In this beginner ETF portfolio building phase, it is not time to let analysis paralyze you. The intent is to use the dollar cost average. The markets move up and down and you cannot predict the move. Just accept it and be ready to capitalize when the time comes.
What I’ve noticed is that investors who invest in index ETFs either feel that one ETF isn’t enough, they itch to branch out, or they buy an index that invests in the world, but when they do if you break it down, the ETF invests in 6 different ETFs. You end up paying double for MER (the one you own and the other – not always huge, but know the MER).
Use the investment accounts
Depending on your personal situation, you have access to different accounts. You may be wondering if you should start on your TFSA or your RRSP.
An important concept of RRSP is tax refund and it sometimes takes time to realize that the tax refund is not a travel bank but your pension money. With an RRSP, you can defer taxes, while a TFSA is completely tax-free.
The difference matters and plays a huge role in your retirement and the way you withdraw money, since RRSP withdrawals are income for income tax purposes and a TFSA withdrawal does not add to your income.
Both accounts play an important role in your entry-level portfolio and have different tax advantages and contribution limits (see your TFSA contribution limits).
Example of an ETF portfolio for beginners
The first entry-level ETF portfolio starts with 100% in one index – the S&P 500 index. In this case, let’s use VFV.
Did you expect a chic model? Boring works.
It is imperative that you track the performance of your portfolio to understand your return on investment. I was disappointed with the discount broker basic performance metrics and built a portfolio and dividend tracker to have confidence in the numbers.
What can you expect in terms of performance? Well, the first year can be a roller coaster ride with ups and downs. There can always be short-term noise nuisance in the markets, but after 2 or 3 years growth begins to normalize.
More about risks
What about risks? How high is your risk tolerance? In general, the financial industry rates the risk tolerance for investors as follows:
- Conservative – 70% borrowing target
- Careful – 50% borrowing target
- Balanced – 30% bond target
- Assertive – 15% borrowing target
- Aggressive – 0% bond target
One way the financial industry is managing risk is to add bonds for a less aggressive portfolio. Here is an investment risk tolerance questionnaire.
University of Missouri Risk Tolerance Questionnaire
What you will notice about the questionnaire is that it covers emotional responses to portfolio losses (real or not), your growth expectation based on a potential loss, and your confidence and understanding of the stock market.
Regardless of your risk tolerance, you can start with an index ETF to really understand what you are capable of, as long as you track and compare the performance of your investments.
Using an index ETF still invests in stocks, and from a risk tolerance standpoint, you’re fully invested in stocks, but you take away the potential stock picking mistakes if you pick a stock for the wrong reasons and lose money.
Income Tax Considerations
The account selection covered earlier may be enough to get you started with the basics of capital gains taxes, but there are basics you need to know about the impact of income taxes on your investments. The choice of investments per account will be crucial to keeping more of your money.
There are five main categories in which income taxes are incurred on investments:
- Capital Gains – The tax investors pay on gains outside of a registered account.
- Income Tax – Interest on cash or investments (distributions) or payments on bonds fall into this category
- Dividend Tax – The preferential rate for creditable dividends
- Return on Investment – Income trusts and REITs do this and add significant expense on the accounting front
- Foreign Dividend – The tax rate on foreign dividends.
While you may be interested in high yield REITs, taxes on REITs in an unregistered account can be complicated.