Key principles to follow when starting out as an investor
One of Warren Buffett’s famous maxims is to buy when everyone else is selling. This principle has helped male him, through his investment company Berkshire Hathaway Inc., one of the richest men in the world. Right now, prices of stocks and bonds have tanked, as the fire of inflation rages on and central banks raise interest rates in an effort to quench it. Eventually inflation will be tamped down, but probably not without a recession, as economic activity contracts. It sounds bad no matter which way you look at it. But with asset prices much lower than they were a year ago, it could be a great opportunity for novice investors looking to start an investment portfolio.
And there are plenty of investment choices to go around – ETFs, mutual funds, stocks, and bonds. All are languishing at reduced prices – in the bargain basement, as Mr. Buffett might say. But where to start? Most novices will initially look at mutual funds and exchange-traded funds (ETFs) for their first forays into portfolio building. These offer easy entry, instant diversification, and in the case of ETFs, very low cost.
The choice of investment products truly is overwhelming in sheer numbers and complexity. The Fund Library currently tracks about 40,000 mutual funds and clones (various series of the same fund). All funds are categorized into various types of equity, bond, income, balanced, international funds, and so on by the Canadian Investment Funds Standards Committee. Then, there are also close to 1,000 exchange-traded funds traded on the TSX.
A “passive,” or “index,” approach may be the best strategy for investors with smaller account sizes (e.g., less than $250,000). This would be especially attractive for investors who do not have a lot of investing knowledge and are not quite ready to become day traders and all the risk that entails.
Passive investing is a strategy for building a diversified, low-maintenance portfolio designed to deliver the same returns as the overall stock and bond markets, minus very small fees. ETFs offer the simplest way to execute this strategy. ETFs hold a basket of stocks or bonds and track a specific index. They are bought and sold on a stock exchange and typically have lower annual MERs than index mutual funds.
If you are a conservative investor, you might look to invest with 60%/40% split between equities and bonds, or vice versa, keeping a small allocation in cash. Adjust the weightings within that ratio as your personal circumstances or market conditions warrant.
You can build these portfolios yourself or use online “robo-advisors” offered by several financial firms, which pre-select a diversified portfolio of ETFs for you based on a fairly intensive questionnaire. You get an online account, along with statements, and limited communication. You don’t get much personal advice, but that’s the point. The rest is up to you. It’s a cost-effective way for smaller investors with limited investment knowledge to get started. And it helps you avoid the mistake of building a portfolio of randomly selected individual mutual funds, stocks, and ETFs.
Beyond creating that initial portfolio, novice investors need to apply my three basic investing principles in order to succeed in the market.
1. Discipline. That type of portfolio you choose will produce results, but only if you have the discipline to stick with it over time. It’s tempting to tinker with it when business news blares “recession,” or “bear market,” or “inflation” day after day. But discipline is critically important. If you succumb to the “fear” part of the fear/greed equation, you’ve made a fatal mistake in your financial planning. The discipline lies in making sure you don’t blow up your portfolio at every turn – because you’ll almost certainly do it at the wrong time.
2. Patience. The longer you stick with your plan, the more likely you are to achieve your wealth creation targets, regardless of market fluctuations. Over the long term, stocks outperform virtually every other asset class. The S&P/TSX Composite Index, for example, has returned an annual average 7.6% compounded annually since inception in December 1999, as of July 31.
3. Prudence. When choosing assets for your portfolio, you have to ensure they match your risk tolerance and portfolio weighting objectives. For example, you are unlikely to buy ETFs that hold only speculative junior stocks or junk bonds. Do your research and know what you’re investing in, including the history and outlook of any funds you are considering. Get the facts and figures and proof of performance. It’s your money. Treat it prudently, and give it the respect it deserves.