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TRANSCRIPT
The Short Book on Investments
The basics of personal investments,
written in clear and simple language
BY D R . J I N WO N C H O I
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This book is for those who are new to investing. It’s for those who want to know what they need to know, without spending too much time or money. It’s for those who want to be wise with their money.
Introduction
WhyLearntoInvest?
WhyshouldYoutrustMe?
Concepts
CompoundReturns
Risk
Liquidity
Diversification
Financial Products
Stocks
BondsandGICs
MutualFunds
IndexFundsandETFs
RealEstate
Commodities
LifeInsurance
Table of Contents
Taxation
CapitalGainsTax
RRSP
TFSA
RESP
Practical Considerations
PayingDownDebtvs.Saving
HowToBuyStocksandETFs
KnowingWhichStocksandETFsToBuy
HowToOptimizeForTaxes
HowMuchToSaveEachMonth
OnceYou’veInvested
EconomistsandOtherTalkingHeads
Final Thoughts
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Why Learn to Invest?You’vebeenworking,andyou’vestartedtoaccumulatesome
meaningfulsavings.You’veopenedasavingsaccountatabankbut
havenoticedthattheinterestpaymentsaremeagre,ifnotpathetic.
Youareconvincedthattheremustbeabetterwaytoputyour
savingstowork.Inotherwords,youwanttoinvest.
Theproblemis,youdon’tknowmuchaboutinvesting.
You’vereadabitaboutitinthenewspapersoronline,butsometimes
youfeelasiftheexpertsarespeakingadifferentlanguage.You
justdon’thavethatmanyhourstospendtryingtofigureitallout.
Investinghasalwaysjustseemedtoocomplicated.You’vethought
aboutgettingafinancialadvisororaplannertohelpyouout,butyou
don’tknowwhomtotrust.
Iftheaboveringstrueforyou,thenthisbookisforyou.
Thisbookisforpeoplewhoarenewtoinvesting.It’sforthosewho
wanttobeinvolvedin,oratleastunderstand,thedecisionmaking
fortheirinvestments,ratherthansittingbacktoletafinancialadvisor
tellthemwhattheyshoulddo.Thisbookisforbusypeopleofall
backgroundswhowanttoknowwhat’sgoingonwiththeirmoney.
Quitesimply,itisforthosewhowanttobewisewiththeirmoney.
Thisbookwillteachyouthebasics.Itwillteachyouconceptstohelp
youunderstandinvestments.Itwillgiveyouthebasiclow-downon
financialproductssuchasstocks,bonds,andmore.Itwillteachyou
practicaltips,includingastep-by-stepguideonhowyoumightinvest
foryourself.Youwilllearnallofthisinunder30pages.
Today,manypeoplegotofinancialadvisorstogainthisknowledge.
Unfortunately,thefinancialadviceindustryhasawell-deserved
reputationforbeinguntrustworthy.Fartoooften,financialadvisors
lackenoughknowledgetoproperlyadvisetheirclients.Often,they
arenotupfrontabouttheirfees.Theyoftendon’tactintheirclients’
bestinterests.Yettheygetawaywithallthisbecauseforalloftheir
lackofknowledge,theystillknowmorethantheirclients.Thisbook
willnotonlyequipyouwithabasicknowledgeofinvesting,butitwill
alsohelpyouchoosetherightfinancialadvisor,shouldyoudecideto
gotoone.
Investingwellcanliterallymakeadifferenceofhundredsof
thousandsofdollars,eventotheaveragemiddleclassearner.Read
thisbook,andyouwillseethatI’mnotexaggerating.
Why should You trust Me?Inthefinancialplanningindustry,trustisessential.Youshouldnot
trustanybodywithoutreason,andthatincludesme.So,canyoutrust
me?Well,hereiswhyIthinkyoucan:
MynameisDr.JinWonChoi.IhaveaPh.D.intheareaofFinancial
Mathematics.ThatmeansIspentanumberofyearsresearchingand
learningabouthowthefinancialmarketswork,howassetsarepriced,
andhowtomeasurerisk,etc.
Ialsoworkedasananalystfortwoyearsforatopperforminghedge
fund.Inthisjob,Iworkedasamemberofathree-personteamto
analyzevariousinvestmentopportunitieswithdifferentcompanies,
butmainlywiththeoilandgassector.WhileIcan’tsaytoomuchin
detailaboutthishedgefundbecauseofconfidentiality,Icantellyou
thatits3-yeartrackrecordfrom2009to2012wouldhaveplacedthe
fundwellwithinthetop1%ofallmutualfundsfoundontheGlobe
Investor.
Sofar,I’vepassedtwooutofthreelevelsoftheCharteredFinancial
Analyst(CFA)designation,whichiswidelyregardedasthemost
rigorousdesignationintheinvestmentindustry.
IamKoreanbybirth,andhavelivedinKorea,theU.S.,Irelandand
Canada.Iammarried,andmylovelywife’snameisJennifer.Iamalso
adevotedChristian.
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Concepts In this section, I will explain the concepts you need to know in order to get a handle on understanding your investment opportunities.
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Compound ReturnsAlbertEinsteinwasonceaskedwhathethoughttobethemost
powerfulforceintheuniverse.Hisanswerwas“Compoundinterest.”
Ithinkthetermcompoundingcanbestbeunderstoodthrough
anexample.Sayabanklentyou$1,000atarateof20%peryear,
compounded.Afterthefirstyear,youowethebank$1,200.Afterthe
secondyear,younowowe20%notontheoriginal$1,000,buton
thenewowingof$1,200.Thatmeansyouowenot$1,400,butrather
$1,440(i.e.$1,2001.2).Ifyourloanwentontoathirdyearandyoustill
hadn’tpaidanythingback,you’dthenowe20%on$1,440,or$1,728.
Compoundingturnsmoneyintoagrowingsnowball.Thebiggerthe
amount,thefasteritgrows,andlikeEinsteinsaid,thatcanbeavery
powerfulforce.
LegendhasitthatManhattanwasboughtforjust5pearlsin1626.
Someestimatethat5pearlsintoday’sdollars—assumingthepearls
werereal—wouldbeworthabout$1,000.Fastforwardto2010.
Someestimatedthatin2010thelandofManhattanwasworth$210
billion.Couldyouguesswhatthecompoundrateofreturnwould
havebeenoverthatperiodof384years?Itwasactuallyjust5.1%per
year.Here’sanotherwayofsayingit;ifyouhadinvested$1,000in
1626andgrewitat5.1%peryear,youwouldbeleftwith$210billion
after384years.
Youmayask,“Sowhat?I’mnotgoingtolive384years.”True.Solet’s
consideramorerelevantexample.Sayyouhad$10,000toinvest.In
onescenario,youreturned6.5%peryear.Inanotherscenario,you
returned8.5%peryear.There’sareasonwhyIchosethosenumbers,
andI’llexplainwhylaterinthisbook.Let’salsosaythatinboth
scenarios,yourmoneywasallowedtocompoundfor30years.How
muchwouldyouhaveafter30years?
With6.5%peryear,youwouldhaveendedupwitharound$66,000
after30years.With8.5%peryear,youwouldhaveendedupwith
$116,000.Thisisadifferenceof$50,000.Nowlet’sgoonestep
further,andsayweinvestedatthesedifferentratesfor60years.
With6.5%peryear,youwouldendupwith$437,000.Notbad.But
with8.5%peryear,youwouldendupwith$1,336,000.Thedifference
thistimeisalmost$900,000.Astimegoeson,thegapbetween
moneyinvestedatahigherandlowerreturngrows.
Insummary,compoundedratesofreturnmatter,andtheymattera
lot.Youwouldbewisenottoignorethedifferencethata“mere”2%
peryearcanmake.
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RiskSupposesomeoneproposedthefollowingbet.Hewillflipacoin.
Ifitturnsupheads,youwin$22,000;ifit’stails,youlose$20,000.
Wouldyoutakethisbet?Thechancesare,youwouldn’t,andyou’re
notalone.Accordingtoresearch,mostpeople(thoughnotall)would
refuseabetlikethis.
Whywouldn’tpeopletakethebet?Onaverage,peoplewillmake
moneyiftheygoforthis.Chalkituptohumannature.Thehuman
mindinstinctivelyunderstandsthatthisbetisrisky.Formostpeople,
thepotentialtoearnmoneyisnotworththerisk.
Everyinvestmenthassomerisk.Witheachinvestment,notonly
shouldyoulookatitspotentialreturns,youshouldalsolookatits
risk.LikeSiamesetwins,riskandreturnsalwaysgotogether.Ifreturns
arehigh,it’susuallybecauserisksarehigh,andviceversa.
Astatisticalconceptcalled‘standarddeviation’isoftenusedto
measurerisk.Thehigherthestandarddeviation,thewidertherange
ofpossibleoutcomesforyourinvestment,andthereforethehigher
therisk.
Let’sconsideranexample.Youhave$10,000,whichyouuseto
buysomerailroadstock.NeitheryounorIknowforsurewherethe
stockisgoingtoendup.However,you’refairlyoptimistic.Youthink
thatinthenextyear,there’sa50%chancethatyourinvestmentwill
growto$11,500—a15%gain.Youalsothinkthere’sa50%chance
yourinvestmentswilldeclineto$9,500—a5%loss.Ifyougeta
mathgeektopunchinthenumbers,youwillfindthatthestandard
deviationis10%.
Nowlet’scontrastitwithanotherexample.Thistime,youinvest
$10,000inanup-and-comingtechnologystock.You’restilloptimistic.
Youthinkthatinthenextyear,thereisa50%chanceyourinvestment
willgrowto$15,000—a50%gain.Butyou’rearealistandyoualso
thinkthere’sa50%chanceyourinvestmentwilldeclineto$7,000,
a30%loss.Inthiscase,thestandarddeviationis40%;muchhigher
$9,500
$7,000
$11,500
$15,000
$10,000 $10,000
Lowerriskbet Higherriskbet
LiquidityInhisbook“DeliveringHappiness,”TonyHsiehrecountedthestory
ofhiscompany,Zappos,theonlineretailernowownedbyAmazon.
AccordingtoHsieh’sbook,therewasonepointinZappos’history
whenthecompanyalmostwentbankrupt.Inordertokeepthe
companyalive,Tonyputhisloftupforsale.Iftheloftwassold,his
thanfortherailroadstock.Whatdothenumberstellus?Buying
thetechnologystockisamuchriskierpropositionthanbuyingthe
railroadstock.Youstandtogainalotmore,butyoustandtolose
moreaswell.
Insummary,alwayskeepriskinmindwhenthinkingabout
investments.Youcanmeasureaninvestment’sriskinessbylooking
atstandarddeviation.Thehigherthestandarddeviation,thehigher
therisk.
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companywouldhavecashtoliveanotherday.Ifnot,hiscompany
wouldgobankrupt.ItwascertainthatTony’sloftheldvalue,butit
wasfarfromcertainthathe’dbeabletosellitintime.Inotherwords,
Tonyhadaliquidityproblem.
Ifafinancialassetisliquid,itmeansthatyoucantradeitveryeasily.
Forexample,stocksaregenerallyliquid—youcantradethemwithin
seconds.Thiscontrastswithfinancialassetsthatareilliquid.Asan
example,realestateisanassetclassthatisgenerallyilliquid.
Alongwithrisksandreturns,liquidityisalsosomethingyoushould
beverymindfulof.Ifyouholdilliquidassets,youcouldbevulnerable
toshocksinyourlife—suchasjoblosses,accidents,etc.Yourmillion
dollarhomemightfetchonly$800,000ifyouhadtosellittomorrow.
Toclarify,I’mnotsuggestingthatyousellyourhouseatthesoonest
opportunitytobuyliquidinvestments.Rather,Ibelieveeveryone
shouldhaveatleastsomeoftheirsavingsinmoreliquidassetsthan
realestate.Lifethrowscurveballsatyou,oftenwithoutwarning.Be
prepared.
DiversificationWeallknowthecommonproverb,“Don’tputallyoureggsinone
basket.”Aninvestorwoulddowelltoheedthisadvice.
Diversificationmeansspreadingoutyourinvestmentssothatyou’re
notvulnerabletoanybadnews.You’reproperlydiversifiedwhenyour
investmentsareunrelated.ThefateofanickelmineinAustraliais
unrelatedtothefateofasoftwarecompanyinToronto.Supposeyou
investinboth.Towipeoutyourinvestments,boththenickelmineand
thesoftwarecompanywouldhavetofail.Itmaybeunlikelytosee
oneofthemfail,buttoseebothfailwouldbetrulyrare.Youaresafer
holdingbothofthesecompanies,ratherthanholdingjustone.
However,you’renotproperlydiversifiedifyourinvestmentsare
correlated.Anexamplemightbeaninvestmentinacarmanufacturer,
aswellasaninvestmentinthecompanythatsuppliesitsengines.
Bankruptcyforthecarmanufacturercanleadtothebankruptcyof
thesupplier.Ifyouinvestinboththesecompanies,youarejustas
vulnerableasinvestingonlyinthemanufacturer.
Insummary,diversificationmeansspreadingoutyourinvestments.
Todiversifyproperly,investinunrelatedopportunities.Proper
diversificationwilllowertheriskofyourinvestmentportfolio.
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FinancialProducts This section contains my explanations
of the various financial products available to the average investor. It also contains my unashamedly biased views on those products.
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StocksAstockisapartownershipofacompany.Thatiswhywhenyouown
stock,youarecalleda“shareholder”—i.e.someonewhoholdsshare
ofacompany.Thecompany’sassetsandfutureprofitsdeterminethe
valueofyourstock.
It’sveryeasytotradestocks.Mostbanksofferbrokerageservices
whereyoucanbuyorsellstocksforafee.However,it’smuch
cheaperifyouuseadiscountbrokerageservice.Wewilldealwith
thesubjectofdiscountbrokerageslateroninthisbook.Unlessyou
areamultimillionairepouringmillionsintoasinglestock,youwillfind
thatstocksareveryliquidinvestments.Youcansellyourstocksin
seconds.
Therearesome15,000publiclylistedcompanies(i.e.companieswith
tradablestock)intheU.S.,andsome6,000inCanada.Asthenumber
ofpubliclytradedcompaniesgrew,itbecamehardertotrackhowthe
stockmarketasacollectivewasdoingoverall.Youcouldnolonger
pointtoafewstocksandsaythemarketdidwelloverallinanygiven
year.So,peoplecreatedindices.
ThetwomostfamousU.S.indicesaretheDowJonesIndustrial
Average,andtheS&P500.TheDowconsistsof30verylarge,very
stableU.S.companies.It’sbyfartheolderofthetwoindices,dating
backto1896.TheS&P500,ontheotherhand,consistsof500of
thelargestU.S.companies.Botharewidelyquotedinthemedia.
InCanada,thetwomostprominentindicesaretheTSXComposite
Index,andtheTSX60Index.TheTSXCompositeincludeshundreds
ofthelargestCanadiancompanies,whiletheTSX60includesjustthe
60largest.
Inthepast,stocksgeneratedhighreturnsatthecostofmoderately
highrisk.Overthepast100years,thevolatilityratewasaround
15%,whichmeantthatreturnswereunpredictable.Returnsranged
between-20%and+35%duringmostyears,andevenwentoutside
thatrangeeverycoupleofdecades.Butoverall,ifyouhadinvestedin
everystockintheDowindex,yourinvestmentswouldhavereturned
9%peryear,withastandarddeviationof15%.TheS&P500hashad
similarriskandreturnsastheDowsinceitsinception.
9%returnsforstockssoundsgreat,butwillitcontinue?Ithinkso,at
leastintheverylongterm.
Forthepast100years,theaveragereturnoncapitalforU.S.and
Canadiancorporationswas9%.Inotherwords,witheverydollar
theaverageU.SorCanadiancorporationreceivedfrominvestors,it
generatedprofitsof9centsperyear.
AccordingtobusinesstycoonWarrenBuffett,thecorporations
generatedsuchprofitsnotbecauseAmericansandCanadianswere
anysmarterthanpeoplefromothernations,butbecausetheir
capitalistsystemandrulesoflawallowedhumanpotentialtoblossom.
Forallthetroublesourcountriesface,thehistorical,positivestock
returnsshouldcontinueintothefutureaslongastheirbasicsystems
remainintact.
NoticethatIhavekeptourdiscussiontoindices—i.e.thestock
marketasawhole—insteadofindividualstocks.That’sbecauseI
wanttoofferabigwordofcautiontoanyonewishingtoinvestin
individualstocks.Pickingstocksishard.
Ifyoubuyoneortwostocks,orevenseveral,you’renotproperly
diversified.Everyonefeelsthattheycan“beatthemarket”-inother
words,generateaboveaveragereturns.Researchhasshownagainand
againthatthegreatmajorityofstockpickersgeneratebelowaverage
returns,thoughnotalldo.Unlessyouplanonspendingthousandsof
hoursresearchingstocks,takemyadvice—don’tdoit.Instead,be
properlydiversifiedbyholdingmany,manystocks.Inlaterchapters,I’ll
showyouhow.
Insummary,stocksarepartownershipofcorporations.Theaverage
corporationhasreturned9%historically,whichIbelievewillcontinue.
Thestandarddeviationisabout15%,whichmakesstocksmoderately
highinrisk.They’realsoveryliquidinvestments.However,trynotto
pickindividualstocks—doingsowilllikelycostyou.
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Bonds and GICsAbondisbasicallysomeone’sdebt.Ifyouholdabond,itmeans
thatsomeoneowesyoumoney.Forexample,ifyouholdatypeof
bondcalledaCanadaSavingsBond(CSB),thefederalgovernment
ofCanadaowesyoumoney.Ontheotherhand,ifyouholdaTim
Horton’sbond,TimHorton’sowesyoumoney.
Bondshavethreeimportantcharacteristics:maturity,creditrating
andyield.
Maturityiswhenthebondwillbefullypaidback—e.g.aTim
Horton’sbondmaymatureonJune1,2017.You can trade bonds
before maturity.Infact,bondsareusuallyprettyliquid—youcan
normallytradetheminseconds.Maturitiesareimportantnotbecause
theylockyouin,butbecausebondswithlongermaturitiesareriskier.
You’llseewhylater.
Thebond’screditratingindicatesthelikelihoodthatyourbond
willbepaidinfull.Generallyspeaking,creditratingsoflargestable
corporationsareverygood—thechanceofoneofthemdefaultingis
usuallylessthan2%.However,ifthemarketthinksthecorporationis
anywhereclosetodefaulting,watchout;thebondcansuddenlydrop
invalue.
Yieldistherateofreturnearnedbythebondholder.It’snotthesame
ascoupons,whichareregularpaymentsmadetobondholders.For
example,abondmaypay5%peryearofitsprincipaleveryyearuntil
itmatures.The5%peryearisthecoupon.Butitmayhaveadifferent
yield.Iwillexplainwhyinthenextfewparagraphs,butthediscussion
isslightlytechnical.Ifyoudon’tfollow,that’sokay.Justunderstand
theconclusionsattheend.
Saythereisabondwitha$1,000principalanda5%peryearcoupon
thatmatures1yearfromnow.If youbuythebondat$1,000,theyield
isthesameasthecoupon.Doingsoiscalledbuyingatpar.However,
youwillnotbuythebondatparmostofthetime.
Let’ssayyouboughtthebondwementionedat$900instead(i.e.
atbelowpar).Yougetthe$50incouponsand$1,000inprincipalat
maturity.Yourtotalgainwas$150(1,000+50-900),andsoyouryield
was$150/$900=17%.Inotherwords,yougained17%onyour$900
investment.
Youcanalsobuythebondatabovepar.Let’ssayyouboughtour
examplebondat$1,025.Youstillonlygetthe$50incouponsand
$1,000inprincipalatmaturity.Yourtotalgainwas$25(1,000+50-
1,025),andsoyouryieldwas$25/$1,025=2.4%.Inotherwords,you
onlygained2.4%onyour$1,025investment.
Here’stheconclusion:lower yields come with higher prices, and
higher yields come with lower prices.Generally,bondsarenotrisky
becauseyou’reafraidthatthedebtorwon’tpayyouback,although
thathappenssometimes.Instead,bondsareriskybecausewhen
yieldsgoup,thevalueofyourbondsgodown.
Ifyoureadfinancialpublications,youwillfindthattheyliketotalk
alotaboutcentralbanks.Somepeoplethinkcentralbankersare
themostpowerfulpeopleintheworld,evenmorepowerfulthan
presidentsorprimeministers.Here’spartofthereasonwhy.They
controlinterestrates,andbydoingso,theycontroltheyieldonyour
bonds.Iftheyadjustinterestratesup,youryieldsgoup,andyour
bondpricesgodown,andyouarepoorer.Iftheyadjustinterestrates
down,theoppositegenerallyhappens,andyou’rericherforit.
Bondswithlongermaturitiesaremoresensitivetointerestratesthan
bondswithshortermaturities.Bondswith30yearstomaturitywill
oftenlose15%oftheirvaluewitheach1%riseinyield,whilebonds
with2yearstomaturitymayonlysufferabout2%.
NotethatGuaranteedInvestmentCertificates(GICs)arebasically
bonds.Theyarebondsissuedbyfinancialinstitutionssuchasbanks
andtrusts.GICsgenerallyhaveacommonflaw:liquidity.Traditional
GICshavelock-ins,whichmeansyoucan’ttradeinyourGICbefore
maturity.FlexibleGICsallowyoutotradeinyourGICduringspecific
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times,butoftenatapenalty.Thisisdifferentfromregularbonds,
whichyoucantradevirtuallyanybusinessday.I’mpersonallynota
fanofGICsforthisreason.
Lastly,aswithstocks,don’ttrytopickandchoosethe“best”bond.
Ittakesalotofeducationandexperiencetopickoutthebestones.
Instead,ownmanydifferentbonds.Youwillseehowlateroninthis
book.
Insummary,bondsaredebtowedbyanentity.Wetalkedabout
whatmaturity,creditratingandyieldmean.Youcaneasilysellbonds
beforematurity.Asyieldgoesup,bondpricesgodown,andvice
versa.Interestratesaffectyield.Watchoutforlongtermbonds;
they’remoresensitivetochangesinyield.GICsaresimilartobonds,
butthey’relessliquid.Aswithstocks,don’ttrytopickoutindividual
bonds—ownmanyinstead.
Mutual FundsYougenerallyshouldn’townasmallnumberofstocksandbonds,
becauseyou’renotdiversifiedenough.However,youshouldn’tbuy
hundredsofthemeither,notjustbecauseit’stedioustobuyevery
singlestock,butalsobecauseyou’dpayfartoomuchintransaction
costs.Forexample,ifyouhadjust$5,000savedup,youshouldn’t
divideitupintofivehundredpiecesworth$10each.Ifyoumade
500transactions,youwouldpay$2500eveniftransactioncosts
werejust$5/trade.
Manypeoplesharedthesameconcern,sotheycameupwithan
idea.Whatiftheypooledmoneytogetherandboughtalotofstocks
andbonds?Someonewillmanagethispoolofmoney,andinvestors
willeachownapieceofthispool.That’showmutualfundsgot
started.
Youcanbuyamutualfundthroughadiscountbroker,orthrough
afinancialadvisor.Financialadvisorsactuallymakealivingselling
mutualfunds.Mutualfundsareliquidinvestments—youcan
withdrawmoneyduringanybusinessday.
Withthepoolofcapital,themutualfundmanagerscansthe
investmenthorizon,andpicksoutwhatheorshethinksisthebest
investment.Theaveragemanagercharges2.5%ofmoneyunder
managementeveryyearinCanada.Thisamountgetscharged
whetherthemanagerperformswellornot.
Thisiswheremycriticismbegins.
Ifyou’reamutualfundholder,you’retheoreticallypayingthefund
managertopickandchoosethebestinvestments.You’rehoping
themanagerwilloutperformthemarketenoughtojustifythefees.
However,beatingthemarketisveryhard.Manystudieshavebeen
publishedonthesubjectoffundperformance,andtheconclusionis
universal:thegreatmajorityoffirmsunderperformthemarket.From
thebeginningof2003totheendof2012,theTSXCompositeIndex
returned9.2%peryear.Ofthemanythousandsofmutualfundsin
Canada,3154had10yeartrackrecords.Ofthose,only254(lessthan
10%)didjustaswellorbetterthantheindex.
Investingisabitlikepoker.Everytimeyouwinapot,somebodyelse
loses.Thatmeansnomatterhowhardtheytry,youraveragemutual
fundwillperformaverage.However,thisaverageperformancecomes
beforefees—the2.5%peryearmentionedearlier.Afterfees,your
averagefundwillunderperformby2.5%.Thestatisticsbearthisout.
Forthepast10years,theaveragemutualfundreturned6.9%,which
is2.3%belowwhattheindexreturns.
Comparingmutualfundperformanceagainsttheindexmatters,
becauseifyouheldmanyrandomlychosenstocksandbonds,you
wouldprobablyperformjustaswellastheindex.Thisiswhyfinancial
professionalssaymonkeysthrowingdartscanbeatmutualfunds.
Mutualfundsarealsoplaguedbysystemicproblems.Starmanagers
oftenjumpshipsotheycanearnmore.Mutualfundscharge2.5%no
matterhowwelltheydo.Thosewhohaveagoodtrackrecordoften
switchtohedgefunds,wheretheycantypicallycharge2%ofmoney
undermanagementplus20%ofprofits.Atahedgefund,astar
performercanearnmanytimestheamountrelativetomutualfunds.
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2.5%peryearisalottopay.Inthe‘CompoundReturns’section
earlierinthisbook,wesawthedifference2%makesovertime.This
iswhyI’mnotafanofhighcostmutualfunds.Thankfully,thereare
betteralternatives,aswewillsee.
Insummary,mutualfundsarepoolsofmoneymanagedby
professionals.Ifyouinvestinamutualfund,youownapieceofthis
pool.Mutualfundsaregreatforhelpingyoudiversify,buttheirfees
areterrible.Mostofthetime,theirperformancefailstojustifytheir
fees.
Index Funds and ETFsIndexfundsarelowcostmutualfundsthattrackindicessuchas
theS&P500ortheTSXComposite.Themoneyinsidethefunds
areallocatedamongstocks/bondsinthesamewaytheindicesare
allocated.Forexample,ifTDwas5%oftheTSX60,5%oftheTSX
60indexfundwouldbeinvestedinTD.Becauseindexfundsfollow
aprescribedwayofallocatingfunds,theydon’thavemanagers.
AcompanycalledVanguardcreatedthefirstindexfund,because
itbelievedthatindexfundswouldoutperformmostmutualfunds.
Vanguardbelievedthatbyeliminatingthefees,itsindexfunds
wouldoutperformmostothermutualfundsinthelongrun.They
wereright,andtheirinvestorsrewardedthembygivingthemmore
moneytomanage.Asaresult,Vanguard’sfundsareamongthe
biggestintheworld.
MostExchangeTradedFunds(ETFs)arebasicallyindexfunds.
Thereisonlyonemeaningfuldifference:ETFsaretradedonthe
stockexchange,whereasindexfundsareboughtandsoldasmutual
funds.Bothareterrificwaystoinvest.
WithETFsandindexfunds,thefeesaremuchlower.Someof
Vanguard’sETFs,forinstance,havemanagementexpensesofless
than0.1%peryear.Otherindexfunds’andETFs’feesarenotquite
aslow,buttheygenerallycomeinbelow0.5%peryear.
OpponentsofETFsandindexfundsarguethatifyouinvestinthem,
you’reguaranteedtonotbeatthemarket.Thisistrue—youwill
alwaysperformaboutaswellasthemarket,andnomore.However,
aswehaveseeninthesectiononmutualfunds,veryfewmutual
fundsbeatthemarketafterfees,becausethefeesaretoobig.By
investinginETFsandindexfunds,ifthefuturelookslikethepast,you
willoutperformmorethan95%ofthemutualfundsina20yearspan.
TherearemanytypesofindexfundsandETFs.Somearebondfunds
thattrackbondindices.Someareforeignstockfundsthattrack
foreignindices.Laterinthisbook,you’llseehowyoucanchoose.
Insummary,indexfundsandETFsarebasicallymutualfundswithout
managers.Insteadofpickingandchoosinginvestments,theyhold
everystockintheindicestheytrack.Thefeesaremuchlower—
generallyintherangeof0.1–0.5%peryear.They’reaverygoodway
toinvest.
Real EstateIdon’tthinkrealestateneedsanyintroduction.Forsomepeople,
housesaretheonlyacceptableinvestmentbecausetheycanseeand
touchthem.
Analyzingpastreturnsonrealestateisnotverystraightforward.
Unlikewithstocksorbonds,ahomeownerhastodealwithrepairs,
renovations,taxesandotherconsiderations.Forexample,someone
mighthaveboughtahousefor$200,000andsolditthefollowing
yearfor$260,000.Thatwouldbea30%gaininayear,right?But
whatifthepersonputin$50,000toaddanextension,andpaid
$10,000torealestateagentsandlawyers?Thegainwas0%—no
returnatall.
However,somebrightpeopleputtheirmindstotrackingthereal
estatemarketandinventedhousingmarketindices.IntheU.S.,the
Case-Shillerindextrackshomeprices.InCanada,StatisticsCanada
tracksthepricesofnewhomes,andTeranettrackschangesinprices
15
everytimeahomeisresold.Theindicesmentionedadjustfor
changesinthequalityofhouses.
AccordingtoProfessorRobertShiller,theauthoroftheCase-Shiller
index,housingpricesgrewattherateofinflation(3%/year)forthe
past100+years.Thereweretimeswhenhousepricesincreased
muchfasterthaninflation,suchasduringtheyearsleadingupto
2008intheU.S.However,thosetimesweretheexceptionrather
thanthenorm.
Togetafullpictureofrealestateasaninvestment,wemustalso
factorinrentsaved,aswellason-goingcostssuchasmaintenance
andtaxes.Thoughitvarieswidelyfromhousetohouse,according
todatafromtheIMFandotherreliablesources,rentsinCanada
averageabout3%peryearofthevalueoftheaveragehome.Onthe
otherhand,maintenancecostsaverage1.5%peryear,andproperty
taxesaverage1%peryear.Combined,thisboostsrealestate’sreturn
oninvestmentsbyroughly0.5%peryear.Thismeansthathistorically,
theaveragehomereturnedroughly3.5%peryear.
Measuringriskinessofrealestateinvestmentsisverydifficult.
However,somecalculationsshowthatthestandarddeviationfora
singlepropertyisaround10%.Thismeansthepriceofasinglehouse
willchangebetween-15%and+21%duringmostyears.
Forthepast60years,shorttermgovernmentbondsyielded
roughly5%peryear.ThismeansthatowningaGICorashortterm
governmentbondwouldhavebeenmoreprofitableandmuchsafer
thanowningahouse.Unfortunately,wecan’tescapetheconclusion:
houseshavebeenbadinvestments.
Somepeoplecounterthisbysayingtheyknowofsomeauntor
unclewhosehousedoubledinvalueoverthelastxyears.Ihavetwo
responsestothis:
First,justaswithindividualstocks,individualhousepricescanvary
alot.Perhapssomeoneboughtahousebeforetheneighbourhood
wasrevitalized.Perhapsasubwaystationappearedafewyearsafter
someoneboughtahouse.Therearemanyreasons,butthey’renot
typical.Wearejustmorelikelytohearaboutthesetypesofstories
becausethey’reexcitingandunusual,ratherthanstorieswhereprices
appreciatedbyjust2%lastyear.
Second,thepowerofcompoundinterestissosignificant,thateven
3%peryearmakesaninvestmentlookgood.Maybeyou’veheardof
anunclewhoboughthishouseforamere$100,000in1973.In2013,
itwasdeemedtobeworth$330,000,morethan3timestheoriginal
amount.However,ifyouanalyzethecompoundrateofreturnover
thepast40years,youwillfindthattherateofincreasewasamere
3%peryear.
Realestatecanbeparticularlydangerousbecausethebuyernormally
takesonalotofdebttopurchasethehouse.You’reprobablyfamiliar
withthisratio:20%downpayment,80%mortgage.However,itcan
takealongtimetosaveupforadownpayment,somanypeoplebuy
mortgageinsurance,whichletsthemputlessmoneydown;say5%
down,95%mortgage.
Becauseofthedebt,youhaveamuchgreaterchanceoflosingall
yourmoneyinyourinvestment.Sayyouput$80,000downona
$400,000house,whichmeansyouhave$320,000inmortgages.
Imaginethepriceofthehousegoesdownsignificantlythenextyear,
by15%.Thatmeansthehouseisnowworth$340,000.Youprobably
stillowecloseto$320,000inmortgages,whichmeansyourequity
(i.e.thedebt-freeportion)onthehousewentdownfrom$80,000to
$20,000,a75%loss.
Tomakemattersworse,realestateisanilliquidinvestment.Inthe
Conceptssection,wetalkedaboutTonyHsieh,whocouldn’tsellhis
propertyquicklywithoutasignificantdiscount.Mostpropertiestake
monthstosell.
Insomeextraordinarycircumstances,suchasrightafterthehousing
crashintheU.S.,realestatecanbeagoodinvestment.However,
thoseoccasionsarerare.Therearealsoprofessionalinvestorswho
traderealestateandconsistentlymakemoney.Justaswithinvesting
inindividualstocksandbonds,ittakesalotofknowledgeand
experiencetodowhattheydo,andIwouldn’trecommendtryingit
yourself.
16
I’mnotsuggestingyoushouldneverbuyahouse.Buyingahouse
givespeoplejoy,andmoneyisnotallthatmattersinlife.WhatIam
sayingisthatbuyingahousepurelyforinvestmentreasonsisnota
greatidea.Thereturnsarenotgreat,theriskishigh,andtheliquidity
islow.
CommoditiesCommoditiesarethings.Theyaresuchthingsasoil,livestock,wheat,
uranium,andmostfamously,gold.However,notevery‘thing’isa
commodity.Forexample,thesweaterthatyourgrandmaknitisnota
commodity.Tobeacommodity,theremustbemanyofthose‘things,’
andtheymustbeessentiallythesame‘thing.’Apoundofcopper,for
instance,isessentiallythesameasanotherpoundofcopper.
Mostcommoditiestradeonacommodityexchangethatisseparate
fromastockexchange.Thatmeansyoucan’tbuyaherdofcattle
whilesittinginfrontofyourcomputerthroughyourdiscountbroker.
Sorry.However,youcanbuyETFsthatholdcommodities.Oryoucan
buysomephysicalcommoditieslikegoldanddiamonds,andstore
themyourself.
Fortherestofthischapter,Iwillfocusontheexampleofgold.
Manypeopleholdgoldintheirportfolios,andtheyinvestingoldfor
roughlythesamereasonpeopleinvestinothercommoditiesforthe
longterm:inflationprotection.Assuch,muchofourdiscussionabout
goldappliestoothercommoditiesaswell.
Until1971,theU.S.operatedonthe‘goldstandard.’Thatmeantthe
U.S.artificiallypeggedthepriceofgold.Backthen,$38andone
ounceofgoldwasoneandthesamething.Since1972whentheU.S.
wentoffthegoldstandardtothepresent,goldhasappreciatedby
7.9%peryear,significantlyoutperformingtherateofinflation.During
thesameperiod,thestandarddeviationofgoldhasbeenaround
25%,whichmeansgoldhasbeenahighlyriskyinvestment.
Willgoldcontinuetoreturn8%inthefuture?Thereismuchdebate
onthisissue.Ontheonehand,somesaygoldpriceswillcontinueto
appreciateatahighrate.Theysaythatinflationwillshoothigherasa
resultofgovernments’printingmoney.Otherssaytheopposite,that
goldpriceswilldepreciate,becausetheythinkinflationwillremain
subdued.Despitethedisagreements,expertsagreeononething:
goldpriceswillgothewayofinflation.
Investingingolddiffersfrominvestinginstocks.Ifyouinvestina
stock,you’rethepartownerofacorporation.Thiscorporationmay
grow,oritmaydecline.Ifyouowngold,orsomeothertypesof
commodities,youownsomethingthatneithergrowsnordeclines.
That’swhyit’sreasonabletothinkthatgoldpriceswilltrackinflation
inthefuture.Inthepast40years,goldoutperformedinflation,but
thatprobablyhappenedbecauseofspecialcircumstancesrelatingto
theendofthegoldstandard.
Ifthenext100yearslooksimilartothepast100years,theeconomy
andfinancialmarketswon’tbestable.Theworldwillgothrough
depressionsandpanics.Governmentswilltakeondebtandprint
money.Inflationwillshootupfromtimetotime,andmanypeoplewill
bemoanthedeclineofWesternCivilization.Butdespiteitall,ifthe
next100yearslooklikethepast100years,inflationwillaverage3%
peryear.Ifthisistrue,investingingoldwillbeabadidea.
Notallcommoditiesareexpectedtotrackinflation.Certain
commoditiesarebecomingmorescarceovertime,eitherbecause
theyareusedupafterextraction(eg.oil),orbecausepeopleare
findingincreasingusesofthecommodity(eg.palladium).Pricesof
suchcommoditiesareexpectedtoincreaseovertime,butanalyzing
theoutlookofthosecommoditiesisdifficult,andIdon’trecommend
itformostinvestors.
Insummary,commoditiesarethingslikegold,livestockanduranium.
Theaverageinvestorgenerallycan’ttradethem,buttheycanbuy
ETFsthatholdthem.Goldreturned8%peryearforthepast40+
years,withastandarddeviationof25%,whichmeansgoldishighly
risky.Thefutureofgoldisuncertain,butexpertsagreethatitwillrise
attherateofinflation.Ipersonallythinkit’sabadinvestment.
17
Life InsuranceAswithothertypesofinsurance,holdinglifeinsurancecanbea
goodthing.Holdingitprotectsyoufinanciallyintheeventofthe
lossofyoursignificantother.However,notallformsoflifeinsurance
aregreat.Insurancecompaniesnormallyofferustwotypesoflife
insurance:termlifeinsuranceandwholelifeinsurance.
Termlifeinsuranceisstraightforward.Thepolicyholderpaysthe
feesandifthedesignatedpersondiesduringthepolicyterm,the
policyholderreceivesmoney.Normally,thepolicyholderandthe
designatedpersonaredifferent.Ifthepolicytermexpiresandthe
designatedpersonisstillalive,theholderreceivesnothing.Since
yourriskofdyingincreasesasyouage,thepremiumonyourtermlife
insuranceincreaseseachyear.
Withwholelifeinsurance(alsocalledpermanentlifeinsurance),
yourpremiumstartshigher,butstaysatthesamelevelthroughout
yourlife.Theinsurancepolicyhasacashreserve,whichbuildsasthe
holdermakesmorepayments.Thepolicyholdercanborrowfrom
thiscashreserveifheorshewantsto.Uponthedesignatedperson’s
death,asumofmoneyispaidout,minustheloanedamount.
I’mgoingtoslightlyoversimplifythingshere,butwholeinsurance
isbasicallyterminsurance+inclusioninamutualfund.Tohelpyou
understand,let’sreplicateitourselves.Let’ssaywholeinsurancecosts
$2000/year,andterminsurancecosts$500/yearinitially.Insteadof
payingwholeinsurance,buyterminsurance,andinvest$1,500/year.
Your‘cashreserve’isbasicallyyourinvestments,withonedifference.
Thechancesareyou’llgetbetterreturnsinvestingyourselfthanifyou
trustedyourcashwithalifeinsurancecompany.
Theinvestmentreturnsoncashreservesdifferfromcompanyto
company,butthey’vegenerallyunderperformedthestockmarketby
3%peryear.However,tobefair,insurancecompaniesinvestinbonds
aswell.Ifwecomparetheperformanceoflifeinsurancecompanies
withatypicalportfolioconsistingof80%stocksand20%bonds,life
insurancecompaniesstillwouldhaveunderperformedbyatleast
2.5%peryear.Does2.5%soundfamiliar?It’stheaveragefeecharged
bymutualfunds.Inotherwords,bypurchasingwholelifeinsurance,
you’rereallybuyingterminsurance+inclusioninamutualfund.Ifyou
wanttobericher,buyterminsurance,andinvesttherestyourself.
Insummary,therearetwolifeinsurancecategories:termandwhole
insurance.Terminsuranceispureinsurance,whilewholeinsuranceis
essentiallyterminsurance+mutualfund.Don’tbuywholeinsurance.
Buyterminsuranceandinvesttherestyourself.
18
Taxation In this section, we’ll talk about how your investments are taxed, and how registered savings plans work.
4
19
Capital Gains TaxCapitalgainstaxesaretaxesonyourinvestmentprofits.Let’ssayyou
bought100sharesofCoca-Colaat$30lastyear,for$3000.Thisyear,
yousoldthemat$35/share,for$3,500.The“capitalgains”is$500.
(3,500-3,000.)You’retaxedonyourcapitalgainswhenyousellyour
shares,butnotbeforethen.
Onlyhalfofyourcapitalgainsaretaxedatyourmarginaltaxrate.For
example,ifyouearn$60,000/year,yourmarginaltaxrateisabout
34%.Ifyouhadmade$500fromtradingCoca-Colastock,only$250
wouldhavebeentaxedat34%,whichcomesouttoroughly$85.
Nowlet’sconsiderahypotheticalscenario.Youworkhardatyourjob,
andyouearnapre-taxincomeof$40,000.Youearmark$6,000of
itforinvesting.Let’ssaythegovernmenttaxedyouat25%onyour
income,andyou’releftwith$4,500toinvest.
Youinvestthe$4,500well,anditdoublesin10years.Now,youhave
$9,000ininvestments,a100%gain.Yourcapitalgainsis$4,500.
Yousellallyourinvestments,whichmeansyouhavetopaytaxeson
yourcapitalgains.Thegovernmenttaxeshalfofthe$4,500atthe
marginalincometaxrate—wewillassume34%atthispoint.This
meansanother$765goestothetaxman.
Attheendoftheday,youareleftwith$8,235.
$6,000 $4,500 $9,000 $8,235
Incometax
of$1,500
Investmentgain
of100%
Capitalgainstax
of$765
$6,000 $12,000 $7,920
Investmentgainof100% Incometaxof$4,080
Insummary,capitalgainsareprofitsonyourinvestments.The
governmentonlytaxeshalfofyourcapitalgainsatyourmarginal
incometaxrate.
RRSPTheRegisteredRetirementSavingsPlan(RRSP)allowsyoutodefer
taxesonyourincome.OnceyouhaveanRRSPaccountsetup,any
moneyyouputintothataccountgetsdeductedfromyourincome.
Forexample,ifyouearned$50,000lastyearandput$5,000into
anRRSPaccount,yourincomewillbetaxedasifyouonlyearned
$45,000.
InsidetheRRSPaccount,youcangrowyourinvestmentswithout
anycapitalgainstaxes.Youcanbuystocks,sellitattwicethe
price,andaslongasitstaysintheRRSP,youdon’tpayanytaxes.
YoucansetupanRRSPwithabank,oradiscountbrokerage.I
personallyrecommendthelatter.Somebanksmaytrytosellyou
RRSPswhereyourmoneyinsidetheRRSPsautomaticallygets
investedinGICs.Don’tdoit—they’retakingadvantageofyou.
However,whenyouwithdrawfromanRRSP,yougettaxedat
thefullpersonaltaxrate.Inotherwords,whateveryouwithdraw
istreatedlikeanyotherincome.Ifyouearn$50,000,andyou
withdraw$10,000fromanRRSP,youpaytaxesasifyourincome
were$60,000.
Nowlet’srepeatthehypotheticalscenariointhe‘capitalgains’
section,butwithanRRSP.Let’ssayyouearned$40,000lastyear,
andcontributed$6,000totheRRSP.Thegovernmentdoesn’ttax
the$6,000.
Thismoneyisinvestedwell,anddoublesin10yearsto$12,000,a
100%gain.
Youwithdrawthismoneyatthemarginaltaxrateof34%.After
taxes,youhave$7,920left.
20
Inthe‘capitalgainstax’section,theinvestorwasleftwith$8,235
aftertaxes.Thus,thebenefitofusinganRRSPwas$7,920-$8,235=
-$315,anegativenumber!Thatmeansyouwouldhavebeenbetteroff
notusingtheRRSPatall.
Thishappenedbecauseyourtaxratesweremuchhigherinthefuture
thanwhenyoucontributed(25%vs.34%).Thiscalculationwillvary
accordingtoeachperson’suniquesituation.Ifyou’realreadyinahigh
taxbracket,orifyoudon’texpectyourincometorisesubstantially
whenyoutakemoneyout,itmakessensetouseRRSPs.Sincemost
peopledon’tplanontakingmoneyoutuntilretirementwhentheirtax
ratesarelower,thisisgenerallythecase.Butinothertimes,itmakes
sensenottouseRRSPs.
AcoupleofotherthingstoknowaboutRRSPs:Whenyouhita
certainage(71currently),thegovernmentrequiresyoutoconvert
yourRRSPsintowhatarecalledRegisteredRetirementIncomeFund
(RRIF).WithanRRIF,you’reforcedtowithdrawacertainamount
eachyear.
Also,youcantakeoutupto$25,000fromyourownRRSPtobuy
ahouse.Thisisgreatbecauseyoudon’tpaytaxesonthat$25,000.
However,youmustputthismoneybackintoRRSPswithin15years.
There’salimitonhowmuchyoucancontributetoRRSPseachyear.
Youcanfindyourcontributionlimitonyourmostrecentincometax
noticeofassessment,orbycallingCRA.
Insummary,RRSPsallowyoutodeferyourincometaxes.Butany
moneyyoutakeoutfromanRRSPaccountgetstaxedatyournormal
incometaxrate.RRSPsaregreatwhenyourtaxrateswon’trisemuch
inthefuturewhenyou’reexpectedtotakemoneyout,orifyou’re
closetoretirement.Butit’snotalwaysgreat.Ifyouchoosetouse
RRSPs,IrecommendsettingupanRRSPaccountwithadiscount
brokerage.RRSPsbecomeRRIFswhenyouhitretirementage.You
canalsotemporarilytakeoutupto$25,000fromyourownRRSPto
buyahouse.
TFSAThegovernmentintroducedtheTaxFreeSavingsAccount(TFSA)in
2009.YoucancontributemoneyintotheTFSA,andinvestwiththat
money.WithinvestmentsinsideyourTFSA,youdon’thavetopayany
capitalgainstaxes.However,unlikewithanRRSP,yourcontributions
arenottaxdeductible—i.e.youwouldhavealreadypaidincome
taxesonthemoneygoingintoTFSAaccounts.Instead,there’snotax
whenyoutakemoneyoutoftheTFSA.
YoucaninvestinmanydifferentkindsoffinancialproductsinaTFSA,
includingstocks,bondsandETFs,whethertheybeU.S.orCanadian.
However,somebanksletyouinvestonlyinalimitednumberof
products—liketheirownGICsormutualfunds.Forthisreason,I
recommendopeninganaccountwithadiscountbrokerinstead.We
willdiscussmoreaboutdiscountbrokerslaterinthisbook.
Weshallrepeatthehypotheticalscenarioshowninthelast2
sections.Youearn$40,000,andyouearmark$6,000forinvesting.
Atthemarginaltaxrateof25%,youpay$1,500inincometaxes,and
contributethe$4,500leftoverintoaTFSAaccount.
Youinvestwell,anddoubletheinvestmentto$9,000,a100%gain.
Youselltheinvestmentsandwithdrawthe$9,000tax-free.
$6,000 $4,500 $9,000
Incometaxof$1500 Investmentgainof100%
Aswehaveseen,payingthefullcapitalgainstaxwouldleaveyou
with$8,235.ThebenefitofusingtheTFSAis$9,000-$8,235=$665.
YoualmostalwaysbenefitbyusingtheTFSAthanbyusingnothing
atall.However,sometimesit’smorebeneficialtouseRRSPsthan
TFSAs.Thishappenswhenyouexpectyourincometaxratestogo
downinthefuture.
21
Youcouldcontribute$5,000toyourTFSAfrom2009to2012.
Startingin2013,youcancontributeupto$5,500.Ifyoudidn’t
contributeanymoneybetween2009-2012,nottoworry;youcanstill
contributethemissedamounts.Thatmeansyoucancontributeup
to$46,500in2016ifyoudidn’tcontributeanythingsofar.Youcan
withdrawfromtheTFSA,butifyoudoso,youcan’tre-contributethe
withdrawnamountuntilthenextyear.
Insummary,youdon’tpayanycapitalgainstaxeswithinyourTFSA
account.UsingaTFSAisalmostalwaysbetterthanusingnothing.I
recommendopeningaTFSAaccountwithadiscountbrokerage.
RESPRegisteredEducationSavingsPlan(RESP)helpsyousaveforyour
child’seducation.UnlikeRRSPsorTFSAs,youhavetonamea
beneficiary(i.e.thechild).Therearenotaxbreaksfortheparentfor
usingtheRESP.Instead,thegovernmentcontributessomemoneyto
theRESPiftheparentcontributes.Theparentcancontributeupto
$2,500/yearandreceiveabout20~40%extrafromthegovernment.
Notethatthereisalimitof$50,000/child.
InsidetheRESP,themoneycangrowtax-free,justasinsideRRSPs
orTFSAs.Whenthechildbecomesauniversity/collegestudentand
takesoutthatmoney,themoneyistaxedatthestudent’spersonal
taxrate,whichwillprobablybeverylow.Thisgivesthefamilyatax
advantageontopofthefreemoneythegovernmentgives.
Ifthestudentdoesn’tcontinueontouniversityorcollege,theparent
cantakebacktheircontributionstax-free,buttheyhavetopayahigh
taxrateonthegains(normalincometaxrate+20%).
Forexample,let’ssayyoucontributed$20,000intoanRESPover
manyyearsandthegovernmentgaveyou$5,000.Duringthistime,
youalsorealizedaninvestmentgainof$5,000.Ifyourchilddoesn’t
gotocollegeoruniversity,you’llbeabletowithdrawthe$20,000tax
free.Butthegovernmentwilltakebackthe$5,000itgaveyou,and
ifyourtaxrateis30%,you’llhavetopay50%taxesonthe$5,000
gains.Inotherwords,you’llonlyget$2,500.
JustaswithTFSAsandRRSPs,youcanopenanRESPaccountwith
eitherabankoradiscountbrokerage.Ifyouopenanaccountwith
abank,theymayonlyallowyoutobuyfromalimitedselectionof
investments.Forthatreason,Igenerallyrecommendopeningan
RESPaccountwithadiscountbrokerageinstead.
Insummary,RESPsareforsavingforyourchild’spost-secondary
education.Theparentcontributes,andthechildcantakemoney
outonceinuniversity/college.It’snotverytaxadvantageous,but
thegovernmentcontributessomemoneytotheRESPinstead.Ifthe
childdoesn’tgotouniversity,theparenthastopayaheavytaxon
investmentgains.UsingRESPsisagoodideaiftheparentissurethe
childwillgotouniversityortocollege.
22
Practical Considerations In this section, I outline some
of the practical steps you can take to plan your own investments.
5
23
Paying Down Debt vs. SavingShouldyoupaydowndebtorshouldyouinvest?Thatdependson
thedebt.
Certainkindsofdebtcomewithverylowinterestrates.Those
includestudentloansandmortgages.Whenthisbookwaswritten,
interestratesonsuchloansrangedfrom3~3.5%peryear.Theseare
historicallylowrates.Ithinkit’sokaytoinvestratherthanpaydown
lowinterestratedebt,aslongasthedebtloadisnothuge.You
willlikelygeneratehigherreturnsandendupbeingricherthrough
investments,albeitatahigherrisk.
However,Idefinitelythinkyoushouldpaydownhigherinterestrate
debtbeforeyouinvest.Thisespeciallyappliestocreditcarddebt,
whichtypicallycarriesratesofover19%peryear.Ifyoucarried
$1,000worthofcreditcarddebtat19%for30years,withoutpaying
anyofitdown,you’dbewith$185,000indebt.Theawesomepower
ofcompoundreturnscanworkagainstyou.Don’tletthishappen.
Paydownyourhighinterestdebt.t
How To Buy Stocks and ETFsAsafirststeptoplanningyourinvestments,youshouldopena
discountbrokerageaccount.
ThereareafewdiscountbrokeragesavailabletoCanadians.
Personally,IrecommendQuestradebecauseIbelieveit’sthe
cheapestservicefortheaverageCanadianinvestor.However,I
thinkotherdiscountbrokeragessuchasVirtualBrokersaregood
optionsaswell.Asafulldisclosure,Idoreceiveaffiliateincomefrom
Questradeforreferringpeopletothem,butIhonestlythinkthey’re
thebestoptionformanyCanadians.Youcanreadmycomparison
ofpopulardiscountbrokershere.
Youwillnoticethatbrokeragesofferatypeofaccountcalleda
‘Margin’account,aswellasthefamiliarRRSPandTFSAaccounts.
Marginaccountsrefertothoseaccountsthataretaxednormally—
i.e.youpaythecapitalgainstax.Marginaccountshaveadditional
benefits,suchasbeingabletoborrowmoneytoinvest,notthatI
recommendborrowingmoneythisway.
Ifyoualreadyhaveabrokerageaccountwithabank,itmight
beworthswitchingtooneofthediscountbrokerages.Youcan
potentiallypayalotmoreintradingfeeswithotherbrokerages,
especiallywithbank-ownedbrokerages.
Manypeoplefindtheapplicationprocesstoopenabrokerage
accountconfusing.Ipreparedavideothatshowsyouhowtoopena
Questradeaccountinthislink.
Knowing Which Stocks and ETFs To BuyAfterreadingthisfar,youmaybeconvincedthatETFsandindex
fundsareagreatwaytoinvest.Butwhichoneshouldyoubuy,and
howmuch?TherearethousandsofETFsandindexfundsoutthere,
soit’shardtochoosejustafew,andit’sharderstilltoknowhowto
allocateyourmoneybetweenthem.
Properlyallocatingaportfolioishard.Optimizedportfolioshave
lowerrisksforthesamepotentialreturn,comparedtoportfolios
thathaven’tbeenoptimized.Alotofresearchwentintothistopic,
andsomebrightpeopleinventedthe‘ModernPortfolioTheory’
(MPT),forwhichitscreatorswontheNobelprize.Anyonecanuse
thetheorytoconstructoptimizedportfolios,butusingitrequiresa
lotofknowledge.
Tosolvethisproblem,mycompany,MoneyGeek,hasconstructeda
setofoptimizedportfoliosusingtheBlackLittermanmodel,which
isanimprovedversionoftheMPT.Withoutgoingintotoomuch
detail,MPThassomeflaws,whichtheBlackLittermancorrects.
24
YouwillneedtopaytoaccessMoneyGeek’sportfolios.Butasfaras
Iknow,it’stheonlyplaceinCanadawhereyoucangetoptimized
portfoliosforCanadians.
IputalotofthoughtandresearchintopickingwhatIbelieveto
bethebestinvestmentsfortheportfoliosatanygiventime.These
portfolioswillchangeveryslowlyovertimeasIcontinuetoanalyze
whichinvestmentsshouldbeincludedorexcludedbasedonthe
investments’currentandpotentialvalues.
Ifyou’rebudgetconscious,youcouldalsogetunoptimized
portfoliosfromthecanadiancouchpotato.com,amongotherplaces.
ThoughIdon’tfullyagreewiththeseportfolios,theywilllikelydoa
decentjob.ForafulllistofdifferencesbetweenMoneyGeekandthe
CanadianCouchPotato,seethislink.
Youcanalsocheckoutwealthfront.comforfreeoptimizedmodel
portfolios.However,theirportfoliosareoptimizedforU.S.investors.
CanadiancurrencycanfluctuatewildlyagainsttheU.S.dollar,so
anoptimizedportfolioforCanadianswilllookdifferentfromone
optimizedforAmericans.
How To Optimize For TaxesUnfortunately,it’sdifficulttoknowthebestwaytodivideup
investmentsbetweenTFSA,RRSP,orMargin(normallytaxed)
accounts.Itdependsoneachindividual’scircumstances.
Tosolvethisproblem,Icreatedatoolthatefficientlyallocates
investmentsbetweensuchaccounts.Thetooliscalledthe
InvestmentTaxOptimizer,anditsimulateshundredsofdifferent
scenariostoarriveattheallocationthatIbelieveshouldsavethe
mostontaxes.
ThefreeversionallowsyoutoefficientlyallocateCanadianstocks
andCanadianbondsbetweentheaccounts.Paidmembershave
accesstothetoolthatalsoallocatesU.S.stocks.Bothversionsare
availableonoursiteatmoneygeek.ca.Asfarasweknow,it’stheonly
toolofitskindinCanada.
Therearemanyothernuancesregardingtaxationbeyondjust
allocatinginvestmentsbetweendifferentaccounts.Ifyouwantmore
advice,Iwouldencourageyoutotalktoanaccountant.
How Much To Save Each MonthHowmuchyoushouldsavedependsonyourgoal.Mostworking
peoplehopetoretireoneday,andtheyshouldsavetowardsthat
goal.Manypeoplealsosaveupforabigpurchase,suchasahouse.
It’spartofthefinancialadvisor’sjobtoputtogetherafinancialplan
foryou,tohelpyoureachyourgoals.Afinancialplanshowsyou
howmuchyoushouldsave,andhowyourinvestmentsareexpected
togrowovertime.However,manyfinancialadvisorsdon’tgivesuch
plans,perhapsbecausetheydon’tmakemuchmoneyfromit.
I’mpersonallynotafanofthewaymostfinancialadvisorscreate
financialplans.Mostfinancialplansassumeasmoothgrowthin
investments.However,that’snotthewaytherealworldoperates.
Investmentsareinherentlyuncertain—marketssometimescrash,and
theysometimessoar.Peopleareoftenlulledintobuyingtheriskiest
investments,sincetheytendtopromisethehighestreturns.However,
buyingriskiestinvestmentsalsoputstheclientatrisk.Onemarket
crashatthewrongtimecanwipeoutenoughininvestmentssoasto
virtuallyguaranteefailuretoreachaclient’sgoals.
25
Sinceit’simpossibletopredictexactmarketmovements,noone
cansaywith100%certaintywhethertheycanachievetheirgoals.
Atbest,youcanprojectthechancesofachievingyourgoals.
AtMoneyGeek,welookedaroundforaplanningcalculatorthat
tookriskintoaccount,butfoundnothingsatisfactory.Asaresult,
Icreatedaretirementcalculator,whichisavailableforourpaid
members.
Manyyoungprofessionalsputoffsavingforretirementsinceit’sso
farinthefutureforthem.However,Ithinkevenifyouareyoung,
it’sprudenttostartsavingnow.Moneysavedearlierinlifewillhave
moretimetogrow,soit’smoreefficienttogetsavingwhenyou’re
young..Butmoreimportantly,Ibelievemostpeopleunderestimate
theamountofmoneyneededtoretirecomfortably.
Manyoftoday’sgenerationcanexpecttoliveuntiltheageof90.If
theyplanonretiringattheageof65,thatmeanstheyhavetofund
25yearsofretirement.25yearsisalongtime-that’slongerthanit
takesforanewborntobecomeauniversitygraduate.Retiringat65
isachievable,butitrequiressavingearlyanddiligently.
Insummary,yourgoalsdictatehowmuchyoushouldsave.Afinancial
plandetailshowyoucanreachyourgoals.Mostfinancialplans
assumeinvestmentsgrowpredictably,butyoucanuseMoneyGeek’s
orsimilarcalculatorstoallowforuncertainfutures.It’sagoodideato
saveforretirementasearlyasyoucan.
Once You’ve InvestedWarrenBuffettsaid,“Thegreatestenemiesoftheequityinvestorare
expensesandemotions.”
Afewtimesinourlife,themarketswillcrash.Usually,it’sthestock
marketthatcrashes,butbondmarketscanaswell.Whenthis
happens(not‘if’,but‘when’),youwillfeelfear.Itwillseemasthough
themarketsaregoingdowneveryday.Youwillfeelvirtuallycertain
thatthemarketswillgodownthenextday.Toprotectyoursavings,
youmightfeeltheurgetosellallyourinvestments,andkeepthe
moneyundertheproverbialmattress.
Whenyoufeelthisway,don’tgiveintoyoururges,oryouwilllose.
Letmetellyouaparadoxicaltruth.Thebesttimetoinvestiswhen
everybodyisfearful.Becauseeveryoneelseisselling,youhavethe
opportunitytopickupbargains.Muchofthetime,marketprices
don’tgodownbecausethecompaniesreallyaregettingcrushed,but
becausepeoplethinktheyaregettingcrushed.
Similarly,theremaybetimeswheneuphoriasweepsthemarket.
Themarketsarerisingeverysingleday.Youfeelasthoughyoucan’t
possiblylosebyinvestinginthefuture.Duringthesetimes,youwill
feeltheurgetoborrowmoneyandinvestmore.
Whenyoufeelthisway,don’tgiveintoyoururges,oryouwilllose.
Theworsttimetoinvestiswheneverybodyisgreedy.Because
everyoneelseisbuying,thepricesofeverythingwillbehigh.When
26
youbuyexpensivestock,yourreturnswillbefarless.Justask
thosewhoinvestedduringthedot-combubble.
Inthewakeofthe2008financialcrisis,Iborrowed$20,000to
investinthestockmarket.Ididsobecauseitwasanunusualtime.
Everybodywaspanicking.Icouldpickupcompaniesforlessthan
halftheirtrueworth.Ittakesexperienceandalotofself-control
toidentifyandtakeadvantageofsituationslikethesesoIdon’t
recommenddoingthisyourself.Thatsaid,Iwillprovideregular
marketcommentaryforMoneyGeek’smembers,toatleasthelp
ourclientsunderstandthemarketsituation.
Insteadofreactingemotionally,Irecommendaddingsteadilyto
yourinvestmentswithyoursavings.Asstockandbondmarkets
lurchupanddown,yourportfoliowillgooutofbalance.I
recommendrebalancingyourportfolioonceortwiceayear.To
rebalance,simplyconsultthemodelportfoliosagain,anddivide
upyourinvestmentsaccordingly.
Economists and Other Talking HeadsThereisasaying:“Economistswereputontheearthtomake
astrologerslookgood.”
Everynowandthen,youmayreadorhearwhata‘stareconomist’
hastosay.“TheCanadianeconomywillslowdown!”theywillbellow,
orperhapstheymightshout,“Unemploymentrateswilldrop!”You
mightcomeacrosssucheconomistsonTV,oryoumightreadone
oftheironlinearticles.Theywilloftendresswellandspeakwith
confidence.They’refuntowatch,butdon’tlettheminfluencehow
youinvest.
Everynowandthen,peoplerecordeconomists’projectionstosee
howoftentheycometrue.Theresultsareconsistent—economists
areprettybadatpredictingthefuture.Forexample,90%of
economistsdidn’tseethe2008financialcrisishappening.One
ofthestareconomistswho‘predicted’thefinancialcrisis,named
NourielRoubini,hasatrackrecordofpredicting10economiccrises,
andonlygetting3.However,thisisconsideredagreatrecordforan
economist.
Economistsareentertaining.Justdon’ttaketheirpredictionstoo
seriously.
28
Final ThoughtsSaya30yearoldsaved$5,000ayearfor35years,andgotarate
ofreturnof7.5%peryearonhisorhersavings.Thispersonwould
havesavedatotalof$175,000dollars,butthispersonwillhave
gainedanextra$570,000frominvestments,endingupwithatotal
of$745,000after35years.
Ifthisstorysoundstoogoodtobetrue,it’snot.Afterreadingthis
book,youwillhavelearnedhowtomakethisstoryyourown.We
cansummarizehowinafewsimplesteps.
1. Know which Stocks/Bonds/ETFs to buy.
2. Know how to allocate your investments between RRSP, TFSA, or margin (normally taxed) accounts.
3. Know how much to save, and keep saving. Rebalance your investment portfolio as you save.
Withtherighttools,takingeachstepiseasy.Weprovidesuchtools
atMoneyGeek,oryoucancheckouttheotherfreetoolsmentioned
inthisbook.Investingismorerewardingtheearlieryoustart,so
startasearlyasyoucan.Goodluck.
TheShortBookonInvestmentsbyJinWonChoi
Copyright©2016MoneyGeekInc.
Allrightsreserved.Nopartofthisbookmaybereproducedinanyformor
byanyelectronicormechanicalmeans,includinginformationstorageand
retrievalsystems,withoutpermissioninwritingfromJinWonChoi,except
forbriefexcerptsinreviewsoranalysis.
Whileeveryprecautionhasbeentakeninthepreparationofthisbook,
theauthorassumesnoresponsibilityforerrorsoromissions,orfordamages
resultingfromtheuseoftheinformationcontainedherein.