Investing in stocks in the beginning, seems like a daunting task. However, in 2020, exploring stocks might actually be a more lucrative facet and an excellent way to begin your investing journey if you are a novice. Here’s what you need to know about investing in stocks—in this tumultuous or any other “normal” year. If you have ever wondered “how to invest in stocks in Canada”, this post will give you all the basic information you need to answer that question.
How to Invest In Stocks: Things You Need to Know
Why Invest in Stocks?
Stocks are a great way to invest money in Canada. People invest in common stocks so as to earn additional income via three primary means: capital gains from speculation, dividends, and compounding returns to take care of buying power. That was a mouthful, so let’s break each concept down into terms that are easier to digest.
Speculation for Capital Gains
When we sell a stock for a higher price than what we bought it for, we “realize” a financial gain. Capital gains are very favourably taxed compared with earnings from a job, so they’re a tax-efficient way to build wealth, since more money stays in your pocket.
Many established companies pay dividends. What’s more, they tend to extend their dividends annually; consider it like getting a raise per annum. Shareholders get the cash at the same time that the share price (hopefully) rises, and these dividends are usually better than what you would get on a GIC or savings account. From a tax perspective, dividend income is taxed more favourably than salary or rental income, (but not quite as favourably as capital gains), so once again, your wealth grows faster.
Investing in stocks remains one among the simplest ways to take care of buying power over the long-term, particularly in retirement once we stop receiving inflation-adjusted earnings. Even low inflation gradually eats into our savings. If our investments fail to keep up with the speed of inflation, we fall behind. Investing in stocks is best at beating inflation due to its historical out-performance compared to GICs, savings accounts or government bonds.
How Risky Are Stocks?
Stocks are called “risk assets” for a reason. Unlike savings accounts or government-backed bonds which guarantee interest payments and at maturity, return the first investment, stocks make no such promises. A stock’s price could, theoretically, go into the stratosphere—or it could go to zero. Here are some of the major risks when you invest in stocks:
- Financial Risk: You lose money if the corporate isn’t successful or is out of favour with investors.
- Interest Rate Risk: When interest rates go up, a lot of investors tend to transfer their money into assets that are relatively risk free. GICs are a great example of risk-free assets.
- Market Risk: Market prices rise and fall constantly. Prices may drop when you need to sell.
- Liquidity Risk: If you buy stocks that trade infrequently, you may not be able to sell them when you need to, at the price you want.
- Foreign Exchange Risk: If the corporate you invest in is exposed to foreign markets, the rate of exchange differential could hurt your investment return.
- Emotional Risks: Because stock prices change frequently, you’ll make irrational investment decisions which might be driven by fear or greed.
- Short-Term Risk: Stock markets tend to rise over the long-term but can drop precipitously within the short-term.
Important Things To Do Before You Invest In Stocks
Investing in stocks has never been easier, more accessible, and more affordable. But before you dive in, here are some essential action items you need to check off.
Set financial goals. Why are you investing in stocks? Is it to fund a child’s education? For a mortgage down payment? Saving for retirement? Just for fun?
Identify your risk tolerance. People say, “I have a high tolerance for risk.” What they actually mean is, “I have a high tolerance for making a lot of money, fast.” They are not the same thing. In general, younger people have a longer investment runway and can usually afford to take on more risk than those closer to retirement.
Make your financial bucket list. Divide your money into three buckets: 1) Money you need in the short-term (within 1-3 years); 2) Money you need in the medium-term (3-5 years); and, 3) Money you won’t need for a while (5+ years). The funds within the 3rd bucket are for investing in stocks. Also, before you start investing in stocks, make sure you have a reasonable emergency fund, in cash.
Who Should Invest in Stocks?
If you’ll answer “yes” to all or any of the points below, then investing in stocks is the right thing for you.
- You have a medium to long-term time horizon of a minimum of 4-5 years.
- You possess the patience to wait and allow the capital and dividends compound. A great example of that is an investment with an average annual rate of return of 7%. If you wait for 10 years, it will double in value.
- You are willing to find out more about the fundamentals of stock exchange investing, including how financial markets work, economic cycles, the way to evaluate stocks. This article, though a very good start, should be just that: a start. You need to read more, a lot more.
- You understand your risk tolerance and goals.
Who Shouldn’t Invest in Stocks?
If you answer “no” to both of the statements below, you should invest your money in other more liquid and secure options for now and reconsider stock investing sometime in the future.
- You will need the cash within the short-term, within 1-3 years.
- You can’t tolerate financial risk.
Still feel like investing in stocks is right for you at this time? Well congratulations, we’re going to get started.
Types of Stocks To Take A Position In: Individual Stocks, ETFs, and Mutual Funds
You can invest your money in stocks if you purchase shares of companies that are publicly traded, through pooled funds like mutual funds; or through ETFs (exchange-traded funds). Here are a few pros and cons to look at for each of those routes.
Investing in Common Stocks
The moment you invest your money and buy a public company’s shares, you become a part owner of that company. You literally hold “shares in that company”. And like any business partner, you’re entitled to a share of the company’s growth, which can come from a rise in share price, dividends, new shares from spin-offs, a merger, or share-splits. You also receive voting rights on company matters.
- You’re a direct beneficiary of the company’s growth.
- If the corporation features a DRIP (dividend reinvestment plan), the corporation issues additional full or fractional shares rather than cash payments, saving you the brokerage cost.
- You have control of the investment. You decide when to buy or sell.
- It can take a long time, or an initial large lump-sum of money, to build a diversified stock portfolio.
- Buying individual stocks exposes you to greater losses should one or more of the businesses falter.
- You currently lack the talents or the arrogance to settle on investment-worthy stocks. (Note that anyone with average intelligence can eventually become a successful investor, but building skills and knowledge takes time.)
- Emotional attachment to individual stocks could impair rational decision-making.
- Subject to “analysis paralysis” when choosing individual investments.
Investing in Stock ETFs
Unlike a mutual fund, ETFs (Exchange-Traded Funds) are passive investment products that hold a basket of stocks that mirrors an index, like the S&P/TSX Composite, for example.
- Shares are often traded throughout the day exactly like stocks.
- Like all common stocks, market value is transparent and changes throughout the trading day.
- They can be bought on margin (using leverage) or with the help of options on them (these are more advanced investing strategies and are not recommended for beginners).
- Usually cheaper than mutual funds.
- Index-tracking ETFs provide instant diversification. For example, the Vanguard Total World Stock ETF owns a staggering 8,116 stocks from all over the world!
- There’s an outsized and potentially confusing sort of ETFs to settle on from, a number of which are very niche and expose a novice investor to considerable risk.
- The ease of trading ETFs could lead on to over-trading, which could harm returns.
Investing in Stock Mutual Funds
Mutual funds are investment pools containing money from a large group of investors. They can invest within a broad stock exchange index just like the S&P/TSX Composite, or be based around a selected mandate, like “oil and gas companies in Canada.” Most mutual funds are actively managed by portfolio managers who aim to provide an above-average return to all the investors.
- Potential for above-average returns compared to general stock exchange benchmark.
- Professionally and actively managed by portfolio managers.
- Higher fees than most ETFs. Canada’s mutual fund fees are among the highest in the world.
- Mutual fund investors must buy or sell units of the fund directly with the fund company, not the stock market. Unlike stock and ETF prices which change throughout the trading day, a fund’s unit price, called NAV (net asset value) is merely calculated once each day after the markets close. If you want to trade units, your order will go through on the following day, when the price may be higher or lower than the previous day. This turns mutual funds into an inefficient tool for frequently trading investors.
- Less tax-efficient than stocks or ETFs because mutual fund holders are obligated to receive capital gains payouts annually—whether they want them or not—and must pay tax on them. (Individual stock and ETFs owners can trigger tax once they, not the fund managers, choose to do so)
- Surveys show that most active managers do not consistently outperform the market after the mutual fund fees are taken into account.
- Some fund managers are “closet indexers.” They charge higher fees for active management but copy their benchmark index, like the S&P 500. This means the investor will get index-like returns, minus the upper fees.
How To Invest In Stocks
You can choose one (or all) of the following ways to invest in stocks.
While low cost/discount brokerages don’t provide advisory services, they do tend to provide a lot of affordable trading guidelines through online resources like webinars, analyst reports, and market news. For a better commission, full-service brokers offer advice and trade on your behalf. This can actually be cost effective if you don’t trade frequently and need professional guidance.
Hire a Financial Advisor
A financial advisor will assess your risk tolerance and your investment goals and then build and execute an investment plan for you. But it’s not an accessible option for everyone. Typically you would like a minimum investment amount from $250K to $1M or more to get some attention from them.
These are low cost investment tools specifically targeted for the
tech savvy millennial investor. They manage financial portfolios using
complex and effective algorithms. Robo advisors tend to invest using
ETFs based on a client’s risk tolerance, financial goals, and
time-horizon. Robo Advisor services are almost always exclusively online
and the human contact tends to be minimal. As a result of that, they
tend to cost less than traditional financial advisors. However, it’s
important to remember that investors also pay the cost of ETFs
themselves. Add up the portfolio management fees along with the ETF
management fees and the total comes in around 1%—better than most mutual
funds, but not super cheap. The big advantage with robo-advisors is
that they need few, if any, restrictions on investment size. This makes
them ideal investment tools for those starting out their investment
journey, with less money to invest.
Hopefully, this post has provided you with enough information to get started on your journey to find the answer to the question of “how to invest in stocks in Canada”. Remember, all the information in the post is meant to be a starting point for you. So read more, learn more, and earn more through your stocks investment in the future.