Read This If You Want to Know What to Invest In
Before I started investing, the thing I was most unsure about wasn’t the possibility of losing money. It was knowing what to invest in.
I worried that I would have to be constantly researching stocks and checking my portfolio every day to determine trends of when to buy and when to sell. My knowledge of the stock market was based on conversations with some active investors, as well as movies portraying guys who worked on Wall Street.
Then there was the option of working with an investment advisor. The thing is, I firmly live by my grandma’s rule of not doing things with money that I don’t understand.
Even if I did find someone trustworthy, I would still have to do research to understand my options and make sure that this advisor was aligned with my values and goals.
Finally, having an actively managed account comes with a price. Investment bankers typically take 1-2% of the money they’re managing for you, with the potential for more, depending on the services they perform.
If your investment professional has a philosophy of trading frequently, you will also be paying for the trades.
All of this is fair and square, of course, but these extra costs are something to consider.
Now, before I go any further, I just want to say that I have nothing against financial advisors or stock brokers, but I would challenge you to do some research before entrusting one person with control over your financial future.
Anyway, I expected that investing was going to take a lot of ongoing time and effort, no matter which way I went about it. But the reality is: this couldn’t have been farther from the truth! And it’s all thanks to passive investing.
What is Passive Investing?
Passive investing is a long-term strategy in which you buy and hold onto your stocks, despite fluctuations, allowing your money to grow exponentially over time.
Passive investing typically deals with index funds, which are a combination of major company stocks that make up an “index” or section of the stock market.
In other words, investing in index funds is about buying a slice of the market and riding its wave, rather than trying to beat it — as many day traders attempt and fail to do.
Now, why should you trust that your money will grow over time? Well, the historic average return of one popular index, the S&P 500 — which includes the top 500 companies in the American stock market — has been 10% (i.e. you’re earning 10% interest on average, per year).
This means, of course, that some years it may be 20% and others it might be -10%. But overall, as you can see from the chart below, since 1929, the S&P 500 has grown a lot.
For some perspective, earning 10% per year (on average) in compound interest means that your money will double approximately every 7 years (using the rule of 72)!
So hypothetically, if you invested $1000 in 2020, you would have
$2000 in 2027,
$4000 in 2034,
$8000 in 2041,
$16 000 in 2048,
and $32 000 in 2055.
In 35 years, your money would make $31 000 without you having to lift a finger.
Of course, it generally doesn’t work as cleanly as that because, like I said, the returns go up and down. But over time, according to the average, these are the kinds of numbers you can expect.
Just imagine the growth if you were also consistently contributing a couple more thousand dollars each year!
Now, of course, one thing to be aware of is timing. We can see from the chart that if someone who started investing in 1950 tried to take their money out in 1980, they would probably be disappointed with their returns — not devastated, but definitely disappointed. Just a few years later makes a difference, though, as there is a huge upward trend throughout the 1980s.
As you get closer to needing to liquidate the money in your stocks, it’s important to readjust your strategy to make sure that its volatility (risk) decreases. But if you’re a millennial who is investing for retirement, this won’t be a concern for at least a few decades.
In fact, time is really on our side. It’s important to start investing now to allow maximum growth, even if all you can mange is a few hundred dollars.
Why Not to Invest Actively
I made a slight jab about day trading a few paragraphs up, and that’s because it’s one of those get-rich-quick schemes on the internet that I’m just not here for because day trading is basically gambling.
The goal of day traders is to beat the market, i.e. beat that index average return rate. But in reality, the success rate of active day traders is about 10%. This means that 90% of day traders are seeing returns at or much lower than the level of the index.
These aren’t encouraging statistics, especially considering the time and effort it takes to learn how to day trade and then actually monitor the market and do the trading.
Besides this, remember what I said about the cost of trading? Every time you buy/ sell a stock, you are spending some money to do so. If this is going to be a regular practice, you’d better hope that you’re seeing some astronomical returns to make up for that.
Overall, active investing is more time-consuming, expensive, riskier, and much more difficult to keep up in the long term.
How to Start Passive Investing
Now that I’ve (hopefully!) convinced you of the merits of passive investing, how do you get started?
You can start by buying index funds through an online discount brokerage or robo-investor.
You want to make sure that the platform you use is government insured. If you’re Canadian, for example, check that it’s under CIPF, the Canadian Investor Protection Fund, which protects investments up to $1 million, in case the brokerage collapses.
Depending on the way your particular brokerage sets you up, you can buy one index fund (for now) or open a portfolio built on several indices.
Investing a few hundred dollars in even one index fund is a great way to get started and to get comfortable with the idea that you are an investor (!!). Keep in mind, however, that buying only one individual fund is not enough of a strategy for your entire investing life.
Choosing an index fund is better than investing all your money into your cousin’s start-up, but it’s still not enough baskets for all your eggs.
Diversification is important, and even though funds like the S&P 500 have some built-in diversity since they’re a group of companies, one fund is still one fund.
There are multiple index funds — American, Canadian, international, emerging markets, etc. — and the best strategy is to have a bit of your money in all of them.
More about diversification in the future. Plus:
Stay Tuned to Hear About My Personal Investing Portfolio
I use Wealthsimple, a robo-advisor featuring diversified portfolios, which invests primarily in index funds. In an upcoming post, I’ll let you know why I chose Wealthsimple as my passive investing platform.
For now, if you want to learn more, check out my previous post which includes three resources created by financial professionals about how and why to start investing.