Investment Basics

Last week, I wrote a blog about some basic personal finance and the tools I liked to use. I briefly touched on the various investment accounts available in Canada, but I did not get into the weeds of what I am investing in. I didn't envision myself writing a second post, and if I had, it might have been an ugly one (not suitable for LinkedIn) about the Canucks and their recent struggles. However, a few people reached out asking where I thought might be a good place to start when it comes to putting money into the stock market. This got me thinking. Am I up to the task of trying to explain my investment strategy in a way that might help people and at the same time absolve me of any and all responsibility if things go bad? Let's give it a shot.

The Basics

The first thing to consider when starting out with investing, is "What is my risk appetite?". Are you someone that is willing to lose all your money in the pursuit of finding the next Nvidia? Or are you someone like me? Looking to put away money periodically and have it safely earn a few percent year over year. My investment strategy is not for the thrill-seeking risk takers. It is for those that are looking to maybe one day have a white picket fence and a ride-on mower to accompany it. If you ride a motorcycle, this strategy is not for you. If you have ever been bungee jumping, move on pal. And if you have ever gone hang gliding, I don't know what to tell you.

Before I can go into what to invest in, we need to define some of the financial instruments that are used in investing and trading:

• Stocks – A stock represents ownership in a single company. When you buy a stock, you own a share of that company, making you a shareholder.
• Options – Options are derivatives that give the buyer the right (but not the obligation) to buy or sell an underlying asset (e.g., stock) at a predetermined price (known as a strike price) within a specified time period.
• Bonds – A bond is a fixed-income financial instrument that represents a loan made by an investor to a borrower (typically a corporation, municipality, or government). When you buy a bond, you are lending money to the issuer in exchange for periodic interest payments and the return of the principal amount at maturity.
• Mutual Funds – A mutual fund is an investment vehicle that pools money from multiple investors to buy a diversified portfolio of stocks, bonds, or other assets, managed by a professional fund manager.
• ETFs (Exchange Traded Funds) – ETFs are investment funds that hold a collection of assets such as stocks, bonds, or commodities. They are traded on stock exchanges like individual stocks. An ETF is essentially just a mutual fund that can be bought and sold on an exchange rather than through a mutual fund dealer.

From here on out I am really only going to focus on ETFs. I do play around with stocks from time to time for fun, but they are not a part of my overall investment strategy. Options are for my motorcycle riders and fortune tellers trying to predict the market. In full transparency, I don't completely understand how options work, so I keep them at a distance. Wealthsimple also charges a fee of $2 per option along with a pretty hefty fee when it comes time to exercise those options.

Moving over to bonds. I know I said I am not a risk taker so bonds might seem like the perfect instrument, but bonds can be just as risky as any other market activity. Despite their reputation of being plain vanilla, bonds are often sold in the secondary bond market for an amount that is different from their face value. Thus, although the underlying asset is relatively safe (assuming no default, a bond is a known series of cash flows at known points in time), knowing how much to pay for these known cash flows still requires that bets be made. Back in WWII the government created Victory Bonds to help finance the war. In that scenario, I would put all my money in bonds, but for now, they are not for me.

Lastly, there are mutual funds. To me, these are along the same lines of still investing with mom and dad's guy. Yes, Wealthsimple and other platforms offer mutual funds, but you are still paying for someone else to manage your money. The goal is to get you investing on your own so we will stay away from these as well.

Investment Strategy

Now that we know everything about investing, we can talk about strategy. The key to a steady portfolio is diversification – the act of not putting all your eggs in one basket. Here is how I think of it for myself: I work in tech. I invest in tech. However, I don't invest all my money in tech because if one day another tech bubble were to burst, I would likely lose my job and my investment savings all in one shot. We call this getting fucked.

So, what are the steps we can take in order to avoid getting fucked? Well, we could invest in something that has less (or less obvious) correlation to where our income is coming from, such as a gold or materials index. We could also sprinkle a little cash on an S&P 500 index (although this is made up of a lot of tech companies these days) because it contains 500 of the top companies rolled up into one index. Or, we could put our money towards a generic index that tracks market capitalization globally to reduce our reliance on North American markets. I propose we do all the above because by doing this, we are lowering our risk through diversification. The theory is that if you have enough stocks/ETFs with no direct correlation to each other, you will reduce your dependency on a certain industry, market, or currency, thus improving the chance that you will continue to earn in tough times (or at least reduce the magnitude of hurt).

Here are a few ETFs that I have personally chosen to create a broad range of index classes to keep my investment portfolio diversified:

BlackRock Canada iShares MSCI World Index ETF (XWD)

This fund tracks a market-cap-weighted index of stocks that cover 85% of the developed world's market capitalization. This index makes up the majority of my portfolio and here are a few reasons why:

• Global diversification: Stocks from markets around the world are included, offering exposure to various economies and industries.
• Focus on large-cap and mid-cap stocks: Emphasis on larger, well-established companies with significant market capitalization.
• Currency exposure: Since international stocks are included, the index reflects currency fluctuations, adding another layer of diversification.

Vanguard S&P 500 Index ETF (VFV)

This fund tracks the S&P 500, a market-cap-weighted index of US large- and mid-cap stocks selected by the S&P Dow Jones Index Committee. Essentially what you are investing in here is the performance of the S&P 500 – one of the world's most popular market indexes. Dollar-cost averaging the S&P 500 over an extended period of time has been said to be a strategy that can outperform some professionally managed funds. Keep it simple.

TD Global Tech Leaders Index ETF (TEC)

This fund tracks an index of mid- and large-cap stocks from developed markets, globally. The portfolio targets traditional technology companies plus those companies considered to be engaged in disruptive technologies. I chose this index for a couple of reasons. As I mentioned, I work in tech, and I want to reduce my exposure of being tethered to that sector. At the same time, it would be silly to think I shouldn't invest in tech – it has been one of the most lucrative sectors over the last 20 years. The reason I like this specific tech index is because of the global exposure. It includes companies from developed markets across North America, Europe, and Asia, which at least reduces my geographic exposure. It also includes companies that are seen as "disruptive". Once in a while, a company that is labeled as "disruptive" will make a splash i.e., Netflix, Apple, Tesla. Heard of them?

BlackRock Canada iShares S&P/TSX Capped Materials Index ETF (XMA)

This one tracks a market cap-weighted index of large and mid-cap Canadian materials firms drawn from the S&P/TSX Composite. I have this index strictly for portfolio diversification purposes as it is tracking companies associated with mining, forestry, and chemicals. The nature of the companies within the index can cause volatility but sometimes more risk equals more reward.

Fidelity Global Innovators ETF – Series L (FINN)

The fund-of-fund invests in companies of any size perceived as innovative and disruptive. Like I mentioned with TEC above, I am hoping to catch a piece of the next Tesla, Apple, or Netflix with this one. The key thing to note about FINN is that they look at companies of any size. This means that the index can be comprised of some inherently riskier companies such as early-stage start-ups. This is probably the riskiest ETF that I am investing in at the moment, but I have been seeing solid returns.

Notes

There are a couple things that I want to point out with these ETFs. The first is that they are all listed on Canadian Exchanges. The reason for this is that if you have a Standard Account with Wealthsimple (less than 100k in cumulative value across all accounts) then a 1.5% currency conversion fee will be applied when converting the currency for a US stock trade (every time). That adds up. Quickly. You could alternatively use a USD account which is $10 a month if you have a Standard Account or free once you hit the $100k threshold across your accounts. The advantage of having the USD account is that you won't be charged a conversion fee on each trade, but instead once you decide to convert the funds between CAD and USD.

If you are dying to trade on US exchanges, go for it. But just know you are paying a bit of a premium to do so. I like to stick to ETFs and stocks listed on Canadian Stock exchanges because you don't get rinsed with fees. There are also a bunch of ETFs listed on Canadian exchanges that exist to mirror a US listed ETF. If you see something that is appealing but it's listed on a US exchange, ask ChatGPT if there is a Canadian equivalent. If it's a popular ETF, chances are that it exists on both a Canadian and US exchange.

I also want to talk about dividends. Lots of the ETFs that I have listed above pay out dividends on a quarterly basis. For those that don't know what a dividend is, a dividend is a payment made by a company to its shareholders as a distribution of profits. When you receive a dividend, you might be inclined to take the earnings to the bar and buy 12 tequila sodas. I urge you to resist that temptation and enable Automatic Dividend Reinvestment within your investment platform settings. Dividends should be accounted for as part of your expected return with any investment. Treating it otherwise is what is known as girl/boy math.

The last thing I want to mention is the various methods of executing a stock or ETF trade. Once you have decided exactly what you want, your investment platform will ask you if you want to place a "market", "limit", or "fractional" order. Let me quickly define these:

• Market Order – An instruction to buy or sell a security immediately at the best available current price. This guarantees the execution of the trade but not the price.
• Limit Order – An instruction to buy or sell a security at a specific price or better. This method guarantees the price, but not the execution of the trade.
• Fractional Order – An instruction to buy or sell a fraction of a share instead of a whole share. This allows investors with smaller budgets to invest in high-priced stocks. This method is relatively new and may not be offered on all platforms or for all securities.