The Friendly Investor

This blog is meant to place where we can document our investment stories, share tips, ask questions, and get feedback. While I'm writing it specifically for a few friends who are just now starting their journey, the goal is to help anyone who wants to take control of their finances and start building wealth.

⚠ Disclaimer: I am not a financial advisor and this is not financial advice... it's just means to exchange stories and opinions that may or may not inspire you...

So without further ado, lets begin.

Why should I care about investing?

I'm sure you all know at least one story - maybe a friend, or even a family member - who managed to succeed in life and was making obscene amounts of money... only to practically go bankrupt when the tide changed, and the money stopped flowing.

Life is constantly throwing you curveballs. Today your job or business is flying high, tomorrow everything crumbles and you are suddenly deprived of your golden goose.

What can we do? How can we protect ourselves from life's whims? This is where building wealth, specifically through investing, comes in.

"If you don't find a way to make money while you sleep, you will work until you die."

- Warren Buffet, the Oracle of Omaha

Investing equates to building wealth. You take part of your earnings, and rather than spending it all on expensive luxuries, you buy something that will, hopefully, be worth more in the future and/or supplement the income you get from your day job. To some people, this can be investing in real estate - buying apartments or houses and renting them out for cash flow. Others prefer to build their own businesses, drive growth, and perhaps sell them at a huge profit.

But for most of us, especially those without business acumen (like myself), the easiest way to build wealth is by buying stock and/or bonds in established, public corporations.

Now, I will never advise you to buy stocks of specific companies. See, that's for the smartest cookies, and to be honest I'm just not that good at either finding the "best" investments, or even the market trends. So in essence, when I say "buying shares", I really mean buying investment funds - these are almost like advisors who invest your money for you, following whatever strategy they outlined for the fund (more on this later).

One note on cryptocurrencies: since I don't believe in cryptocurrencies - honestly they seem pure speculation to me -, you will not find anything here related to cryptos, except for this: if you absolutely want to buy cryptos and take a gamble on getting filthy rich overnight, do it with no more than 5% of your investment portfolio. Meaning, 95% of your dollars should be going towards stocks, bonds, or real estate, and only 5% (max) should go into cryptocurrencies. Keep your exposure small, just in case the crypto market ends up imploding on itself and/or banned by worldwide governments (China was the first, and we never know who else might follow).

So am I going to get rich? What exactly can I hope to accomplish?

As you take your first steps into the world of investing, determining how far you want to go and what you want to accomplish will be something you should define, and refine, by yourself.

How do you define your goal? Well, the sky is the limit, but here's a shortlist of what you could plan for:

Invest to generate passive income - rather than relying entirely on your day job, have some more money coming in from investments. Renting out a condo or buying dividend paying stocks would provide you a steady stream of income for the foreseeable future. This will help you during economical downturns, and I'd definitely recommend this goal if you own your own business.
Invest to retire wealthy - stories abound of people who retired with millions in their bank account - or more specifically, with millions in investments. By investing consistently throughout your working life (say, 15% of your yearly income over 30 or 40 years), you will most certainly accumulate enough wealth to ensure you have a financially secure retirement. This takes on critical importance if you realize that Canada's pension plan will only pay you a small fraction of what you earned during your work life, and there's absolutely no guarantee they won't cut it down even lower, some time in the future...
Invest for Financial Independence - ah, you think I'm going to recommend FIRE (Financial Independence, Retire Early) to you? Not even close. FIRE proponents want to build enough wealth so that work becomes optional. This means investing hundreds of thousands, or even multiple millions of dollars, in order to obtain enough returns that you can live off of it. This is an extreme goal that is honestly not for everyone. Not because it's impossible to achieve, but because it requires extreme frugality and Hawkeye iron will - "eye on the prize". People who follow this are known to invest over 50%, and sometimes as high as 80% of their disposable income. This is definitely a challenge for most of us, but since myself and my partner are doing exactly this, I plan to explain our calculations and how exactly we are trying to achieve FIRE in a future post.

But remember to temper your expectations - investing will most surely not make you rich overnight. Building wealth is a lifelong, never ending process - more than a process, it's a lifestyle. To build wealth, you must make the conscious effort of toning down your luxuries, and allocating that money into investment assets instead. You must strive to increase your income while keeping your cost of living stable, and invest as much as you can spare into financial assets.

Let me stress that again - building wealth is hard. For the first 4-5 years it will seem like you're going nowhere. If you're unlucky to witness an economic crisis during that period, you may see your investments dwindle in value as much as, say, 50%. Imagine spending 5 years living frugally and investing every penny you can muster, only to see all that accumulated wealth lose half it's value in a couple of months.

You need to develop thick skin, and learn to control your emotions. Or, even better, use the fire-and-forget method - invest your money, and never look back. Until you finally need it, of course.

You also need to be aware that over any random 10 year period, there's a chance you will actually lose money from investing. It's not a trivial chance - by my calculations the chance of losing money over 10 years is about 10%. This means that when you're throwing money at investments, you need to commit to leaving it there for 10 years, or even more if possible. The rewards can be an average growth of 10% per year, give or take. This means over 10 years you will likely more than double your money.

But the future is never certain, and so you must do your due diligence and educate yourself about what may go wrong. Despite rare, things can most definitely go wrong, as we've all seen with Venezuela, Argentina, Turkey, and Japan in the 90's.

The Japanese case is a particularly interesting one, because of its similarities to today's markets. Back in 1990, Japanese banks started reducing interest rates to near zero, in order to stimulate the economy. However, Japanese corporations decided to buckle up and pay out their debt, instead of borrowing for business expansion. This triggered an incredibly long recession from which Japan is still recovering to this day. There's much more to this phenomenon, known as "The Lost Decades", than I could write here, but here's a nice video about it, if you're curious.

Japan's Nikkei 225 stock index from 1970 to 2021

Today, stocks, real estate, and any other asset that can potentially be sold for a profit (think NFTs, Cryptos, pieces of art, collectibles, etc.) are all highly overpriced. Central banks worldwide have cut down interest rates to zero or near-zero, and have injected massive amounts of cash into the economy (the US alone increased US dollar supply by 26% between 2020 and February 2021).

Ultimately, it is extremely difficult for any one person to predict what will happen. Doomsday predictions are a dime a dozen, and yet markets move up and down almost with a mind of their own.

Unless you think you are the next investor of the year, my suggestion is for you to play it as safe as possible over the next decade or so. Avoid get rich quick schemes, gambling in crypto and other risky assets, and you should be fine.

Ok that was a long intro. But what exactly should I be investing in?

Ah, now we're getting into the juicy part. So say you have some cash available and you want to somehow put to work for you. You typically do so by taking your money and strategically buying something you think will appreciate in value over time. These are called investments, and they come in several types and flavors. While I can't cover all of them in depth, I'll talk describe the major ones.

The investments I will be covering are the following:

Stocks
Exchange Traded Funds (ETFs)
Bonds
Real estate

And as I mentioned before, I will definitely not be covering cryptocurrencies, and most likely will not cover other categories such as commodities, collectibles, or art.

So what exactly are these assets all about? Chances are you already know some of this, but please bear with me...

1. Stocks

Ah, the stock market. The mythical place where traders live on the edge, where great deals are forged, where fortunes are made... and lost.

So what are stocks? Well, having "stock" means you own part of a business - say, the Coca Cola corporation. When a company makes their business available for anyone to purchase (aka, "going public"), they sell shares to the general public.

The benefit for anyone who buys those shares is that they are entitled to part ownership of the company, while the benefits for the company is the influx of capital into their bank account, which they can then use to expand the business.

There's more to it than this, but that's the gist. By buying shares, you are effectively acquiring part of a company (aka, you become a shareholder). As the company grows, so does the value of their shares.

Some companies will pay a dividend to their shareholders. Dividends are one of the company's ways to reward shareholders, and can be quite hefty. This means that in addition of seeing your shares grow in value as the company itself grows, you may also receive periodic cash payments as a reward for simply owning shares of that company.

Publicly traded companies can be categorized in many ways, but the main ones are the following:

The industry they do business in (for instance, Financial services, Energy, Utilities, Technology, etc.)
How valuable the company is (large cap would be over $10 billion worth, for instance)
Future potential (value stocks vs growth stocks)

We'll cover these segments in a future post, but for now just know that they exist, and they are relevant if you're trying to pick individual stocks by yourself. As previously mentioned, I adamantly recommend you do not invest in individual stocks by yourself, and instead buy indexed funds that invest in large groups of stocks for you. This is explained right below.

Oh, and one more worthy mention for "pink slips", popularized more recently in the story of Jordan Belford, also known as The Wolf of Wall Street. Pink slips are the old school paper & pen method by which "penny stocks" are traded. As the name implies, penny stocks refers to their low, low price. Generally speaking, this where most of the scams happen. You're well advised to stay away, but then again I suspect you already know this.

2. Exchange Traded Funds (ETFs)

Exchange Traded Funds (aka, ETFs) are just a long name for something that behaves exactly the same as stocks. The difference is these funds invest in a group of stocks, rather than their own business.

See, if you buy Coca Cola shares, you're going to be reaping the rewards of Coca Cola's profit and growth. However, if you buy an ETF, you're not just buying one stock, but all the stocks that are owned by that fund.

Now imagine you bought into Enron in 1998. This would have cost you around $20 per share. Three years later, you'd have made 250% as Enron's stock flew up to $70 per share and more! A $10,000 investment would be worth $35,000 just three years later - an average return of 51% per year! Not bad for a stock pick, right?

But chances are you actually heard of Enron somewhere, and not for how well they're doing. Enron was essentially quickly going bust, with their leadership scrambling to cover the losses. Their downfall in 2002-2003 would have caused you to lose all your money. No one saw this coming, until it was too late.

Enron's fabulous stock blowup and quick demise

These are the dangers of investing in individual stocks. Seemingly healthy companies may be ticking time bombs masking unsustainable business practices. Chances are you likely won't really invest into one of these, since there's not really that many of them anyway. But the probability is never zero, so the risk is not negligible.

So how do we get around the perils of owning individual stocks? Jack Bogle, the founder of Vanguard, the company that created the first indexed ETF back in 1975, came up with the best idea - why don't you just buy into a whole bunch of stocks all at once? This would be impractical for the vast majority of investors, which is why he came up with the idea for low cost indexed ETFs.

"Don't look for the needle in the haystack. Just buy the haystack!"

- Jack Bogle

In essence, indexed ETFs invest according to their strategy - for instance, Vanguard's VFV.TO fund invests into the companies listed in the S&P500 index, the top 500 companies in the United States. These are Amazon, Tesla, Facebook, Netflix, Coca Cola, Wells Fargo, and many others. This means that when you buy one share of VFV.TO, you're actually buying a small piece of the top 500 companies in the US. You may not see a 250% growth in 3 years, as you'd have seen if you owned Enron back in 1998, but you are also not likely at all to lose the entirety of your money.

There are many other index funds provided by Vanguard and others, so even if you don't like the idea of putting all your eggs into the top 500 US companies, there's certainly other funds that will entice you.

My next post will focus exactly on exploring some of these funds, what their strategy is, and how they've done in recent years.

3. Bonds

Bonds are the "IOUs" (aka, "I owe you", if you've never heard the term) of the business world. Companies and governments will issue bonds, which you can then purchase. A bond will pay out a pre-determined interest rate, which is payed out at agreed dates during the bond's term. After the term expires, the company or government pays you back the entirety of the money the bond cost you.

Here's a practical example: Coca Cola needs money to fund a new factory in Mississauga. Rather than getting a bank loan, which is expensive and will surely require collateral, they decide to issue bonds instead. Coca Cola issues 10.000 bonds at $100 each, for a total of $1 million worth of bonds. The rate is fixed at 5%, and the term is 4 years. If you stepped in and bought 10 bonds, for a total of $1000, this is what you'd get:

By the end of the first year, you'd get 5% interest ($50)
You'd also get 5% interest ($50) by the end of years 2 and 3
Finally, by the end of year 4 you'd get $50 interest, as well as the cost of the bonds ($1,000)

So in total, you invested $1,000 and got back $1,000 + 5% times 4 years, for a total of $1,200. Not a flashy 250% total return like Enron, but it's still easy money.

So in essence, a bond will pay you a fixed income until it expires, at the end of which it will pay you back the full cost of the bond. This may sounds like an attractive proposition, and generally is. However, these days interest rates are at rock bottom, at or close to zero. This means bonds will hardly pay anything at all, except for risky bonds when there's some uncertainty regarding the capacity of the issuer to pay back the bonds. This is actually what's going on in China right now, with several real estate developers unable to pay back bonds.

Just to add an extra level of complexity, trading bonds is different that trading stocks - bonds are priced not only according to what they were bought for, but also for their future returns. Sure, a stock price reflects what the market thinks the stock will be worth sometime in the future, but it's always nebulous and open to interpretation. A bond, however, is 100% predictable. If you know the rate, the cost, and the term, then you know exactly how much the bond is worth.

This means that when you buy into bonds, you're likely paying not just the cost of the bond, but also for part of the interest that will be paid during it's term. These bonds are not really sounding very attractive, are they? But in other times they are a hedge against stock market turbulence. When the market crashes, investors hold on to bonds to get some much needed return.

As with stocks, you don't need to buy individual bonds. There's ETFs that specialize in trading bonds, such as Vanguard's VBG.TO - global bond market (except US). Rule of thumb is that you want to have anywhere from 10% to 40% of your investment portfolio in bonds. However, due to how poor the market is for bonds right now, you'd excused for not owning any bonds at all.

4. Real estate

Ah, the elephant in the room. Or should I say the building on the street? Anyway, real estate has been the staple investment of the super wealthy for millennia. Not only is land a finite resource, the steady increase of human population, and most notably it's concentration around certain geographical areas, provides a never ending source of great deals.

It's not as easy as investing in stocks or ETFs. While investing in an ETF is a 2 minute ordeal, real estate investing requires a lot more work in all phases - finding the right property, acquiring funds to purchase it, dealing with maintenance and renovations, and not to mention the headache of finding the right tenant, and everything else that goes with it.

However, if done right it can be quite lucrative. Perhaps one of the main reasons why real estate provide a really juicy opportunity is leverage. When you buy a property, very often you're getting it with the help of a mortgage provided by your bank. Now, this money isn't yours - it was provided by the bank. However, as the property appreciates in value, the bank is getting none of it - you are! This is the one best thing about investing in real estate, in my view.

Despite this I have not taken any steps towards investing in real estate, as of yet. It's not all sunshine and roses, there's also plenty of problems that come with renting out property. Finding the right tenant, hoping they pay on time, dealing with issues and house maintenance, etc. Not to mention you need to find a sweet enough deal to make it worthwhile. Otherwise you'd be better off investing your hard earned money into the stock market.

As an example, remember that some folks who bought into the Vancouver/Toronto real estate craze in 2017 are still in the red in 2021. Their investment has actually lost value, and you can find plenty of listings where investors (or homeowners) lost their hard earned money because they got in at a bad price point. Either overbid, didn't read the market right, or were victims of the fear of missing out (FOMO) trap. So finding a good deal is essential.

When you own stock, you have absolutely not one care in the world - it's just sitting there making money for you. But when investing in real estate, you can count on having plenty of work ahead of you. Does that time account for the potential benefits of owning real estate? That's mostly up to you, and how much you're willing to endure.

You can count on a post analyzing the cost vs benefit analysis of real estate investing somewhere down the line. In the meantime I'll leave you with this rental property calculator, which does a pretty good job of laying it out for you. FYI the historic average expected returns for the stock market are around 10% per year (although in the last 8-9 years it's been around 16% per year), so when doing the real estate math, be sure you're not ending up with much less than that, otherwise you'd definitely be wiser to invest that money in stocks instead.

Alright, I think I get it. But how exactly do I start investing?

First of all let me thank you for reading this far! Even though I'm passionate about investing, I really had no idea how hard it would be to transpose my thoughts into writing. I can only hope my efforts hit the mark, which I trust they did by the simple fact that you're reading this paragraph. Please leave a comment below if this helped you, or feel free to ask any questions - I'll be happy to answer them as well as I can.

Not sure you've noticed by now, but I'm based in Canada (Ontario specifically) and so most advice I'll provide on this blog will assume you are a Canadian resident. Canada is by and large investor friendly, and you'll be able to take advantage of some really nice perks provided by the government.

So to start investing, and I'm referring here to the act of acquiring stocks, bonds, and ETFs, you will need a brokerage account (also known as a trading account, or self-directed investing account) AND/OR an automated investment account. By automated investment account, I mean the new fad of "robo advisors", which are modern, digital apps that take care of investing your money for you for a low fee (compared to traditional financial advisors and managed funds).

Trading Accounts

As to where to open a trading account, I promise to publish an exhaustive list in the future, but here's a few ideas to get you started (links are not sponsored):

TD and Questrade are traditional brokerages. They'll present you with detailed views of stocks and ETFs, industries, indexes, etc. Wealthsimple, on the other hand, is a new contender that provides only minimalist features. Although Wealthsimple boosts about not charging fees, the truth is that one way or another, all of these find a way to charge you for using their services. Wealthsimple, for instance, charges you a hidden fee on currency conversions. TD and Questrade are more transparent and charge a fee per transaction.

Automated Investing Accounts

As for automated investing, and again there are many more that I'm not shortlisting here, but the ones I know best are (links are not sponsored):

Automated investing providers, also known as "robo advisors", provide simpler solutions where all you do is deposit money into an account, and they will take care of investing it for you. Typically they will spread your money on a few ETFs covering global stocks and bonds. This is the easiest solution to get started with investing, and the recommended one if you know next to nothing and are just now taking the first few steps.

And let me reiterate my promise to come up with a list of brokerages, along with a breakdown of their costs and features, sometime in the near future. You can hold me to that.

Types of accounts

Now don't go running to the brokerages just yet. There's still a few more details you need to know. Brokerage accounts come in a few flavors, so you need to plan exactly what account(s) you are going to open, and how much of your hard earned money to deposit into each account.

We'll keep it simple and talk only about three of the main account types that you can open in Canada:

Registered Retirement Savings Plan (RRSP)
Tax-Free Savings Account (TFSA)
Non-Registered Account

RRSP accounts

An RRSP account is where you deposit money for your retirement - that means from age 55 onwards. While you can withdraw money from an RRSP account at any time, doing so may carry severe penalties, and so you should consider doing so only as a last resort. Additionally, your employer may provide you RRSP benefits, which means they will open an RRSP account for you, allow you to automatically put part of your paycheck into the RRSP account, and even match your contribution to a certain limit. Contribution matching is simply free money, and you should take all you can without hesitation - you can read more on contribution matching below.

RRSP accounts have a few marvelous advantages that make RRSPs the top priority account you should open and start investing with:

They are tax deferred, meaning you pay absolutely no taxes on your gains, except when you start withdrawing money in retirement - at this point you'll pay a comparatively low tax rate.
On top of not paying taxes on investments held in RRSP accounts, you can also deduct RRSP contributions from your income tax! You can use EY's RRSP savings calculator to check how much income tax you'd be saving - it could go as high as $10,000 savings depending on your income and tax bracket.
If your employer offers contribution matching, this is free money and you'd be a fool if you don't take it. With contribution matching, your employer will pay you extra straight into your RRSP account. My employer, for instance, offers up to 3% contribution matching - if I deposit 6% of my paycheck into an RRSP, my employer will kindly deposit an extra 3% on top of those 6%. This adds up over your work life, quite a lot.

The main drawback of RRSP accounts is that once you deposit the money there, you have few options to withdraw it before you retire without paying taxes. For example, you may withdraw funds from an RRSP account, without penalty, if you're buying a home (up to $35,000), or if paying for education.

Otherwise, in most situations withdrawing from the RRSP will carry severe tax penalties. In either case, my advice to you is to never withdraw from your RRSP.

The other, minor drawback of RRSP accounts is that you are limited in how much you can contribute per calendar year. In 2020 the limit was up to 18% of your 2019's reported income, or at most $27,830. This means you may not be able to invest all your disposable income into your RRSP account every year.

TFSA accounts

Similarly to RRSP, any capital gains in your TFSA account is tax free. The big difference is that a TFSA is also free when you withdraw money, which incidentally you can do at any point in time.

So the TFSA is what we wished RRSP was - a completely tax free investment account where none of the money you make from your investments is taxed. This sounds like a dream come true, right? And it is... except that, of course, there are some limitations.

The primary limitation is that the amount you can deposit into your TFSA account every is rather small - for the past years of 2019 and 2021, it was a mere $6,000 per year. It is definitely better than nothing, but not enough to make you a millionaire.

The good news is that unused amounts accumulate to the following year. This means that if you've been a Canadian resident since 2009 and if you never deposited into a TFSA account, right now you can invest $75,500 tax free! Not a bad sum at all, even if it will take several decades to bring you somewhat close to a million... or more realistically, a half million.

As such, a TFSA account should be your second priority. Any disposable income you can't put into your RRSP should find a home in a TFSA account, up to the legal limits that is. Remember you can log in to CRA's My Account portal to find out your RRSP and TFSA limits for the current year. Although take that number with a grain of salt - I learned the hard way that the number published by CRA is seldom not exactly accurate... and I ended up paying with my wallet. Be sure to do a sanity check on their math.

Non-registered accounts

If you've maxed out your RRSP and TFSA, well done! Now what do you do? The easiest solution is to open a non-registered account. These are "normal" accounts, in which you can deposit and withdraw money at your convenience. They are, however, fully taxable. Meaning you will need to declare your gains (or losses) from investments when you do your income taxes in April, every year.

The fact that you pay taxes, however, makes them the best account to hold USA stocks and ETFs that pay dividends. See, the USA charges a 15% withholding rate to any dividends payed to foreign accounts by American corporations. If you hold these stocks in your TFSA account, you will not be able to deduct that 15% withheld amount - it becomes purely lost money. However, if you the same ETFs in a non-registered account, you can deduct the withheld amounts from your Canadian income taxes! A silver lining.

Conclusion

If you read this far, congratulations and thank you for hanging in there. I hope you found it an interesting read, and you learned something new. If you were already into investing, perhaps you gained a few ideas on what to do next. If you are completely new to investing, then I hope this article opened your mind to the idea of building wealth through investing.

There will be more to come. In the following articles I aim to explore some of the ETFs available to us in Canada, compare real estate to stocks/ETFS with some math skills, and explore what brokerages and robo advisors are available in the market.

If you enjoyed reading this or if you didn't and have some constructive feedback, please leave a comment below.

Friendly Investor

Wednesday, October 27, 2021

The Why, What, and How of Investing