As a young professional, you may be worried about the basics in regards to your financial life, like budgeting, saving and investing. While four in five millennials have started saving for the future, only one in two millennials are investing!
Whatever your age, investing can be an intimidating endeavour. Because of this, it is possible you have put off investing or have not given it much consideration. Regardless of where you currently stand with investing, here are five tips to help you get started and make sure that you are on the right track.
Tip #1: Start Early
When it comes to building wealth, your greatest asset is time! If you’re able to, start small with what you have. A modest amount of money can grow exponentially over time thanks to what Albert Einstein has referred to as the 8th wonder of the world, the power of compound interest. Einstein said “he who understands it, earns it; he who doesn't, pays it” and the earlier you start investing, the longer your money has to compound and grow. Starting to invest early will give your money more time to multiply: rather than investing huge sums over a short period of time, you can save bite-size amounts and reach your target by allowing your money to grow slowly (and substantially) over several decades.
The best way to invest small amounts is to start to pay yourself first with pre-automated contributions (PACs). A general rule of thumb is to have at least 10% of every pay cheque be automatically invested before you even have a chance to see the funds in your bank account. This is important as you do not want to give yourself the chance to spend it. Automating your savings in this way is fundamental to maximizing your savings. As your career progresses and your income increases, the percentage you save stays the same, but the amount you save will increase as you enter your highest earning years.
Tip #2: Invest Regularly & Don’t Try to Time the Market
While it may be tempting, it isn’t productive to wait around deciding when the perfect time to invest is. This is called trying to time the market, and it has a reputation for not being a successful strategy for investors. We have all heard that the name of the game in investing is to ‘buy low sell high,’ but trying to predict exactly when the stock market will go up and down is impossible. If this was your strategy you are ultimately trying to predict whether or not millions of people and money managers are going to buy and sell stocks during any given period and the direction of market sentiment at any given time.
There is an old investing adage ‘its not about timing the market, its about time in the market.’ Legendary investor Peter Lynch has said “far more money has been lost by investors trying to anticipate corrections, than lost in the corrections themselves.” Instead of trying to time the market, invest small amounts of money on a scheduled basis to try and achieve averages prices, this tactic is known as dollar cost averaging. It’s also important to invest regardless of your recent returns, as past performance does not guarantee or indicate future performance and stocks tend to go up over time. Instead, create a plan and stick to it.
Tip #3: Diversify
If you only invest in one company you could lose a lot of money if something happens to the company that causes its stocks to drop significantly. The same applies to if you were to invest only in one sector. If that sector becomes unfavourable and performs poorly then your entire portfolio would perform poorly. The key message here is to avoid putting all your eggs in one basket by keeping your portfolio diversified. Check out the chart below. If you look at the top performing sector each year, you will see there is little consistence and no pattern.
The power of diversification is rooted in the fact that different assets perform differently even under the same conditions. Blending assets with different characteristics can create a portfolio better able to withstand changing market and economic conditions. Diversification is best achieved through asset allocation which is essentially how your investments are divided among various asset classes such as equities, fixed income and cash. Asset allocations typically changes over time, for example younger investors typically have higher exposure to equites as they have time on their side to withstand short-term volatility. Older investors typically have higher exposure to fixed income and less exposure to equites as they have less time for markets to recover if a downturn were to occur. There is no one right asset allocation, it depends on what makes you comfortable and gives you the best chance at meeting your financial goals but in any case diversification is key.
Tip #4: Investing Registered Accounts
Chances are you have heard people talk about RRSPs (Registered Retirement Savings Plan) , TFSAs (Tax Free Savings Account) and RESPs (Registered Education Savings Plan) at some point. All of these are know as ‘registered’ investment accounts. A registered account is an investment account that is given tax-deferred or tax-sheltered status by the government. Income, dividends and growth earned on investments in the account is not taxed until withdrawal or in the case of a TFSA, is never subject to taxation.
The two accounts most young investors should focus on maximizing are RRSPs and TFSAs.
At a basic level the way an RRSP works is you are allocated ‘contribution room’ based on your previous years income up to a certain amount, and your contribution amount lowers your taxable income, resulting tax savings. Also, when you earn income in your RRSP or sell something within the account for a gain you do not pay tax on the income earned or capital gains tax. This allows more money to stay in your account and allows you to compound your returns on more dollars. It is not until you are 71 that the government forces you to open a RIF (Retirement Income Fund) account and withdraw a minimum amount each year and pay taxes on what you withdraw.
A TFSA works like an RRSP except the government released the maximum contribution room each year that is the same for all Canadians, regardless of income and you never have to pay taxes on any income, gains, or withdrawals from the account.
Tip #5: Work With an Advisor
You are always going to have a certain amount of bias when it comes to your money. This can make it tricky to make fact-based, unemotional investment decisions. An investment advisor offers unbiased, educated guidance to help you make investment decisions based on your long-term goals, not short-term worries. An advisor can provide the dedicated time and know-how needed to properly manage a portfolio that you yourself may not have. Another benefit of Investment Advisors is that they often have many years of experience and have experienced all sorts of market conditions and have worked with many different client who have their own unique requirements.
Hindsight is 20/20, and there are ways in which everyone wishes they would have handled their money differently in the past. If you’re just beginning to build your portfolio, take the advice we wish we could give our past selves. These five tips are just the beginning, so please feel free to reach out before making any big decisions regarding your financial future or if you have any questions in regards to what we have discussed above.