Embarking on the journey as a DIY investor requires both bravery and thoughtful planning. Congratulations on making this decision! Before diving into stock purchases, it’s crucial to grasp your investor personality type. We’ll guide you through the key aspects that are vital for building a well-rounded portfolio.
What are your investment objectives?
Clarifying your objectives when investing is fundamental for achieving financial prosperity. Picture your ideal future—what does it entail? It could be exploring new countries, buying your own home, or preparing for retirement. You might categorize these goals into short-term (up to three years), mid-term (three to five years), and long-term (beyond five years) objectives.
Take some time to jot down your financial aspirations. Ensure they follow the SMART criteria. Here’s how they might look:
- Short-term: I intend to enjoy a four-night trip to Bermuda next year costing $2,500. To achieve this, I will need to save $156.25 monthly over the next 16 months, using a dedicated savings account for this vacation.
- Medium-term: I aim to save $8,000 each year for the next five years in line with the new First Home Savings Account (FHSA) initiative. This will accumulate to $40,000, contributing to a down payment on a one-bedroom condo.
- Long-term: I envision retiring in 35 years. To retire comfortably, I will need $1.5 million. With an initial investment of $150,000 and a monthly contribution of $255 for 35 years, paired with an annual compound interest of 6%, I will amass a stock market portfolio worth $1.5 million.
With your aspirations clearly defined, you’re equipped to devise a strategy to meet your financial ambitions. Investing on your own can accelerate your journey to these goals.
Understanding your investment timeframe
The next step is to establish your investment timeframe, which indicates how long you can keep your money invested before you need access to it. You can identify your timeframe by pinpointing when you hope to achieve your financial goals. For example, if your retirement savings target is the year 2058, your investment period is 35 years. The longer your investment horizon, the more you can capitalize on compound interest benefits.
Evaluating your risk appetite
Another vital aspect is determining your risk tolerance—the level of risk you’re comfortable taking on when investing. The stock market is subject to constant fluctuations, and while it may appear promising when values are rising, the true challenge arises during downturns.
How will you react when the market declines? Are you prepared to endure losses of -5%, -10%, or even -30%? For instance, the market experienced a dramatic drop of around -37% in March 2020. In similar situations, will you panic and sell, or will you manage to stay composed?
Your attitude towards risk can generally be classified into these categories:
- Conservative/Low-risk: These investments tend to be safe and provide steady growth over time, often requiring funds to be locked away for interest payouts. Common examples include bonds and Guaranteed Investment Certificates (GICs).
- Moderate/Medium-risk: These investments balance potential growth and loss, featuring blue chip stocks and dividend stocks.
- Aggressive/High-risk: These investments are highly volatile. While they offer opportunities for significant gains, they also come with the risk of substantial losses. Typical examples include speculative stocks, meme stocks, and cryptocurrencies.
You can assess your risk profile by taking this online quiz.
Establishing your asset distribution
Your time horizon and risk tolerance will guide your asset allocation—the balance of stocks and bonds in your investment portfolio. Let’s explore a few scenarios:
David, a conservative investor approaching retirement, maintains a portfolio consisting of 40% stocks and 60% bonds.
Lauren, a moderate investor, has eight years left to invest, with her portfolio comprising 60% stocks and 40% bonds.
Kyle, an aggressive investor in his early 20s, holds a portfolio with 80% stocks and 20% bonds.
Each investor has distinct circumstances. The key is to balance the desire for risk with the need for stability.
Canadian Couch Potato model portfolios
The Canadian Couch Potato website by Dan Bortolotti is a valuable resource for exploring asset allocation via ETFs.
In the past, creating a portfolio required selecting multiple index funds or ETFs. However, in recent years, Canada has welcomed all-in-one ETFs that simplify this process. Dan elucidates their function and how they can streamline your portfolio management, which could save you fees and time on rebalancing. We’ll delve deeper into this topic in future installments.
If you’re searching for a brokerage with low fees to start investing, consider opening a Qtrade Direct Investing account, which offers bonuses up to $150.
Expected returns on investment
While predicting stock market performance is impossible, historical data suggests an average annual return between 6% and 8%. Nonetheless, past performance is not a guarantee of future results. Despite the market’s upward trajectory over the years, it’s wise to maintain conservative return expectations to mitigate potential setbacks.
Investing now allows you to harness the advantages of compound interest, leading to greater returns compared to leaving your savings in a high-interest account or cash reserves. That said, a high-interest savings account like EQ Bank serves well for short-term savings.
Active versus passive investing
Active investing involves selecting individual stocks with the hope of outperforming market averages, while passive investing entails building a portfolio of low-cost index funds or ETFs that mimic market performance or specific benchmarks.
Human nature often makes us overconfident in our ability to pick winning stocks, but consistently beating the market is a formidable challenge. Rather than getting distracted by market news, consider the labor-intensive nature of active stock trading when you could be enjoying time with loved ones.
By diversifying your investments instead of concentrating them, also known as spreading your risk, you stand a better chance of achieving the historical average return of 6% to 8% per year, allowing for a peaceful night’s sleep.
ETFs and index funds are offered by various providers, including Tangerine, Vanguard, TD, and others.
Investment versus speculation
Understanding the distinction between an investment and speculation is essential. When individuals chase after a single stock hoping for outsized gains—think cannabis shares, cryptocurrency, or Gamestop—it often signifies speculation. While potential rewards are enticing, so are the risks involved. If a stock gains significant attention, it may already be priced too high to invest in it wisely.
Although it may sound mundane, traditional index funds are ideal for most investors. Warren Buffett noted that “periodically investing in index funds allows uninformed investors to outperform seasoned professionals.” Adopting a diversified, long-term strategy positions you to weather market fluctuations and emerge successfully.
If you are drawn to the idea of stock picking, consider allocating a small fraction of your portfolio—preferably less than 5%—to explore these “fun money” investments, but ensure you can accept the possibility of total loss without distress.
Identifying your investor profile
Regardless of your financial aspirations, engaging with the stock market long-term can help you realize them. Now that you have a clearer understanding of your investment timeframe and risk tolerance, you can effectively strategize your portfolio allocation.
Stay tuned for the third part of the DIY Investing Series, where we’ll guide you through assembling your stock market portfolio.