So... you’ve started making money from your summer internship, and your bank account’s looking super full. Although it’s super tempting to use that as your Stages fund for next year, it’s probably a good idea to save some of that money for the future. Although your bank often offers savings accounts to park your cash, there are superior opportunities to let your money grow at little risk!
Why invest?
Investing is an important tool, especially at a young age, to set yourself up for a comfortable financial future. With even minimal initial funds, you can fund your retirement and future milestone purchases such as a house or a car with affordable monthly contributions!
For example, if you had $2,000 to invest today and continued to contribute $100 a month for 30 years, at a 10% annual rate of return (the S&P 500 average annual return), you’d have $265,724! This is thanks to the wonder of compound interest, where the money you earn from your investments is reinvested into the market, subsequently growing at the same rate as your initial investment, creating a “snowball effect”. To illustrate, if I put $100 in the stock market today and it grew 10% in a year, I would have $110 at the end of the year. However, year 2 is where the magic happens. Assuming I keep the $110 in the market and it returns 10% again in year 2, I would then have $121 at the end of year 2- growing by $11 instead of the $10 it did before. This pattern grows exponentially and is amplified over the years, essentially giving you “free money” for staying disciplined!
Investing also is important to ensure your savings don’t lose value over time due to inflation. Inflation typically occurs at approximately 2% per year, reducing your buying power by approximately the same amount annually. By investing, as long as you return over ~2% annually on average, you will ensure your hard-earned money doesn’t lose value, and actually grows!
How do I get started?
Now that I’ve (hopefully) convinced you about the benefits of investing, it’s time to set up your account. There are a few noteworthy options for college students. The most likely option for you is a Tax- Free Savings Account, or TFSA. A TFSA allows you to invest money without being taxed at the Canadian capital gains rate, making it a free way to generate income. One caveat is that American stock dividends are taxed at 10%. You can add a certain amount of funds each year after you turn 18 into your TFSA, known as your contribution amount. If you haven’t been doing this and are above 18, don’t worry- you can retroactively add funds up to your total contribution amount (i.e. if you are 20 and opening a new TFSA, and the past two years allowed you $5,000 in contribution amount annually, you can invest $15,000- the contribution amounts for the three years combined). This year, the maximum contribution amount is $6,000.
If you have reached your TFSA contribution limit, you can set up a Non-Registered account at any brokerage, allowing you to trade. Although this is easy and convenient, you will be charged capital gains tax, which means that any gains will be taxed. In Canada, only 50% of your gains are taxed at your marginal tax rate. For example, if I gained $200 on Apple shares this year, I would pay tax on $100 of these gains at my marginal rate. Another option is a Registered Retirement Savings Plan, or RRSP. Contributing income to this investment vehicle allows you to deduct any contributions from your income tax base (i.e if I have $100,000 in income annually but contribute $20,000 to my RRSP, I am only taxed on $80,000). However, RRSPs are a long-term investment- you will be taxed on this income, just at a later date (retirement) when your income is likely lower). You can also withdraw RRSPs early to buy your first home or pay for your or your spouse’s education. Ultimately, as a student, your most realistic and attractive option is opening a TFSA.
To get started on investing, there are a few platforms where you can join. Although in the past, many just opened accounts at their large financial institution of choice (RBC Direct Investing, BMO InvestorLine, etc.), recent developments in financial technology (FinTech) have birthed alternative platforms with far more attractive fee structures. Where large banks may charge annual fees, commissions on each trade you make, and steep currency conversion fees, two new startups include WealthSimple Trade, and QuestTrade. QuestTrade charges no annual fees, but does charge a commission per trade, whereas WealthSimple charges no fees or commissions, making it highly attractive for college students. One thing to note is that the larger financial institutions often provide premium research databases and other resources to research stocks, whereas the latter two are more bare-bones. WealthSimple also charges a 1.5% currency conversion fee (important if investing in U.S. stocks), which a larger institution may not charge.
What do I invest in?
Now that you have your account set up, it’s time to get into the fun stuff- actually investing your money! The first step is deciding your “asset allocation”. Generally, there are three major “classes” of assets accessible to “retail” (i.e. everyday) investors, being stocks, bonds, and cash. Generally, you can expect higher returns from stocks, followed by bonds, then cash. This is because of something called the risk-reward tradeoff, where investors are “rewarded” for investing in riskier assets such as stocks. As a younger investor, you should have a larger risk appetite as you will be holding your assets for the longer-term, meaning you’ll hold more stocks. A common rule is the “rule of 110”, which subtracts your age from 110 to get what % of your total assets should be in stocks (i.e. I am 20 years old, so 90% of my assets should be in stocks). However, if you’d like to be conservative, you can increase your allocation to bonds! For simplicity’s sake, let’s target 80% of your assets in stocks, 10% in bonds, and 10% in cash. Cash is important to hold in case you find a compelling investment opportunity in the market and want to buy in immediately- it keeps you nimble. Cash also has no risk, reducing your portfolio’s overall risk, while also limiting losses.
Stocks
When picking stocks, you have two major choices- going active, or passive. Passive management aims to match market returns over the long run instead of beating them. Typically, you engage in a passive strategy by buying an index fund, which is an investment vehicle that simulates investing in an entire index at once. For example, SPY is an ETF (exchange-traded fund) that acts like a stock you can buy. Its performance is directly linked to the S&P 500 market index, covering the 500 largest companies in the United States. For beginning investors or those not interested in managing the day-to-day workings of their portfolios, passive investing is a great strategy. Since the S&P 500 gains on average, ~10% annually, you can “set and forget” by going passive, buying the ETF index fund of your choice and happily gaining 10% a year. Some suggested passive funds for beginning investors are SPY (S&P 500), XIC (S&P/TSX-good if you want to invest in Canada), and VEU (all-world except U.S.). If you truly want a “set and forget”, putting ~80% of your stock allocation in SPY, and 20% in VEU, is set to do you well for a long time.
If you decide to go “active”, you effectively aim to beat the market every year, thus generating “alpha”, or risk-adjusted return. This means that you select stocks which not only return more than the market, but also moreso than the risk you take on to invest in them (i.e. if I buy Tesla shares, I shouldn’t be happy with beating the market by a small amount, because it is a very risky stock). Actively managing stocks is quite difficult- most don’t beat the market, and if you are a beginner, it makes more sense to be passive. However, if you choose to invest actively, consider allocating most of your stock assets to index funds, and allowing for a small percentage to try picking individual stocks. It’s important to remember that investing isn’t about a number on a graph going up- you are buying a piece of a company for the long-run, so you should treat it like a long-term investment. You wouldn’t buy a house without doing the proper due diligence, so you shouldn’t do that with stocks. The single-most important criteria when buying stocks actively is to pick companies with a “competitive advantage”- what can this company do that no other can? For example, McDonald’s has a huge competitive advantage due to its massive scale pushing costs down and global brand recognition. Another key component of active management is valuation-is this company under, over, or fairly valued? For more information on how to invest actively, consider attending QUIC weekly meetings, or attending the QUIC x Burgundy Women’s Investing sessions next year!
Bonds/Other Assets
Fixed income, or bond investing is rather complex. Given the purpose of investing in bonds in your portfolio is likely to decrease risk, you should invest in government bonds. Although these return very minimal amounts, they are guaranteed by the federal government, making them effectively risk-free (as long as you are in a developed, functioning economy like Canada or the United States!). Some suggested bond ETFs (see above) are VGV, which simulates investing across a full range of Canadian government bonds by maturity (years), or GOVT, which does the same for the U.S.. If you want to get fancy, you can invest in higher-yielding (returning) corporate bond ETFs, which assume more risk- but as a beginner, you should likely stay away.
Conclusion
Although investing seems rather scary or complex, it can truly be quite easy! Terms like DCF, beta, and WACC don’t have to be a part of securing a financial future. It can truly be “set and forget”, especially if you sign up for a commission-free platform like WealthSimple Trade, and invest passively. Of course, if you’re interested in learning more, investing actively can attain you significantly more return- to learn more about this, consider attending some of QUIC’s events throughout the year, attending our weekly meetings, or reaching out to a member of the team. We are always happy to help!
Good luck!
Sheel Dalal
Queen’s Commerce 2022
Senior Portfolio Manager, Healthcare Queen’s University Investment Counsel
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