I wish I had a playbook to follow when I first started investing. If I did, maybe I could’ve avoided some of the investing mistakes I made along the way. That journey had me investing in high fee mutual funds, narrowly concentrating on a handful of Canadian dividend paying stocks, and straying from blue-chip stocks to chase higher yields.
I figured things out, eventually. I ditched my expensive mutual funds in 2009 and opened a discount brokerage account. Not knowing anything about index investing, I latched on to a dividend growth approach and started picking individual stocks to hold for the long term.
It wasn’t a bad strategy. My portfolio of dividend payers saw returns of 14.79% a year from 2009 – 2014. That compared favourably to CDZ, the iShares ETF that also tracks Canadian dividend stocks, which returned 13.41% during the same period.
At the same time an enormous pile of evidence showed that passive investing with index funds or ETFs would outperform active investing strategies over time. The idea was simple enough. Just buy the entire market, for a very small fee, and reap the benefits.
One of the biggest catalysts for me to change my behaviour was the evolution of ETF products that made it easy to broadly diversify with just one or two ETFs. Not only that, but the advent of robo-advisors also makes it easy for investors today to get started without first falling for the big bank mutual fund trap.
That’s why I wanted to write this guide – to help new investors avoid the mistakes I made when the landscape was much different than it is today, and to be a playbook for experienced investors to get them through volatile times like these.
Here are my 5 investing rules to follow in good times and bad.
Investing Rule #1: Diversify
Nobel Prize winner Harry Markowitz said that, “diversification is the only free lunch in investing.” It’s easy to fall into the trap of chasing last year’s winners, whether those are individual stocks, ETFs, or top performing countries or regions. But last year’s best performer could just as easily be this year’s worst.
A diversified portfolio holds many stocks and bonds from across the globe and ensures you always capture the best performing asset classes each year.
Yes, that also means you’ll hold this year’s worst performers. But here’s the thing. No one can predict which stocks, bonds, ETFs, countries, or regions will outperform or lag behind. Anyone who claims they can is suffering from some serious hindsight bias.
One clear way to visualize how and why diversification works is with the periodic table of investment returns. Each year it shows how different asset classes perform, and the results are often striking.
Last year’s winners often become this year’s losers (and vice-versa). International stocks have had a miserable decade of returns, but are leading the way so far in 2023. Emerging markets returned a whopping 79% in 2009 but have averaged a pitiful 0.99% per year for the past 15 years. The S&P 500 was the darling of the 2010’s, but suffered a lost decade in the 2000’s. REITs have had a wide range of outcomes, with the best year returning 41.3% and the worst year losing 37.7%.
The lesson? Diversify.
Investing Rule #2: Dollar Cost Average
There’s a compelling study from Vanguard that shows how investing a lump sum all at once outperforms dollar cost averaging two-thirds of the time. But don’t let that fool you into thinking dollar cost averaging doesn’t work. That study talks about investing a large amount – say, from an inheritance. What it says is that it’s best to put that money to work right away rather than over a period of time.
Most of us don’t have a large lump sum to invest. We’re putting away a few hundred bucks a month. The point of dollar cost averaging in this context is to invest small amounts frequently rather than saving all of that money up as cash and then making one lump sum contribution. So, effectively, you are investing a lump sum immediately – just like the study recommends. It’s just that your lump sum may be $500 every two weeks.
Dollar cost averaging works because you’re buying small amounts with every contribution. Think about it like buying gas for your vehicle. Some days the price is higher, some days it’s lower. But if you always put in the same dollar amount every time, you’ll buy more gas when prices are lower, less gas when prices are higher. That smooths out the effects of market fluctuation.
The best way to set up your dollar cost averaging system is with automatic contributions aligned with your pay day. This approach ensures you always pay yourself first, rather than trying to save and invest what’s left in your account at the end of the month.
Most banks, robo advisors, and discount brokerage platforms allow you to set up automatic contributions every week, two weeks, or once a month. Some will even automatically invest that amount into the investment(s) of your choice.
Investing Rule #3: Fees Matter
Global stock markets had a terrific run between 2009 and 2021, and during those good times investors are less likely to question the fees they pay for advice. Here’s why they probably should:
Research from Morningstar clearly shows that fees are the best predictor of future returns. Put simply, the lower the fee, the higher the expected return of a comparable product.
This shows up in my own analysis of the returns of big bank Canadian equity funds versus their index fund equivalents. Banks sell their expensive equity mutual funds to retail investors like you and me, even though they all have a lower cost index fund alternative in their line-up.
In every single case the lower cost index fund outperforms the higher cost mutual fund. The difference in returns is often equal to the difference in fees between the two products. Hmmm.
And, while new investors shouldn’t focus solely on fees, they should look for alternatives to pricey big bank mutual funds and look instead at index funds like TD e-Series, or to a robo-advisor platform, or to buy their own index ETFs with a low-or-no-commission trading platform. Whatever it takes to get you investing regularly in a low-cost diversified portfolio that you can stick with for the long-term.
A robo-advisor might charge a management fee of 0.50%, plus the cost of a portfolio of ETFs (add another 0.15% or so). They’ll automatically invest your money and rebalance it as needed, for a true hands-off investing solution.
Index funds can be purchased at any bank for a management expense ratio (MER) of around 1%. TD’s e-Series funds are the cheapest, where a diversified portfolio will cost around 0.40% (with the caveat that you’ll have to buy and rebalance the funds on your own).
If you opt for a self-directed approach, you can build your own diversified portfolio of ETFs (sometimes with just one ETF) for a fraction of the cost of a robo-advisor. Vanguard’s VBAL, for example, gives investors a portfolio of 60% stocks and 40% bonds from around the world at a cost of just 0.24%.
See my top ETFs for Canadian investors for more information.
Investing Rule #4: Save More
Many investors dream of huge Warren Buffett like returns driving their portfolios higher. In reality, it’s your savings rate that has the biggest impact on the growth of your portfolio, at least in the early stages of investing.
A good rule of thumb is to save and invest 10% of your paycheque for retirement. But that’s not a catch-all rule. Young investors have many competing priorities, such as debt repayment, short-term savings goals, a mortgage to pay, a family to raise, and so on.
Related: How to make saving a priority
Don’t put off investing for retirement just because you can’t meet an arbitrary 10% rule. The key is to get started and build the habit of saving and investing for the future. Start with 2-5% of your paycheque and set up those automatic contributions. You won’t even notice it coming off your paycheque or out of your chequing account, and meanwhile you’ll be well on your way to your first $1,000.
Then, as your budget allows for it, increase that savings rate over time until you can meet that 10% goal.
One important tip is to keep increasing your savings amount (in dollar terms) to align with any increases in income. For example, say you make $50,000 and save $5,000 per year. If your pay increases to $55,000 you should increase your savings contributions to $5,500 to maintain that 10% savings rate.
Finally, for many late starters, saving 10% won’t be enough. If you’re behind on your retirement savings, then you may need to aim for a 15 – 20% savings rate to meet your retirement goals and catch up on lost years of compounding.
Investing Rule #5. Stay the Course
Look in the mirror and you’ll find your own worst enemy when it comes to investing. Despite constantly being told to buy low and sell high, never to time the market, and to ignore market pundits and doomsayers, many investors continue to take the opposite approach to managing their investments.
My all-equity portfolio fell 34% in about a month during the March 2020 crash. Even as an experienced investor, I had to steel my nerves and try to avoid looking at my portfolio and reading all of the pessimistic investment news.
Thankfully, I held on and watched my portfolio recover the following month. It’s up about 62% since then (not including dividends). If I would have sold at the bottom of the crash (March 23), I would have locked in that 34% loss and also missed out on the fast and furious rally that followed.
That’s the point of staying the course. We don’t know what markets are going to do in the short term. But we have lengthy historical data that shows stock markets go up more than twice as often as they go down. Those are pretty good odds to stay invested, even in a severe downturn.
These five investing rules weren’t always my guide, and so they didn’t save me from making mistakes early on in my investing career. I’ve had to learn my lessons along the way.
Today, I invest in a globally diversified portfolio (with Vanguard’s VEQT). I use dollar cost averaging, with frequent contributions going into each of my investment accounts every month.
I keep my costs low. VEQT has a management expense ratio of just 0.24%. I also switched to a low cost trading platforms like Wealthsimple Trade and Questrade to avoid paying transaction costs every time I bought units of VEQT.
I strive to save more every year, with the goal of maxing out the available contribution room in my RRSP, TFSA, my kids’ RESP, plus contributing regularly to my corporate investing account.
Finally, I stick to my plan and stay the course regardless of the market conditions. I’m investing with a long-term outcome in mind.
Need some help getting started? Check out my DIY Investing Made Easy video series where I walk you through exactly how to break up with your advisor and set up your own self-directed investing account.