This is the third post in Minafi’s The Focused Investor series. This series is a chance to hear investing opinions and takes that may differ from my own, but are core to someone else’s investment strategy.
Each Focused Investor article touches on 3 parts:
- Who’s writing and why are they writing about investing?
- What is one core investing opinion you believe in?
- What advice do you have for someone getting started?
The goal of this series is to see what different investors feel is the most important core opinion about investing and share how they believe someone could get started today.
This week features Enoch Omolulu from SavvyNewCanadians.com who writes about personal finance, DIY investing and freedom from debt and more on his blog. In addition to being a
Enoch also has a lot of experience on something I’m completely in the dark on – investing in Canada. Here’s Enoch’s take on how index fund investing can help your portfolio.
I’m Enoch Omololu, a veterinarian by profession and I currently reside in Canada with my wife and two kids. In my spare time I blog about personal finance at Savvy New Canadians.
I am originally from Nigeria and grew up in a home where both parents had worked in the financial industry at some point in their lives before they moved on to start other businesses and side hustles.
My first introduction to personal finances and investing in particular was in my teens when I routinely browsed through the many finance/business magazines my dad subscribed to – both local and international.
By the time I gained admission into university, I was fairly knowledgeable about stocks, mutual funds, fixed deposits, and the other traditional financial assets. Coming from an entrepreneurial background, I already had a few profitable side hustles going into university and so had funds available for investing.
However, it did not take long before I got caught up in the “get-rich-quick” mindset. I spent thousands of dollars attending so-called “Traders Academy’s” where I hoped to learn about how to make it big in the markets day-trading futures contracts (indexes like the S&P 500 e-mini, commodities), currencies (FOREX), and so on.
I was young, determined to be rich, and the urge to discover the “Holy Grail” of investing was undeniable. While I also kept a portfolio of stocks and mutual funds, they became a smaller portion of my investments. I was on this track of gambling (I called it investing back then) for a while, trading highly risky and volatile assets, and losing a ton of money.
Around 2009, when some were making a killing and rising from the ashes of the financial crises, I hit rock bottom and lost pretty much all my hard-earned money.
This was a wake-up call for me. I went back to learning the basics and read (or re-read) great investing books that have come to shapen my investment philosophy over the years, including the likes of:
- John Bogle (Common Sense on Mutual Funds and The Little Book of Common Sense Investing)
- Benjamin Graham (The Intelligent Investor)
- Burton Malkiel (A Random Walk Down Wall Street)
- Nassim Taleb (Fooled by Randomness)
And many others.
To earn the highest of returns that are realistically possible, you should invest with simplicity.John Bogle
Today, I encourage new investors to keep their investing simple. With a simplified, passive, and adequately diversified portfolio, you stand a better chance of outperforming “more experienced” investors who are chasing after returns. I discuss this in more detail below.
What is a Core Investing Strategy or Opinion For You?
I believe that most investors would benefit from using a passive index investing strategy.Enoch Omololu
In the past, I have held a portfolio of individual stocks, day-traded futures contracts, and bought into mutual funds, all at the same time. However, I would not advise the beginner investor to take this approach.
Buying and selling individual stocks is great and can potentially expose you to unlimited upsides in returns, as well as downsides. One main problem I find with basing your investment strategy on individual stocks is a lack of diversification. It can be challenging to build a stock portfolio that is adequately diversified.
Mutual funds are boring (which is good), and hence their attraction to a majority of investors. However, they may be killing you on fees i.e. also referred to as Management Expense Ratio (MER).
Derivatives and other volatile exotic instruments are not suitable for the average investor – at least not when you are banking on them for your retirement fund.
While one or a combination of these assets mentioned above may work for some, they are hardly optimal for an investor who is just starting out and who does not have an unlimited investing time horizon.
This is where index funds come into play.
Simply put, index investing is a way to invest in the broad market so you can earn market returns (less minimal fees and tracking errors). You choose to hold a portion of all the assets that make up the “market” or “index” and aim to replicate the performance of the market.
This investing strategy is generally referred to as a “passive” approach to investing as not much effort is put into chasing returns. When someone says they are an “indexer,” they probably mean that their portfolio is built up of index funds and/or ETFs.
On the other hand, an “active” investing style seeks to beat the market. A traditional mutual fund is an example of active fund management. Because mutual fund managers are aiming to outperform whatever index they use as a benchmark, they expend more resources on research as well as incur higher transaction costs from buying and selling activity. All these and the fact that they expect to be compensated as “star” managers, result in the higher fees that investors pay.
Unfortunately though, the evidence does not do active management a lot of favours. Over 80% of mutual fund managers underperform their benchmark index every year. In other words, the odds are like 1 in 20 that your mutual fund will do better than its index fund counterpart!
When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap out-sized profits, not the clients. Both large and small investors should stick with low-cost index funds.Warren Buffett
I would like to emphasize on fees. Canada for example has one of the highest mutual fund fees in the developed world, with equity mutual funds charging an average of 2.35% in MER! Compare this with MER’s of less than 0.50% on similar index funds and as low as 0.03% on some ETF’s and you start to see why investment fees are important. Interestingly, there are now even zero-fee index funds!
There are many other advantages that come with indexing, including that it allows you to diversify your portfolio at a low cost, potential tax advantages from less capital gains distributions, and more.
It is worthwhile to note one main downside to index investing. If you are not using a one-fund portfolio, you will need to re-balance your portfolio 1-2 times a year. This is because individual funds will perform differently over the course of the year and your asset allocation (and risk profile) may diverge away from their intended targets. Not everyone is comfortable rebalancing their portfolio and this is where a robo-advisor can help you out.
Advice For a New Investor
If I was starting to invest today, I would index from day one!
If my start-up investment fund is say $10,000, my time-horizon is 10+ years and I am being assertive (i.e. I am willing to take on more risk), a sample 4-fund portfolio I could use would look similar to this:
Index funds (Canada): 80% Equity and 20% Fixed Income
- TD Canadian Equity Index Fund – 20%
- TD U.S. Equity Index Fund – 20%
- TD International Equity Index Fund – 20%
- TD Canadian Bond Index Fund – 20%
With a $10,000 portfolio, I would avoid ETFs initially due to transaction fees on ETFs (either buy or sell side or both) that can become significant on a small account that is growing through small regular contributions.
When my portfolio exceed $50,000, and I can make lump-sum contributions and make trades via an online discount brokerage account, a sample ETF 3-fund portfolio for me (similar timeframe and risk tolerance) would looks as follows:
ETFs (Canada): 75% Equity and 25% Fixed Income
- Vanguard FTSE Canada All Cap Index ETF – 25%
- iShares Core MSCI All Country World ex. Canada Index ETF – 50%
- 25% BMO Aggregate Bond Index ETF – 25%
Similar index funds and ETFs are plentiful in the U.S. and the idea is the same.
Beginners who are not comfortable with the idea of rebalancing their portfolios annually can use the services of a robo-advisor. Robo-advisors like Betterment or Wealthsimple provide low-cost investment management to you by helping you design a personalized and diversified portfolio using low-cost ETFs. You can start investing with as little as $1,000, and rebalancing and dividend re-investment is automatic.
In addition, this hands-off approach means you won’t need to think too much about what is going on in your account and can help protect you from dangerous behavioral biases that can afflict both beginner and experienced investors alike.
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