The Short Book on Investments

The basics of personal investments,

written in clear and simple language

BY D R . J I N WO N C H O I

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This book is for those who are new to investing. It’s for those who want to know what they need to know, without spending too much time or money. It’s for those who want to be wise with their money.

Introduction

WhyLearntoInvest?

WhyshouldYoutrustMe?

Concepts

CompoundReturns

Risk

Liquidity

Diversification

Financial Products

Stocks

BondsandGICs

MutualFunds

IndexFundsandETFs

RealEstate

Commodities

LifeInsurance

Table of Contents

Taxation

CapitalGainsTax

RRSP

TFSA

RESP

Practical Considerations

PayingDownDebtvs.Saving

HowToBuyStocksandETFs

KnowingWhichStocksandETFsToBuy

HowToOptimizeForTaxes

HowMuchToSaveEachMonth

OnceYou’veInvested

EconomistsandOtherTalkingHeads

Final Thoughts

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Introduction Why Learn to Invest?Why should You trust Me?1

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Why Learn to Invest?You’vebeenworking,andyou’vestartedtoaccumulatesome

meaningfulsavings.You’veopenedasavingsaccountatabankbut

havenoticedthattheinterestpaymentsaremeagre,ifnotpathetic.

Youareconvincedthattheremustbeabetterwaytoputyour

savingstowork.Inotherwords,youwanttoinvest.

Theproblemis,youdon’tknowmuchaboutinvesting.

You’vereadabitaboutitinthenewspapersoronline,butsometimes

youfeelasiftheexpertsarespeakingadifferentlanguage.You

justdon’thavethatmanyhourstospendtryingtofigureitallout.

Investinghasalwaysjustseemedtoocomplicated.You’vethought

aboutgettingafinancialadvisororaplannertohelpyouout,butyou

don’tknowwhomtotrust.

Iftheaboveringstrueforyou,thenthisbookisforyou.

Thisbookisforpeoplewhoarenewtoinvesting.It’sforthosewho

wanttobeinvolvedin,oratleastunderstand,thedecisionmaking

fortheirinvestments,ratherthansittingbacktoletafinancialadvisor

tellthemwhattheyshoulddo.Thisbookisforbusypeopleofall

backgroundswhowanttoknowwhat’sgoingonwiththeirmoney.

Quitesimply,itisforthosewhowanttobewisewiththeirmoney.

Thisbookwillteachyouthebasics.Itwillteachyouconceptstohelp

youunderstandinvestments.Itwillgiveyouthebasiclow-downon

financialproductssuchasstocks,bonds,andmore.Itwillteachyou

practicaltips,includingastep-by-stepguideonhowyoumightinvest

foryourself.Youwilllearnallofthisinunder30pages.

Today,manypeoplegotofinancialadvisorstogainthisknowledge.

Unfortunately,thefinancialadviceindustryhasawell-deserved

reputationforbeinguntrustworthy.Fartoooften,financialadvisors

lackenoughknowledgetoproperlyadvisetheirclients.Often,they

arenotupfrontabouttheirfees.Theyoftendon’tactintheirclients’

bestinterests.Yettheygetawaywithallthisbecauseforalloftheir

lackofknowledge,theystillknowmorethantheirclients.Thisbook

willnotonlyequipyouwithabasicknowledgeofinvesting,butitwill

alsohelpyouchoosetherightfinancialadvisor,shouldyoudecideto

gotoone.

Investingwellcanliterallymakeadifferenceofhundredsof

thousandsofdollars,eventotheaveragemiddleclassearner.Read

thisbook,andyouwillseethatI’mnotexaggerating.

Why should You trust Me?Inthefinancialplanningindustry,trustisessential.Youshouldnot

trustanybodywithoutreason,andthatincludesme.So,canyoutrust

me?Well,hereiswhyIthinkyoucan:

MynameisDr.JinWonChoi.IhaveaPh.D.intheareaofFinancial

Mathematics.ThatmeansIspentanumberofyearsresearchingand

learningabouthowthefinancialmarketswork,howassetsarepriced,

andhowtomeasurerisk,etc.

Ialsoworkedasananalystfortwoyearsforatopperforminghedge

fund.Inthisjob,Iworkedasamemberofathree-personteamto

analyzevariousinvestmentopportunitieswithdifferentcompanies,

butmainlywiththeoilandgassector.WhileIcan’tsaytoomuchin

detailaboutthishedgefundbecauseofconfidentiality,Icantellyou

thatits3-yeartrackrecordfrom2009to2012wouldhaveplacedthe

fundwellwithinthetop1%ofallmutualfundsfoundontheGlobe

Investor.

Sofar,I’vepassedtwooutofthreelevelsoftheCharteredFinancial

Analyst(CFA)designation,whichiswidelyregardedasthemost

rigorousdesignationintheinvestmentindustry.

IamKoreanbybirth,andhavelivedinKorea,theU.S.,Irelandand

Canada.Iammarried,andmylovelywife’snameisJennifer.Iamalso

adevotedChristian.

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Concepts In this section, I will explain the concepts you need to know in order to get a handle on understanding your investment opportunities.

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Compound ReturnsAlbertEinsteinwasonceaskedwhathethoughttobethemost

powerfulforceintheuniverse.Hisanswerwas“Compoundinterest.”

Ithinkthetermcompoundingcanbestbeunderstoodthrough

anexample.Sayabanklentyou$1,000atarateof20%peryear,

compounded.Afterthefirstyear,youowethebank$1,200.Afterthe

secondyear,younowowe20%notontheoriginal$1,000,buton

thenewowingof$1,200.Thatmeansyouowenot$1,400,butrather

$1,440(i.e.$1,2001.2).Ifyourloanwentontoathirdyearandyoustill

hadn’tpaidanythingback,you’dthenowe20%on$1,440,or$1,728.

Compoundingturnsmoneyintoagrowingsnowball.Thebiggerthe

amount,thefasteritgrows,andlikeEinsteinsaid,thatcanbeavery

powerfulforce.

LegendhasitthatManhattanwasboughtforjust5pearlsin1626.

Someestimatethat5pearlsintoday’sdollars—assumingthepearls

werereal—wouldbeworthabout$1,000.Fastforwardto2010.

Someestimatedthatin2010thelandofManhattanwasworth$210

billion.Couldyouguesswhatthecompoundrateofreturnwould

havebeenoverthatperiodof384years?Itwasactuallyjust5.1%per

year.Here’sanotherwayofsayingit;ifyouhadinvested$1,000in

1626andgrewitat5.1%peryear,youwouldbeleftwith$210billion

after384years.

Youmayask,“Sowhat?I’mnotgoingtolive384years.”True.Solet’s

consideramorerelevantexample.Sayyouhad$10,000toinvest.In

onescenario,youreturned6.5%peryear.Inanotherscenario,you

returned8.5%peryear.There’sareasonwhyIchosethosenumbers,

andI’llexplainwhylaterinthisbook.Let’salsosaythatinboth

scenarios,yourmoneywasallowedtocompoundfor30years.How

muchwouldyouhaveafter30years?

With6.5%peryear,youwouldhaveendedupwitharound$66,000

after30years.With8.5%peryear,youwouldhaveendedupwith

$116,000.Thisisadifferenceof$50,000.Nowlet’sgoonestep

further,andsayweinvestedatthesedifferentratesfor60years.

With6.5%peryear,youwouldendupwith$437,000.Notbad.But

with8.5%peryear,youwouldendupwith$1,336,000.Thedifference

thistimeisalmost$900,000.Astimegoeson,thegapbetween

moneyinvestedatahigherandlowerreturngrows.

Insummary,compoundedratesofreturnmatter,andtheymattera

lot.Youwouldbewisenottoignorethedifferencethata“mere”2%

peryearcanmake.

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RiskSupposesomeoneproposedthefollowingbet.Hewillflipacoin.

Ifitturnsupheads,youwin$22,000;ifit’stails,youlose$20,000.

Wouldyoutakethisbet?Thechancesare,youwouldn’t,andyou’re

notalone.Accordingtoresearch,mostpeople(thoughnotall)would

refuseabetlikethis.

Whywouldn’tpeopletakethebet?Onaverage,peoplewillmake

moneyiftheygoforthis.Chalkituptohumannature.Thehuman

mindinstinctivelyunderstandsthatthisbetisrisky.Formostpeople,

thepotentialtoearnmoneyisnotworththerisk.

Everyinvestmenthassomerisk.Witheachinvestment,notonly

shouldyoulookatitspotentialreturns,youshouldalsolookatits

risk.LikeSiamesetwins,riskandreturnsalwaysgotogether.Ifreturns

arehigh,it’susuallybecauserisksarehigh,andviceversa.

Astatisticalconceptcalled‘standarddeviation’isoftenusedto

measurerisk.Thehigherthestandarddeviation,thewidertherange

ofpossibleoutcomesforyourinvestment,andthereforethehigher

therisk.

Let’sconsideranexample.Youhave$10,000,whichyouuseto

buysomerailroadstock.NeitheryounorIknowforsurewherethe

stockisgoingtoendup.However,you’refairlyoptimistic.Youthink

thatinthenextyear,there’sa50%chancethatyourinvestmentwill

growto$11,500—a15%gain.Youalsothinkthere’sa50%chance

yourinvestmentswilldeclineto$9,500—a5%loss.Ifyougeta

mathgeektopunchinthenumbers,youwillfindthatthestandard

deviationis10%.

Nowlet’scontrastitwithanotherexample.Thistime,youinvest

$10,000inanup-and-comingtechnologystock.You’restilloptimistic.

Youthinkthatinthenextyear,thereisa50%chanceyourinvestment

willgrowto$15,000—a50%gain.Butyou’rearealistandyoualso

thinkthere’sa50%chanceyourinvestmentwilldeclineto$7,000,

a30%loss.Inthiscase,thestandarddeviationis40%;muchhigher

$9,500

$7,000

$11,500

$15,000

$10,000 $10,000

Lowerriskbet Higherriskbet

LiquidityInhisbook“DeliveringHappiness,”TonyHsiehrecountedthestory

ofhiscompany,Zappos,theonlineretailernowownedbyAmazon.

AccordingtoHsieh’sbook,therewasonepointinZappos’history

whenthecompanyalmostwentbankrupt.Inordertokeepthe

companyalive,Tonyputhisloftupforsale.Iftheloftwassold,his

thanfortherailroadstock.Whatdothenumberstellus?Buying

thetechnologystockisamuchriskierpropositionthanbuyingthe

railroadstock.Youstandtogainalotmore,butyoustandtolose

moreaswell.

Insummary,alwayskeepriskinmindwhenthinkingabout

investments.Youcanmeasureaninvestment’sriskinessbylooking

atstandarddeviation.Thehigherthestandarddeviation,thehigher

therisk.

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companywouldhavecashtoliveanotherday.Ifnot,hiscompany

wouldgobankrupt.ItwascertainthatTony’sloftheldvalue,butit

wasfarfromcertainthathe’dbeabletosellitintime.Inotherwords,

Tonyhadaliquidityproblem.

Ifafinancialassetisliquid,itmeansthatyoucantradeitveryeasily.

Forexample,stocksaregenerallyliquid—youcantradethemwithin

seconds.Thiscontrastswithfinancialassetsthatareilliquid.Asan

example,realestateisanassetclassthatisgenerallyilliquid.

Alongwithrisksandreturns,liquidityisalsosomethingyoushould

beverymindfulof.Ifyouholdilliquidassets,youcouldbevulnerable

toshocksinyourlife—suchasjoblosses,accidents,etc.Yourmillion

dollarhomemightfetchonly$800,000ifyouhadtosellittomorrow.

Toclarify,I’mnotsuggestingthatyousellyourhouseatthesoonest

opportunitytobuyliquidinvestments.Rather,Ibelieveeveryone

shouldhaveatleastsomeoftheirsavingsinmoreliquidassetsthan

realestate.Lifethrowscurveballsatyou,oftenwithoutwarning.Be

prepared.

DiversificationWeallknowthecommonproverb,“Don’tputallyoureggsinone

basket.”Aninvestorwoulddowelltoheedthisadvice.

Diversificationmeansspreadingoutyourinvestmentssothatyou’re

notvulnerabletoanybadnews.You’reproperlydiversifiedwhenyour

investmentsareunrelated.ThefateofanickelmineinAustraliais

unrelatedtothefateofasoftwarecompanyinToronto.Supposeyou

investinboth.Towipeoutyourinvestments,boththenickelmineand

thesoftwarecompanywouldhavetofail.Itmaybeunlikelytosee

oneofthemfail,buttoseebothfailwouldbetrulyrare.Youaresafer

holdingbothofthesecompanies,ratherthanholdingjustone.

However,you’renotproperlydiversifiedifyourinvestmentsare

correlated.Anexamplemightbeaninvestmentinacarmanufacturer,

aswellasaninvestmentinthecompanythatsuppliesitsengines.

Bankruptcyforthecarmanufacturercanleadtothebankruptcyof

thesupplier.Ifyouinvestinboththesecompanies,youarejustas

vulnerableasinvestingonlyinthemanufacturer.

Insummary,diversificationmeansspreadingoutyourinvestments.

Todiversifyproperly,investinunrelatedopportunities.Proper

diversificationwilllowertheriskofyourinvestmentportfolio.

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FinancialProducts This section contains my explanations

of the various financial products available to the average investor. It also contains my unashamedly biased views on those products.

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StocksAstockisapartownershipofacompany.Thatiswhywhenyouown

stock,youarecalleda“shareholder”—i.e.someonewhoholdsshare

ofacompany.Thecompany’sassetsandfutureprofitsdeterminethe

valueofyourstock.

It’sveryeasytotradestocks.Mostbanksofferbrokerageservices

whereyoucanbuyorsellstocksforafee.However,it’smuch

cheaperifyouuseadiscountbrokerageservice.Wewilldealwith

thesubjectofdiscountbrokerageslateroninthisbook.Unlessyou

areamultimillionairepouringmillionsintoasinglestock,youwillfind

thatstocksareveryliquidinvestments.Youcansellyourstocksin

seconds.

Therearesome15,000publiclylistedcompanies(i.e.companieswith

tradablestock)intheU.S.,andsome6,000inCanada.Asthenumber

ofpubliclytradedcompaniesgrew,itbecamehardertotrackhowthe

stockmarketasacollectivewasdoingoverall.Youcouldnolonger

pointtoafewstocksandsaythemarketdidwelloverallinanygiven

year.So,peoplecreatedindices.

ThetwomostfamousU.S.indicesaretheDowJonesIndustrial

Average,andtheS&P500.TheDowconsistsof30verylarge,very

stableU.S.companies.It’sbyfartheolderofthetwoindices,dating

backto1896.TheS&P500,ontheotherhand,consistsof500of

thelargestU.S.companies.Botharewidelyquotedinthemedia.

InCanada,thetwomostprominentindicesaretheTSXComposite

Index,andtheTSX60Index.TheTSXCompositeincludeshundreds

ofthelargestCanadiancompanies,whiletheTSX60includesjustthe

60largest.

Inthepast,stocksgeneratedhighreturnsatthecostofmoderately

highrisk.Overthepast100years,thevolatilityratewasaround

15%,whichmeantthatreturnswereunpredictable.Returnsranged

between-20%and+35%duringmostyears,andevenwentoutside

thatrangeeverycoupleofdecades.Butoverall,ifyouhadinvestedin

everystockintheDowindex,yourinvestmentswouldhavereturned

9%peryear,withastandarddeviationof15%.TheS&P500hashad

similarriskandreturnsastheDowsinceitsinception.

9%returnsforstockssoundsgreat,butwillitcontinue?Ithinkso,at

leastintheverylongterm.

Forthepast100years,theaveragereturnoncapitalforU.S.and

Canadiancorporationswas9%.Inotherwords,witheverydollar

theaverageU.SorCanadiancorporationreceivedfrominvestors,it

generatedprofitsof9centsperyear.

AccordingtobusinesstycoonWarrenBuffett,thecorporations

generatedsuchprofitsnotbecauseAmericansandCanadianswere

anysmarterthanpeoplefromothernations,butbecausetheir

capitalistsystemandrulesoflawallowedhumanpotentialtoblossom.

Forallthetroublesourcountriesface,thehistorical,positivestock

returnsshouldcontinueintothefutureaslongastheirbasicsystems

remainintact.

NoticethatIhavekeptourdiscussiontoindices—i.e.thestock

marketasawhole—insteadofindividualstocks.That’sbecauseI

wanttoofferabigwordofcautiontoanyonewishingtoinvestin

individualstocks.Pickingstocksishard.

Ifyoubuyoneortwostocks,orevenseveral,you’renotproperly

diversified.Everyonefeelsthattheycan“beatthemarket”-inother

words,generateaboveaveragereturns.Researchhasshownagainand

againthatthegreatmajorityofstockpickersgeneratebelowaverage

returns,thoughnotalldo.Unlessyouplanonspendingthousandsof

hoursresearchingstocks,takemyadvice—don’tdoit.Instead,be

properlydiversifiedbyholdingmany,manystocks.Inlaterchapters,I’ll

showyouhow.

Insummary,stocksarepartownershipofcorporations.Theaverage

corporationhasreturned9%historically,whichIbelievewillcontinue.

Thestandarddeviationisabout15%,whichmakesstocksmoderately

highinrisk.They’realsoveryliquidinvestments.However,trynotto

pickindividualstocks—doingsowilllikelycostyou.

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Bonds and GICsAbondisbasicallysomeone’sdebt.Ifyouholdabond,itmeans

thatsomeoneowesyoumoney.Forexample,ifyouholdatypeof

bondcalledaCanadaSavingsBond(CSB),thefederalgovernment

ofCanadaowesyoumoney.Ontheotherhand,ifyouholdaTim

Horton’sbond,TimHorton’sowesyoumoney.

Bondshavethreeimportantcharacteristics:maturity,creditrating

andyield.

Maturityiswhenthebondwillbefullypaidback—e.g.aTim

Horton’sbondmaymatureonJune1,2017.You can trade bonds

before maturity.Infact,bondsareusuallyprettyliquid—youcan

normallytradetheminseconds.Maturitiesareimportantnotbecause

theylockyouin,butbecausebondswithlongermaturitiesareriskier.

You’llseewhylater.

Thebond’screditratingindicatesthelikelihoodthatyourbond

willbepaidinfull.Generallyspeaking,creditratingsoflargestable

corporationsareverygood—thechanceofoneofthemdefaultingis

usuallylessthan2%.However,ifthemarketthinksthecorporationis

anywhereclosetodefaulting,watchout;thebondcansuddenlydrop

invalue.

Yieldistherateofreturnearnedbythebondholder.It’snotthesame

ascoupons,whichareregularpaymentsmadetobondholders.For

example,abondmaypay5%peryearofitsprincipaleveryyearuntil

itmatures.The5%peryearisthecoupon.Butitmayhaveadifferent

yield.Iwillexplainwhyinthenextfewparagraphs,butthediscussion

isslightlytechnical.Ifyoudon’tfollow,that’sokay.Justunderstand

theconclusionsattheend.

Saythereisabondwitha$1,000principalanda5%peryearcoupon

thatmatures1yearfromnow.If youbuythebondat$1,000,theyield

isthesameasthecoupon.Doingsoiscalledbuyingatpar.However,

youwillnotbuythebondatparmostofthetime.

Let’ssayyouboughtthebondwementionedat$900instead(i.e.

atbelowpar).Yougetthe$50incouponsand$1,000inprincipalat

maturity.Yourtotalgainwas$150(1,000+50-900),andsoyouryield

was$150/$900=17%.Inotherwords,yougained17%onyour$900

investment.

Youcanalsobuythebondatabovepar.Let’ssayyouboughtour

examplebondat$1,025.Youstillonlygetthe$50incouponsand

$1,000inprincipalatmaturity.Yourtotalgainwas$25(1,000+50-

1,025),andsoyouryieldwas$25/$1,025=2.4%.Inotherwords,you

onlygained2.4%onyour$1,025investment.

Here’stheconclusion:lower yields come with higher prices, and

higher yields come with lower prices.Generally,bondsarenotrisky

becauseyou’reafraidthatthedebtorwon’tpayyouback,although

thathappenssometimes.Instead,bondsareriskybecausewhen

yieldsgoup,thevalueofyourbondsgodown.

Ifyoureadfinancialpublications,youwillfindthattheyliketotalk

alotaboutcentralbanks.Somepeoplethinkcentralbankersare

themostpowerfulpeopleintheworld,evenmorepowerfulthan

presidentsorprimeministers.Here’spartofthereasonwhy.They

controlinterestrates,andbydoingso,theycontroltheyieldonyour

bonds.Iftheyadjustinterestratesup,youryieldsgoup,andyour

bondpricesgodown,andyouarepoorer.Iftheyadjustinterestrates

down,theoppositegenerallyhappens,andyou’rericherforit.

Bondswithlongermaturitiesaremoresensitivetointerestratesthan

bondswithshortermaturities.Bondswith30yearstomaturitywill

oftenlose15%oftheirvaluewitheach1%riseinyield,whilebonds

with2yearstomaturitymayonlysufferabout2%.

NotethatGuaranteedInvestmentCertificates(GICs)arebasically

bonds.Theyarebondsissuedbyfinancialinstitutionssuchasbanks

andtrusts.GICsgenerallyhaveacommonflaw:liquidity.Traditional

GICshavelock-ins,whichmeansyoucan’ttradeinyourGICbefore

maturity.FlexibleGICsallowyoutotradeinyourGICduringspecific

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times,butoftenatapenalty.Thisisdifferentfromregularbonds,

whichyoucantradevirtuallyanybusinessday.I’mpersonallynota

fanofGICsforthisreason.

Lastly,aswithstocks,don’ttrytopickandchoosethe“best”bond.

Ittakesalotofeducationandexperiencetopickoutthebestones.

Instead,ownmanydifferentbonds.Youwillseehowlateroninthis

book.

Insummary,bondsaredebtowedbyanentity.Wetalkedabout

whatmaturity,creditratingandyieldmean.Youcaneasilysellbonds

beforematurity.Asyieldgoesup,bondpricesgodown,andvice

versa.Interestratesaffectyield.Watchoutforlongtermbonds;

they’remoresensitivetochangesinyield.GICsaresimilartobonds,

butthey’relessliquid.Aswithstocks,don’ttrytopickoutindividual

bonds—ownmanyinstead.

Mutual FundsYougenerallyshouldn’townasmallnumberofstocksandbonds,

becauseyou’renotdiversifiedenough.However,youshouldn’tbuy

hundredsofthemeither,notjustbecauseit’stedioustobuyevery

singlestock,butalsobecauseyou’dpayfartoomuchintransaction

costs.Forexample,ifyouhadjust$5,000savedup,youshouldn’t

divideitupintofivehundredpiecesworth$10each.Ifyoumade

500transactions,youwouldpay$2500eveniftransactioncosts

werejust$5/trade.

Manypeoplesharedthesameconcern,sotheycameupwithan

idea.Whatiftheypooledmoneytogetherandboughtalotofstocks

andbonds?Someonewillmanagethispoolofmoney,andinvestors

willeachownapieceofthispool.That’showmutualfundsgot

started.

Youcanbuyamutualfundthroughadiscountbroker,orthrough

afinancialadvisor.Financialadvisorsactuallymakealivingselling

mutualfunds.Mutualfundsareliquidinvestments—youcan

withdrawmoneyduringanybusinessday.

Withthepoolofcapital,themutualfundmanagerscansthe

investmenthorizon,andpicksoutwhatheorshethinksisthebest

investment.Theaveragemanagercharges2.5%ofmoneyunder

managementeveryyearinCanada.Thisamountgetscharged

whetherthemanagerperformswellornot.

Thisiswheremycriticismbegins.

Ifyou’reamutualfundholder,you’retheoreticallypayingthefund

managertopickandchoosethebestinvestments.You’rehoping

themanagerwilloutperformthemarketenoughtojustifythefees.

However,beatingthemarketisveryhard.Manystudieshavebeen

publishedonthesubjectoffundperformance,andtheconclusionis

universal:thegreatmajorityoffirmsunderperformthemarket.From

thebeginningof2003totheendof2012,theTSXCompositeIndex

returned9.2%peryear.Ofthemanythousandsofmutualfundsin

Canada,3154had10yeartrackrecords.Ofthose,only254(lessthan

10%)didjustaswellorbetterthantheindex.

Investingisabitlikepoker.Everytimeyouwinapot,somebodyelse

loses.Thatmeansnomatterhowhardtheytry,youraveragemutual

fundwillperformaverage.However,thisaverageperformancecomes

beforefees—the2.5%peryearmentionedearlier.Afterfees,your

averagefundwillunderperformby2.5%.Thestatisticsbearthisout.

Forthepast10years,theaveragemutualfundreturned6.9%,which

is2.3%belowwhattheindexreturns.

Comparingmutualfundperformanceagainsttheindexmatters,

becauseifyouheldmanyrandomlychosenstocksandbonds,you

wouldprobablyperformjustaswellastheindex.Thisiswhyfinancial

professionalssaymonkeysthrowingdartscanbeatmutualfunds.

Mutualfundsarealsoplaguedbysystemicproblems.Starmanagers

oftenjumpshipsotheycanearnmore.Mutualfundscharge2.5%no

matterhowwelltheydo.Thosewhohaveagoodtrackrecordoften

switchtohedgefunds,wheretheycantypicallycharge2%ofmoney

undermanagementplus20%ofprofits.Atahedgefund,astar

performercanearnmanytimestheamountrelativetomutualfunds.

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2.5%peryearisalottopay.Inthe‘CompoundReturns’section

earlierinthisbook,wesawthedifference2%makesovertime.This

iswhyI’mnotafanofhighcostmutualfunds.Thankfully,thereare

betteralternatives,aswewillsee.

Insummary,mutualfundsarepoolsofmoneymanagedby

professionals.Ifyouinvestinamutualfund,youownapieceofthis

pool.Mutualfundsaregreatforhelpingyoudiversify,buttheirfees

areterrible.Mostofthetime,theirperformancefailstojustifytheir

fees.

Index Funds and ETFsIndexfundsarelowcostmutualfundsthattrackindicessuchas

theS&P500ortheTSXComposite.Themoneyinsidethefunds

areallocatedamongstocks/bondsinthesamewaytheindicesare

allocated.Forexample,ifTDwas5%oftheTSX60,5%oftheTSX

60indexfundwouldbeinvestedinTD.Becauseindexfundsfollow

aprescribedwayofallocatingfunds,theydon’thavemanagers.

AcompanycalledVanguardcreatedthefirstindexfund,because

itbelievedthatindexfundswouldoutperformmostmutualfunds.

Vanguardbelievedthatbyeliminatingthefees,itsindexfunds

wouldoutperformmostothermutualfundsinthelongrun.They

wereright,andtheirinvestorsrewardedthembygivingthemmore

moneytomanage.Asaresult,Vanguard’sfundsareamongthe

biggestintheworld.

MostExchangeTradedFunds(ETFs)arebasicallyindexfunds.

Thereisonlyonemeaningfuldifference:ETFsaretradedonthe

stockexchange,whereasindexfundsareboughtandsoldasmutual

funds.Bothareterrificwaystoinvest.

WithETFsandindexfunds,thefeesaremuchlower.Someof

Vanguard’sETFs,forinstance,havemanagementexpensesofless

than0.1%peryear.Otherindexfunds’andETFs’feesarenotquite

aslow,buttheygenerallycomeinbelow0.5%peryear.

OpponentsofETFsandindexfundsarguethatifyouinvestinthem,

you’reguaranteedtonotbeatthemarket.Thisistrue—youwill

alwaysperformaboutaswellasthemarket,andnomore.However,

aswehaveseeninthesectiononmutualfunds,veryfewmutual

fundsbeatthemarketafterfees,becausethefeesaretoobig.By

investinginETFsandindexfunds,ifthefuturelookslikethepast,you

willoutperformmorethan95%ofthemutualfundsina20yearspan.

TherearemanytypesofindexfundsandETFs.Somearebondfunds

thattrackbondindices.Someareforeignstockfundsthattrack

foreignindices.Laterinthisbook,you’llseehowyoucanchoose.

Insummary,indexfundsandETFsarebasicallymutualfundswithout

managers.Insteadofpickingandchoosinginvestments,theyhold

everystockintheindicestheytrack.Thefeesaremuchlower—

generallyintherangeof0.1–0.5%peryear.They’reaverygoodway

toinvest.

Real EstateIdon’tthinkrealestateneedsanyintroduction.Forsomepeople,

housesaretheonlyacceptableinvestmentbecausetheycanseeand

touchthem.

Analyzingpastreturnsonrealestateisnotverystraightforward.

Unlikewithstocksorbonds,ahomeownerhastodealwithrepairs,

renovations,taxesandotherconsiderations.Forexample,someone

mighthaveboughtahousefor$200,000andsolditthefollowing

yearfor$260,000.Thatwouldbea30%gaininayear,right?But

whatifthepersonputin$50,000toaddanextension,andpaid

$10,000torealestateagentsandlawyers?Thegainwas0%—no

returnatall.

However,somebrightpeopleputtheirmindstotrackingthereal

estatemarketandinventedhousingmarketindices.IntheU.S.,the

Case-Shillerindextrackshomeprices.InCanada,StatisticsCanada

tracksthepricesofnewhomes,andTeranettrackschangesinprices

15

everytimeahomeisresold.Theindicesmentionedadjustfor

changesinthequalityofhouses.

AccordingtoProfessorRobertShiller,theauthoroftheCase-Shiller

index,housingpricesgrewattherateofinflation(3%/year)forthe

past100+years.Thereweretimeswhenhousepricesincreased

muchfasterthaninflation,suchasduringtheyearsleadingupto

2008intheU.S.However,thosetimesweretheexceptionrather

thanthenorm.

Togetafullpictureofrealestateasaninvestment,wemustalso

factorinrentsaved,aswellason-goingcostssuchasmaintenance

andtaxes.Thoughitvarieswidelyfromhousetohouse,according

todatafromtheIMFandotherreliablesources,rentsinCanada

averageabout3%peryearofthevalueoftheaveragehome.Onthe

otherhand,maintenancecostsaverage1.5%peryear,andproperty

taxesaverage1%peryear.Combined,thisboostsrealestate’sreturn

oninvestmentsbyroughly0.5%peryear.Thismeansthathistorically,

theaveragehomereturnedroughly3.5%peryear.

Measuringriskinessofrealestateinvestmentsisverydifficult.

However,somecalculationsshowthatthestandarddeviationfora

singlepropertyisaround10%.Thismeansthepriceofasinglehouse

willchangebetween-15%and+21%duringmostyears.

Forthepast60years,shorttermgovernmentbondsyielded

roughly5%peryear.ThismeansthatowningaGICorashortterm

governmentbondwouldhavebeenmoreprofitableandmuchsafer

thanowningahouse.Unfortunately,wecan’tescapetheconclusion:

houseshavebeenbadinvestments.

Somepeoplecounterthisbysayingtheyknowofsomeauntor

unclewhosehousedoubledinvalueoverthelastxyears.Ihavetwo

responsestothis:

First,justaswithindividualstocks,individualhousepricescanvary

alot.Perhapssomeoneboughtahousebeforetheneighbourhood

wasrevitalized.Perhapsasubwaystationappearedafewyearsafter

someoneboughtahouse.Therearemanyreasons,butthey’renot

typical.Wearejustmorelikelytohearaboutthesetypesofstories

becausethey’reexcitingandunusual,ratherthanstorieswhereprices

appreciatedbyjust2%lastyear.

Second,thepowerofcompoundinterestissosignificant,thateven

3%peryearmakesaninvestmentlookgood.Maybeyou’veheardof

anunclewhoboughthishouseforamere$100,000in1973.In2013,

itwasdeemedtobeworth$330,000,morethan3timestheoriginal

amount.However,ifyouanalyzethecompoundrateofreturnover

thepast40years,youwillfindthattherateofincreasewasamere

3%peryear.

Realestatecanbeparticularlydangerousbecausethebuyernormally

takesonalotofdebttopurchasethehouse.You’reprobablyfamiliar

withthisratio:20%downpayment,80%mortgage.However,itcan

takealongtimetosaveupforadownpayment,somanypeoplebuy

mortgageinsurance,whichletsthemputlessmoneydown;say5%

down,95%mortgage.

Becauseofthedebt,youhaveamuchgreaterchanceoflosingall

yourmoneyinyourinvestment.Sayyouput$80,000downona

$400,000house,whichmeansyouhave$320,000inmortgages.

Imaginethepriceofthehousegoesdownsignificantlythenextyear,

by15%.Thatmeansthehouseisnowworth$340,000.Youprobably

stillowecloseto$320,000inmortgages,whichmeansyourequity

(i.e.thedebt-freeportion)onthehousewentdownfrom$80,000to

$20,000,a75%loss.

Tomakemattersworse,realestateisanilliquidinvestment.Inthe

Conceptssection,wetalkedaboutTonyHsieh,whocouldn’tsellhis

propertyquicklywithoutasignificantdiscount.Mostpropertiestake

monthstosell.

Insomeextraordinarycircumstances,suchasrightafterthehousing

crashintheU.S.,realestatecanbeagoodinvestment.However,

thoseoccasionsarerare.Therearealsoprofessionalinvestorswho

traderealestateandconsistentlymakemoney.Justaswithinvesting

inindividualstocksandbonds,ittakesalotofknowledgeand

experiencetodowhattheydo,andIwouldn’trecommendtryingit

yourself.

16

I’mnotsuggestingyoushouldneverbuyahouse.Buyingahouse

givespeoplejoy,andmoneyisnotallthatmattersinlife.WhatIam

sayingisthatbuyingahousepurelyforinvestmentreasonsisnota

greatidea.Thereturnsarenotgreat,theriskishigh,andtheliquidity

islow.

CommoditiesCommoditiesarethings.Theyaresuchthingsasoil,livestock,wheat,

uranium,andmostfamously,gold.However,notevery‘thing’isa

commodity.Forexample,thesweaterthatyourgrandmaknitisnota

commodity.Tobeacommodity,theremustbemanyofthose‘things,’

andtheymustbeessentiallythesame‘thing.’Apoundofcopper,for

instance,isessentiallythesameasanotherpoundofcopper.

Mostcommoditiestradeonacommodityexchangethatisseparate

fromastockexchange.Thatmeansyoucan’tbuyaherdofcattle

whilesittinginfrontofyourcomputerthroughyourdiscountbroker.

Sorry.However,youcanbuyETFsthatholdcommodities.Oryoucan

buysomephysicalcommoditieslikegoldanddiamonds,andstore

themyourself.

Fortherestofthischapter,Iwillfocusontheexampleofgold.

Manypeopleholdgoldintheirportfolios,andtheyinvestingoldfor

roughlythesamereasonpeopleinvestinothercommoditiesforthe

longterm:inflationprotection.Assuch,muchofourdiscussionabout

goldappliestoothercommoditiesaswell.

Until1971,theU.S.operatedonthe‘goldstandard.’Thatmeantthe

U.S.artificiallypeggedthepriceofgold.Backthen,$38andone

ounceofgoldwasoneandthesamething.Since1972whentheU.S.

wentoffthegoldstandardtothepresent,goldhasappreciatedby

7.9%peryear,significantlyoutperformingtherateofinflation.During

thesameperiod,thestandarddeviationofgoldhasbeenaround

25%,whichmeansgoldhasbeenahighlyriskyinvestment.

Willgoldcontinuetoreturn8%inthefuture?Thereismuchdebate

onthisissue.Ontheonehand,somesaygoldpriceswillcontinueto

appreciateatahighrate.Theysaythatinflationwillshoothigherasa

resultofgovernments’printingmoney.Otherssaytheopposite,that

goldpriceswilldepreciate,becausetheythinkinflationwillremain

subdued.Despitethedisagreements,expertsagreeononething:

goldpriceswillgothewayofinflation.

Investingingolddiffersfrominvestinginstocks.Ifyouinvestina

stock,you’rethepartownerofacorporation.Thiscorporationmay

grow,oritmaydecline.Ifyouowngold,orsomeothertypesof

commodities,youownsomethingthatneithergrowsnordeclines.

That’swhyit’sreasonabletothinkthatgoldpriceswilltrackinflation

inthefuture.Inthepast40years,goldoutperformedinflation,but

thatprobablyhappenedbecauseofspecialcircumstancesrelatingto

theendofthegoldstandard.

Ifthenext100yearslooksimilartothepast100years,theeconomy

andfinancialmarketswon’tbestable.Theworldwillgothrough

depressionsandpanics.Governmentswilltakeondebtandprint

money.Inflationwillshootupfromtimetotime,andmanypeoplewill

bemoanthedeclineofWesternCivilization.Butdespiteitall,ifthe

next100yearslooklikethepast100years,inflationwillaverage3%

peryear.Ifthisistrue,investingingoldwillbeabadidea.

Notallcommoditiesareexpectedtotrackinflation.Certain

commoditiesarebecomingmorescarceovertime,eitherbecause

theyareusedupafterextraction(eg.oil),orbecausepeopleare

findingincreasingusesofthecommodity(eg.palladium).Pricesof

suchcommoditiesareexpectedtoincreaseovertime,butanalyzing

theoutlookofthosecommoditiesisdifficult,andIdon’trecommend

itformostinvestors.

Insummary,commoditiesarethingslikegold,livestockanduranium.

Theaverageinvestorgenerallycan’ttradethem,buttheycanbuy

ETFsthatholdthem.Goldreturned8%peryearforthepast40+

years,withastandarddeviationof25%,whichmeansgoldishighly

risky.Thefutureofgoldisuncertain,butexpertsagreethatitwillrise

attherateofinflation.Ipersonallythinkit’sabadinvestment.

17

Life InsuranceAswithothertypesofinsurance,holdinglifeinsurancecanbea

goodthing.Holdingitprotectsyoufinanciallyintheeventofthe

lossofyoursignificantother.However,notallformsoflifeinsurance

aregreat.Insurancecompaniesnormallyofferustwotypesoflife

insurance:termlifeinsuranceandwholelifeinsurance.

Termlifeinsuranceisstraightforward.Thepolicyholderpaysthe

feesandifthedesignatedpersondiesduringthepolicyterm,the

policyholderreceivesmoney.Normally,thepolicyholderandthe

designatedpersonaredifferent.Ifthepolicytermexpiresandthe

designatedpersonisstillalive,theholderreceivesnothing.Since

yourriskofdyingincreasesasyouage,thepremiumonyourtermlife

insuranceincreaseseachyear.

Withwholelifeinsurance(alsocalledpermanentlifeinsurance),

yourpremiumstartshigher,butstaysatthesamelevelthroughout

yourlife.Theinsurancepolicyhasacashreserve,whichbuildsasthe

holdermakesmorepayments.Thepolicyholdercanborrowfrom

thiscashreserveifheorshewantsto.Uponthedesignatedperson’s

death,asumofmoneyispaidout,minustheloanedamount.

I’mgoingtoslightlyoversimplifythingshere,butwholeinsurance

isbasicallyterminsurance+inclusioninamutualfund.Tohelpyou

understand,let’sreplicateitourselves.Let’ssaywholeinsurancecosts

$2000/year,andterminsurancecosts$500/yearinitially.Insteadof

payingwholeinsurance,buyterminsurance,andinvest$1,500/year.

Your‘cashreserve’isbasicallyyourinvestments,withonedifference.

Thechancesareyou’llgetbetterreturnsinvestingyourselfthanifyou

trustedyourcashwithalifeinsurancecompany.

Theinvestmentreturnsoncashreservesdifferfromcompanyto

company,butthey’vegenerallyunderperformedthestockmarketby

3%peryear.However,tobefair,insurancecompaniesinvestinbonds

aswell.Ifwecomparetheperformanceoflifeinsurancecompanies

withatypicalportfolioconsistingof80%stocksand20%bonds,life

insurancecompaniesstillwouldhaveunderperformedbyatleast

2.5%peryear.Does2.5%soundfamiliar?It’stheaveragefeecharged

bymutualfunds.Inotherwords,bypurchasingwholelifeinsurance,

you’rereallybuyingterminsurance+inclusioninamutualfund.Ifyou

wanttobericher,buyterminsurance,andinvesttherestyourself.

Insummary,therearetwolifeinsurancecategories:termandwhole

insurance.Terminsuranceispureinsurance,whilewholeinsuranceis

essentiallyterminsurance+mutualfund.Don’tbuywholeinsurance.

Buyterminsuranceandinvesttherestyourself.

18

Taxation In this section, we’ll talk about how your investments are taxed, and how registered savings plans work.

4

19

Capital Gains TaxCapitalgainstaxesaretaxesonyourinvestmentprofits.Let’ssayyou

bought100sharesofCoca-Colaat$30lastyear,for$3000.Thisyear,

yousoldthemat$35/share,for$3,500.The“capitalgains”is$500.

(3,500-3,000.)You’retaxedonyourcapitalgainswhenyousellyour

shares,butnotbeforethen.

Onlyhalfofyourcapitalgainsaretaxedatyourmarginaltaxrate.For

example,ifyouearn$60,000/year,yourmarginaltaxrateisabout

34%.Ifyouhadmade$500fromtradingCoca-Colastock,only$250

wouldhavebeentaxedat34%,whichcomesouttoroughly$85.

Nowlet’sconsiderahypotheticalscenario.Youworkhardatyourjob,

andyouearnapre-taxincomeof$40,000.Youearmark$6,000of

itforinvesting.Let’ssaythegovernmenttaxedyouat25%onyour

income,andyou’releftwith$4,500toinvest.

Youinvestthe$4,500well,anditdoublesin10years.Now,youhave

$9,000ininvestments,a100%gain.Yourcapitalgainsis$4,500.

Yousellallyourinvestments,whichmeansyouhavetopaytaxeson

yourcapitalgains.Thegovernmenttaxeshalfofthe$4,500atthe

marginalincometaxrate—wewillassume34%atthispoint.This

meansanother$765goestothetaxman.

Attheendoftheday,youareleftwith$8,235.

$6,000 $4,500 $9,000 $8,235

Incometax

of$1,500

Investmentgain

of100%

Capitalgainstax

of$765

$6,000 $12,000 $7,920

Investmentgainof100% Incometaxof$4,080

Insummary,capitalgainsareprofitsonyourinvestments.The

governmentonlytaxeshalfofyourcapitalgainsatyourmarginal

incometaxrate.

RRSPTheRegisteredRetirementSavingsPlan(RRSP)allowsyoutodefer

taxesonyourincome.OnceyouhaveanRRSPaccountsetup,any

moneyyouputintothataccountgetsdeductedfromyourincome.

Forexample,ifyouearned$50,000lastyearandput$5,000into

anRRSPaccount,yourincomewillbetaxedasifyouonlyearned

$45,000.

InsidetheRRSPaccount,youcangrowyourinvestmentswithout

anycapitalgainstaxes.Youcanbuystocks,sellitattwicethe

price,andaslongasitstaysintheRRSP,youdon’tpayanytaxes.

YoucansetupanRRSPwithabank,oradiscountbrokerage.I

personallyrecommendthelatter.Somebanksmaytrytosellyou

RRSPswhereyourmoneyinsidetheRRSPsautomaticallygets

investedinGICs.Don’tdoit—they’retakingadvantageofyou.

However,whenyouwithdrawfromanRRSP,yougettaxedat

thefullpersonaltaxrate.Inotherwords,whateveryouwithdraw

istreatedlikeanyotherincome.Ifyouearn$50,000,andyou

withdraw$10,000fromanRRSP,youpaytaxesasifyourincome

were$60,000.

Nowlet’srepeatthehypotheticalscenariointhe‘capitalgains’

section,butwithanRRSP.Let’ssayyouearned$40,000lastyear,

andcontributed$6,000totheRRSP.Thegovernmentdoesn’ttax

the$6,000.

Thismoneyisinvestedwell,anddoublesin10yearsto$12,000,a

100%gain.

Youwithdrawthismoneyatthemarginaltaxrateof34%.After

taxes,youhave$7,920left.

20

Inthe‘capitalgainstax’section,theinvestorwasleftwith$8,235

aftertaxes.Thus,thebenefitofusinganRRSPwas$7,920-$8,235=

-$315,anegativenumber!Thatmeansyouwouldhavebeenbetteroff

notusingtheRRSPatall.

Thishappenedbecauseyourtaxratesweremuchhigherinthefuture

thanwhenyoucontributed(25%vs.34%).Thiscalculationwillvary

accordingtoeachperson’suniquesituation.Ifyou’realreadyinahigh

taxbracket,orifyoudon’texpectyourincometorisesubstantially

whenyoutakemoneyout,itmakessensetouseRRSPs.Sincemost

peopledon’tplanontakingmoneyoutuntilretirementwhentheirtax

ratesarelower,thisisgenerallythecase.Butinothertimes,itmakes

sensenottouseRRSPs.

AcoupleofotherthingstoknowaboutRRSPs:Whenyouhita

certainage(71currently),thegovernmentrequiresyoutoconvert

yourRRSPsintowhatarecalledRegisteredRetirementIncomeFund

(RRIF).WithanRRIF,you’reforcedtowithdrawacertainamount

eachyear.

Also,youcantakeoutupto$25,000fromyourownRRSPtobuy

ahouse.Thisisgreatbecauseyoudon’tpaytaxesonthat$25,000.

However,youmustputthismoneybackintoRRSPswithin15years.

There’salimitonhowmuchyoucancontributetoRRSPseachyear.

Youcanfindyourcontributionlimitonyourmostrecentincometax

noticeofassessment,orbycallingCRA.

Insummary,RRSPsallowyoutodeferyourincometaxes.Butany

moneyyoutakeoutfromanRRSPaccountgetstaxedatyournormal

incometaxrate.RRSPsaregreatwhenyourtaxrateswon’trisemuch

inthefuturewhenyou’reexpectedtotakemoneyout,orifyou’re

closetoretirement.Butit’snotalwaysgreat.Ifyouchoosetouse

RRSPs,IrecommendsettingupanRRSPaccountwithadiscount

brokerage.RRSPsbecomeRRIFswhenyouhitretirementage.You

canalsotemporarilytakeoutupto$25,000fromyourownRRSPto

buyahouse.

TFSAThegovernmentintroducedtheTaxFreeSavingsAccount(TFSA)in

2009.YoucancontributemoneyintotheTFSA,andinvestwiththat

money.WithinvestmentsinsideyourTFSA,youdon’thavetopayany

capitalgainstaxes.However,unlikewithanRRSP,yourcontributions

arenottaxdeductible—i.e.youwouldhavealreadypaidincome

taxesonthemoneygoingintoTFSAaccounts.Instead,there’snotax

whenyoutakemoneyoutoftheTFSA.

YoucaninvestinmanydifferentkindsoffinancialproductsinaTFSA,

includingstocks,bondsandETFs,whethertheybeU.S.orCanadian.

However,somebanksletyouinvestonlyinalimitednumberof

products—liketheirownGICsormutualfunds.Forthisreason,I

recommendopeninganaccountwithadiscountbrokerinstead.We

willdiscussmoreaboutdiscountbrokerslaterinthisbook.

Weshallrepeatthehypotheticalscenarioshowninthelast2

sections.Youearn$40,000,andyouearmark$6,000forinvesting.

Atthemarginaltaxrateof25%,youpay$1,500inincometaxes,and

contributethe$4,500leftoverintoaTFSAaccount.

Youinvestwell,anddoubletheinvestmentto$9,000,a100%gain.

Youselltheinvestmentsandwithdrawthe$9,000tax-free.

$6,000 $4,500 $9,000

Incometaxof$1500 Investmentgainof100%

Aswehaveseen,payingthefullcapitalgainstaxwouldleaveyou

with$8,235.ThebenefitofusingtheTFSAis$9,000-$8,235=$665.

YoualmostalwaysbenefitbyusingtheTFSAthanbyusingnothing

atall.However,sometimesit’smorebeneficialtouseRRSPsthan

TFSAs.Thishappenswhenyouexpectyourincometaxratestogo

downinthefuture.

21

Youcouldcontribute$5,000toyourTFSAfrom2009to2012.

Startingin2013,youcancontributeupto$5,500.Ifyoudidn’t

contributeanymoneybetween2009-2012,nottoworry;youcanstill

contributethemissedamounts.Thatmeansyoucancontributeup

to$46,500in2016ifyoudidn’tcontributeanythingsofar.Youcan

withdrawfromtheTFSA,butifyoudoso,youcan’tre-contributethe

withdrawnamountuntilthenextyear.

Insummary,youdon’tpayanycapitalgainstaxeswithinyourTFSA

account.UsingaTFSAisalmostalwaysbetterthanusingnothing.I

recommendopeningaTFSAaccountwithadiscountbrokerage.

RESPRegisteredEducationSavingsPlan(RESP)helpsyousaveforyour

child’seducation.UnlikeRRSPsorTFSAs,youhavetonamea

beneficiary(i.e.thechild).Therearenotaxbreaksfortheparentfor

usingtheRESP.Instead,thegovernmentcontributessomemoneyto

theRESPiftheparentcontributes.Theparentcancontributeupto

$2,500/yearandreceiveabout20~40%extrafromthegovernment.

Notethatthereisalimitof$50,000/child.

InsidetheRESP,themoneycangrowtax-free,justasinsideRRSPs

orTFSAs.Whenthechildbecomesauniversity/collegestudentand

takesoutthatmoney,themoneyistaxedatthestudent’spersonal

taxrate,whichwillprobablybeverylow.Thisgivesthefamilyatax

advantageontopofthefreemoneythegovernmentgives.

Ifthestudentdoesn’tcontinueontouniversityorcollege,theparent

cantakebacktheircontributionstax-free,buttheyhavetopayahigh

taxrateonthegains(normalincometaxrate+20%).

Forexample,let’ssayyoucontributed$20,000intoanRESPover

manyyearsandthegovernmentgaveyou$5,000.Duringthistime,

youalsorealizedaninvestmentgainof$5,000.Ifyourchilddoesn’t

gotocollegeoruniversity,you’llbeabletowithdrawthe$20,000tax

free.Butthegovernmentwilltakebackthe$5,000itgaveyou,and

ifyourtaxrateis30%,you’llhavetopay50%taxesonthe$5,000

gains.Inotherwords,you’llonlyget$2,500.

JustaswithTFSAsandRRSPs,youcanopenanRESPaccountwith

eitherabankoradiscountbrokerage.Ifyouopenanaccountwith

abank,theymayonlyallowyoutobuyfromalimitedselectionof

investments.Forthatreason,Igenerallyrecommendopeningan

RESPaccountwithadiscountbrokerageinstead.

Insummary,RESPsareforsavingforyourchild’spost-secondary

education.Theparentcontributes,andthechildcantakemoney

outonceinuniversity/college.It’snotverytaxadvantageous,but

thegovernmentcontributessomemoneytotheRESPinstead.Ifthe

childdoesn’tgotouniversity,theparenthastopayaheavytaxon

investmentgains.UsingRESPsisagoodideaiftheparentissurethe

childwillgotouniversityortocollege.

22

Practical Considerations In this section, I outline some

of the practical steps you can take to plan your own investments.

5

23

Paying Down Debt vs. SavingShouldyoupaydowndebtorshouldyouinvest?Thatdependson

thedebt.

Certainkindsofdebtcomewithverylowinterestrates.Those

includestudentloansandmortgages.Whenthisbookwaswritten,

interestratesonsuchloansrangedfrom3~3.5%peryear.Theseare

historicallylowrates.Ithinkit’sokaytoinvestratherthanpaydown

lowinterestratedebt,aslongasthedebtloadisnothuge.You

willlikelygeneratehigherreturnsandendupbeingricherthrough

investments,albeitatahigherrisk.

However,Idefinitelythinkyoushouldpaydownhigherinterestrate

debtbeforeyouinvest.Thisespeciallyappliestocreditcarddebt,

whichtypicallycarriesratesofover19%peryear.Ifyoucarried

$1,000worthofcreditcarddebtat19%for30years,withoutpaying

anyofitdown,you’dbewith$185,000indebt.Theawesomepower

ofcompoundreturnscanworkagainstyou.Don’tletthishappen.

Paydownyourhighinterestdebt.t

How To Buy Stocks and ETFsAsafirststeptoplanningyourinvestments,youshouldopena

discountbrokerageaccount.

ThereareafewdiscountbrokeragesavailabletoCanadians.

Personally,IrecommendQuestradebecauseIbelieveit’sthe

cheapestservicefortheaverageCanadianinvestor.However,I

thinkotherdiscountbrokeragessuchasVirtualBrokersaregood

optionsaswell.Asafulldisclosure,Idoreceiveaffiliateincomefrom

Questradeforreferringpeopletothem,butIhonestlythinkthey’re

thebestoptionformanyCanadians.Youcanreadmycomparison

ofpopulardiscountbrokershere.

Youwillnoticethatbrokeragesofferatypeofaccountcalleda

‘Margin’account,aswellasthefamiliarRRSPandTFSAaccounts.

Marginaccountsrefertothoseaccountsthataretaxednormally—

i.e.youpaythecapitalgainstax.Marginaccountshaveadditional

benefits,suchasbeingabletoborrowmoneytoinvest,notthatI

recommendborrowingmoneythisway.

Ifyoualreadyhaveabrokerageaccountwithabank,itmight

beworthswitchingtooneofthediscountbrokerages.Youcan

potentiallypayalotmoreintradingfeeswithotherbrokerages,

especiallywithbank-ownedbrokerages.

Manypeoplefindtheapplicationprocesstoopenabrokerage

accountconfusing.Ipreparedavideothatshowsyouhowtoopena

Questradeaccountinthislink.

Knowing Which Stocks and ETFs To BuyAfterreadingthisfar,youmaybeconvincedthatETFsandindex

fundsareagreatwaytoinvest.Butwhichoneshouldyoubuy,and

howmuch?TherearethousandsofETFsandindexfundsoutthere,

soit’shardtochoosejustafew,andit’sharderstilltoknowhowto

allocateyourmoneybetweenthem.

Properlyallocatingaportfolioishard.Optimizedportfolioshave

lowerrisksforthesamepotentialreturn,comparedtoportfolios

thathaven’tbeenoptimized.Alotofresearchwentintothistopic,

andsomebrightpeopleinventedthe‘ModernPortfolioTheory’

(MPT),forwhichitscreatorswontheNobelprize.Anyonecanuse

thetheorytoconstructoptimizedportfolios,butusingitrequiresa

lotofknowledge.

Tosolvethisproblem,mycompany,MoneyGeek,hasconstructeda

setofoptimizedportfoliosusingtheBlackLittermanmodel,which

isanimprovedversionoftheMPT.Withoutgoingintotoomuch

detail,MPThassomeflaws,whichtheBlackLittermancorrects.

24

YouwillneedtopaytoaccessMoneyGeek’sportfolios.Butasfaras

Iknow,it’stheonlyplaceinCanadawhereyoucangetoptimized

portfoliosforCanadians.

IputalotofthoughtandresearchintopickingwhatIbelieveto

bethebestinvestmentsfortheportfoliosatanygiventime.These

portfolioswillchangeveryslowlyovertimeasIcontinuetoanalyze

whichinvestmentsshouldbeincludedorexcludedbasedonthe

investments’currentandpotentialvalues.

Ifyou’rebudgetconscious,youcouldalsogetunoptimized

portfoliosfromthecanadiancouchpotato.com,amongotherplaces.

ThoughIdon’tfullyagreewiththeseportfolios,theywilllikelydoa

decentjob.ForafulllistofdifferencesbetweenMoneyGeekandthe

CanadianCouchPotato,seethislink.

Youcanalsocheckoutwealthfront.comforfreeoptimizedmodel

portfolios.However,theirportfoliosareoptimizedforU.S.investors.

CanadiancurrencycanfluctuatewildlyagainsttheU.S.dollar,so

anoptimizedportfolioforCanadianswilllookdifferentfromone

optimizedforAmericans.

How To Optimize For TaxesUnfortunately,it’sdifficulttoknowthebestwaytodivideup

investmentsbetweenTFSA,RRSP,orMargin(normallytaxed)

accounts.Itdependsoneachindividual’scircumstances.

Tosolvethisproblem,Icreatedatoolthatefficientlyallocates

investmentsbetweensuchaccounts.Thetooliscalledthe

InvestmentTaxOptimizer,anditsimulateshundredsofdifferent

scenariostoarriveattheallocationthatIbelieveshouldsavethe

mostontaxes.

ThefreeversionallowsyoutoefficientlyallocateCanadianstocks

andCanadianbondsbetweentheaccounts.Paidmembershave

accesstothetoolthatalsoallocatesU.S.stocks.Bothversionsare

availableonoursiteatmoneygeek.ca.Asfarasweknow,it’stheonly

toolofitskindinCanada.

Therearemanyothernuancesregardingtaxationbeyondjust

allocatinginvestmentsbetweendifferentaccounts.Ifyouwantmore

advice,Iwouldencourageyoutotalktoanaccountant.

How Much To Save Each MonthHowmuchyoushouldsavedependsonyourgoal.Mostworking

peoplehopetoretireoneday,andtheyshouldsavetowardsthat

goal.Manypeoplealsosaveupforabigpurchase,suchasahouse.

It’spartofthefinancialadvisor’sjobtoputtogetherafinancialplan

foryou,tohelpyoureachyourgoals.Afinancialplanshowsyou

howmuchyoushouldsave,andhowyourinvestmentsareexpected

togrowovertime.However,manyfinancialadvisorsdon’tgivesuch

plans,perhapsbecausetheydon’tmakemuchmoneyfromit.

I’mpersonallynotafanofthewaymostfinancialadvisorscreate

financialplans.Mostfinancialplansassumeasmoothgrowthin

investments.However,that’snotthewaytherealworldoperates.

Investmentsareinherentlyuncertain—marketssometimescrash,and

theysometimessoar.Peopleareoftenlulledintobuyingtheriskiest

investments,sincetheytendtopromisethehighestreturns.However,

buyingriskiestinvestmentsalsoputstheclientatrisk.Onemarket

crashatthewrongtimecanwipeoutenoughininvestmentssoasto

virtuallyguaranteefailuretoreachaclient’sgoals.

25

Sinceit’simpossibletopredictexactmarketmovements,noone

cansaywith100%certaintywhethertheycanachievetheirgoals.

Atbest,youcanprojectthechancesofachievingyourgoals.

AtMoneyGeek,welookedaroundforaplanningcalculatorthat

tookriskintoaccount,butfoundnothingsatisfactory.Asaresult,

Icreatedaretirementcalculator,whichisavailableforourpaid

members.

Manyyoungprofessionalsputoffsavingforretirementsinceit’sso

farinthefutureforthem.However,Ithinkevenifyouareyoung,

it’sprudenttostartsavingnow.Moneysavedearlierinlifewillhave

moretimetogrow,soit’smoreefficienttogetsavingwhenyou’re

young..Butmoreimportantly,Ibelievemostpeopleunderestimate

theamountofmoneyneededtoretirecomfortably.

Manyoftoday’sgenerationcanexpecttoliveuntiltheageof90.If

theyplanonretiringattheageof65,thatmeanstheyhavetofund

25yearsofretirement.25yearsisalongtime-that’slongerthanit

takesforanewborntobecomeauniversitygraduate.Retiringat65

isachievable,butitrequiressavingearlyanddiligently.

Insummary,yourgoalsdictatehowmuchyoushouldsave.Afinancial

plandetailshowyoucanreachyourgoals.Mostfinancialplans

assumeinvestmentsgrowpredictably,butyoucanuseMoneyGeek’s

orsimilarcalculatorstoallowforuncertainfutures.It’sagoodideato

saveforretirementasearlyasyoucan.

Once You’ve InvestedWarrenBuffettsaid,“Thegreatestenemiesoftheequityinvestorare

expensesandemotions.”

Afewtimesinourlife,themarketswillcrash.Usually,it’sthestock

marketthatcrashes,butbondmarketscanaswell.Whenthis

happens(not‘if’,but‘when’),youwillfeelfear.Itwillseemasthough

themarketsaregoingdowneveryday.Youwillfeelvirtuallycertain

thatthemarketswillgodownthenextday.Toprotectyoursavings,

youmightfeeltheurgetosellallyourinvestments,andkeepthe

moneyundertheproverbialmattress.

Whenyoufeelthisway,don’tgiveintoyoururges,oryouwilllose.

Letmetellyouaparadoxicaltruth.Thebesttimetoinvestiswhen

everybodyisfearful.Becauseeveryoneelseisselling,youhavethe

opportunitytopickupbargains.Muchofthetime,marketprices

don’tgodownbecausethecompaniesreallyaregettingcrushed,but

becausepeoplethinktheyaregettingcrushed.

Similarly,theremaybetimeswheneuphoriasweepsthemarket.

Themarketsarerisingeverysingleday.Youfeelasthoughyoucan’t

possiblylosebyinvestinginthefuture.Duringthesetimes,youwill

feeltheurgetoborrowmoneyandinvestmore.

Whenyoufeelthisway,don’tgiveintoyoururges,oryouwilllose.

Theworsttimetoinvestiswheneverybodyisgreedy.Because

everyoneelseisbuying,thepricesofeverythingwillbehigh.When

26

youbuyexpensivestock,yourreturnswillbefarless.Justask

thosewhoinvestedduringthedot-combubble.

Inthewakeofthe2008financialcrisis,Iborrowed$20,000to

investinthestockmarket.Ididsobecauseitwasanunusualtime.

Everybodywaspanicking.Icouldpickupcompaniesforlessthan

halftheirtrueworth.Ittakesexperienceandalotofself-control

toidentifyandtakeadvantageofsituationslikethesesoIdon’t

recommenddoingthisyourself.Thatsaid,Iwillprovideregular

marketcommentaryforMoneyGeek’smembers,toatleasthelp

ourclientsunderstandthemarketsituation.

Insteadofreactingemotionally,Irecommendaddingsteadilyto

yourinvestmentswithyoursavings.Asstockandbondmarkets

lurchupanddown,yourportfoliowillgooutofbalance.I

recommendrebalancingyourportfolioonceortwiceayear.To

rebalance,simplyconsultthemodelportfoliosagain,anddivide

upyourinvestmentsaccordingly.

Economists and Other Talking HeadsThereisasaying:“Economistswereputontheearthtomake

astrologerslookgood.”

Everynowandthen,youmayreadorhearwhata‘stareconomist’

hastosay.“TheCanadianeconomywillslowdown!”theywillbellow,

orperhapstheymightshout,“Unemploymentrateswilldrop!”You

mightcomeacrosssucheconomistsonTV,oryoumightreadone

oftheironlinearticles.Theywilloftendresswellandspeakwith

confidence.They’refuntowatch,butdon’tlettheminfluencehow

youinvest.

Everynowandthen,peoplerecordeconomists’projectionstosee

howoftentheycometrue.Theresultsareconsistent—economists

areprettybadatpredictingthefuture.Forexample,90%of

economistsdidn’tseethe2008financialcrisishappening.One

ofthestareconomistswho‘predicted’thefinancialcrisis,named

NourielRoubini,hasatrackrecordofpredicting10economiccrises,

andonlygetting3.However,thisisconsideredagreatrecordforan

economist.

Economistsareentertaining.Justdon’ttaketheirpredictionstoo

seriously.

27

Final thoughts6

28

Final ThoughtsSaya30yearoldsaved$5,000ayearfor35years,andgotarate

ofreturnof7.5%peryearonhisorhersavings.Thispersonwould

havesavedatotalof$175,000dollars,butthispersonwillhave

gainedanextra$570,000frominvestments,endingupwithatotal

of$745,000after35years.

Ifthisstorysoundstoogoodtobetrue,it’snot.Afterreadingthis

book,youwillhavelearnedhowtomakethisstoryyourown.We

cansummarizehowinafewsimplesteps.

1. Know which Stocks/Bonds/ETFs to buy.

2. Know how to allocate your investments between RRSP, TFSA, or margin (normally taxed) accounts.

3. Know how much to save, and keep saving. Rebalance your investment portfolio as you save.

Withtherighttools,takingeachstepiseasy.Weprovidesuchtools

atMoneyGeek,oryoucancheckouttheotherfreetoolsmentioned

inthisbook.Investingismorerewardingtheearlieryoustart,so

startasearlyasyoucan.Goodluck.

TheShortBookonInvestmentsbyJinWonChoi

Copyright©2016MoneyGeekInc.

Allrightsreserved.Nopartofthisbookmaybereproducedinanyformor

byanyelectronicormechanicalmeans,includinginformationstorageand

retrievalsystems,withoutpermissioninwritingfromJinWonChoi,except

forbriefexcerptsinreviewsoranalysis.

Whileeveryprecautionhasbeentakeninthepreparationofthisbook,

theauthorassumesnoresponsibilityforerrorsoromissions,orfordamages

resultingfromtheuseoftheinformationcontainedherein.