Average. The Middle of the Road. The Meaty Part of the Bell Curve (What? No other statistics nerds out there?). Lots of euphemisms for boring or plain. Not much fun, if we were talking about movies, date nights or Blog posts.
But, with investing, really average can be really good. In fact, a boring portfolio usually means you sleep well at night and retire on time (with have fewer ulcers and shouting matches than Gordon Gecko.)
Last week we talked Mutual Funds and I barked the following Commandments from my soap box: Make sure you have 5+ years of history to look at, compare it to an appropriate benchmark and keep the MER low. I also teased you with the prospect of a mythical investment that does all that. First, my
Let's talk investing...
- CSB 1 Year rate: between .65 and 1%
- GIC 1 Year rate: between .875 and 1% (RBC rate; provided you have at least $1000 to invest)
- Canada's Inflation Rate: 2.3%
Despite this, it is still important to have Cash holdings - you need liquid assets for emergencies, balancing your Risk and because the above pyramid says so.
- ING Bank Pays you 1.5% on every dollar you put in - no minimums - and you can get at that money anytime. A little internet or telephone banking savvy is all it takes. They are a real bank, despite not having physical branches to visit.
- Be honest, when was the last time you went to a bank anyways? I am not (just ) shilling for them - we have maintained an ING account for over a decade now. It fluctuates up and down - often serving as a parking spot for RESP money before we move it to a mutual fund, but it always is there. And that money is at least almost keeping pace with inflation.
- PC Financial: If you crave the tangibility of a bank machine and people to talk to, President's Choice Financial also offers higher interest savings accounts. They pay less interest than ING, but your money is still liquid and accessible, which makes it better than CSBs and GICs.
Index Funds: The Simple Investment
Index funds are the frugal (both time and money) investor's best friend. They are the magical investment I have been alluding to for a couple weeks now. Here is how they work:
Rather than "Actively Manage" the investments inside the fund, Index Fund Managers need only mirror the Market rate of Return. The Market could be defined by any number of Indexes out there: Standard & Poor's (S&P) top stocks on a given stock exchange (S&P 500 for US stocks, S&P/ TSX for Canada). The Nasdaq and Dow Jones are other indices you have likely heard about. When the evening news reports markets being up or down, they are referring to a Market Index.
An Index tracks the entire Market's average - the ups and downs of all stocks - compared to a baseline point over a period of time. An Index Fund copycats it in Mutual Fund Form. Why do you want that?
- Index Funds are "Passive Investments"; they don't try to second-guess the market, they simply follow it, usually making fewer trades and definitely requiring fewer managers. The payoff to you? Lower Management Expense Ratios (MERs) leaving more money to invest.
- By Definition, if you invest in an Index Fund, you should never underperform the Benchmark. You ARE the Benchmark. By extension, you will also never over-perform, but that isn't our concern. We want the nice, consistent market average compounding for us.
- Historically, you can't get a longer return than the market average. There is over 100 years of data from the Dow Jones Industrial average. No actively managed mutual fund can give you that. And how has the market done over the last 100 years? About 10% average annual return is the most often quoted and calculated average. Not that spectacular 200% 6 month return you saw in a newspaper, not a middling 0.65% return you get from a Canada Savings Bond, but a reasonably predictable 10%. Why do I say reasonably predictable? Well, nestled into that 100 year return was a Great Depression, a bunch of other Recessions, a Dot-Com bust and the most recent Financial Crisis. Here is a cool set of annotated graphs to give you a sense of the ups and downs you will need to ride out to claim your 10% return. I continue to stress, you are in this for the long haul. A down market is simply a discount sale for you to take advantage of. When gas prices are done you don't get upset, you fill up your tank.
If nothing else, Indexes typically represents a good benchmark to compare "Actively Managed" funds against- these are mutual funds where portfolio managers try to outsmart each other and the market and pick stocks that will perform better than the average.
You pay more for this Professional Smarts in the form of higher MERs, which leaves you less to invest. Also, Active Managers don't have a great track record. Don't believe me? Read this (from some guys who won Nobel Prizes) or this (which I referenced last week, if you are in a rush and want some Cole's Notes). If, after reading all that, you still want to roll the dice on an Actively Managed Fund, be my guest. It is definitely more
So how do you tie this back to the Investment Pyramid?
Well, there are Cash and Bond Indexes (Lower to Moderate Risk), Equity Indexes (Moderate Risk) and Emerging Market Indexes (Speculative). Pick an Index fund for each level, invest money to the percentage your Risk Tolerance/Profile suggests and you're done. Check out this cheat sheet to find what your Financial Institution offers and wow at the low MERs.
If you get bit by the Index Fund bug, here is an Entire Blog (the Canadian Couch Potato) dedicated to developing the best, low effort, high return, Index Fund Portfolio. You could also look into a newer investment vehicle: Exchange Traded Funds (ETFs). ETFs are even-lower-MER funds that trade on stock exchanges (which means you will pay a commission to buy them).
The "Be Your Own Investment Manager" Series:
Part 2: How Much and How Often to Invest
Part 3: Invest in Your Debt?
Part 4: Risk and Return
Part 5: Mutual Funds
Part 6: Simple Investment Options
Part 7: Saving for Retirement (RRSPs)
Part 8: The Colour and Psychology of Money
Part 9: Saving for Education