The Moose of Wallstreet vol 1
A journey to financial independence and responsible investing in Canada
It’s 6 PM at your monthly happy hour with your coworkers, the conversation is getting dry and everyone is looking at their phones wondering how early its polite to leave, some more discreetly than others. Steven from HR is trying to lighten up the atmosphere and build a group dynamic, so he asks you what you like to do in your free time. You tell him you have a blog and you like cycling, nobody really cares… But when you say you do some investing on the side, everyone stops and stares. Half of the table is imagining the local race track junkie losing most of his money in the next few months, some think you are Rain man and the rest picture you with partying with strippers because they saw the Wolf of Wallstreet.
The truth is most people have no clue of what investing really is and that’s it’s pretty simple once you get the hang of it. It is one of the main vectors of financial inequalities in modern society. Chances are people who pick up investing early and do it responsibly will have a strong foundation for a comfortable retirement and those who don’t will have a higher likelihood of struggling. It isn’t the only path to a comfortable life, but it is one of the easiest. So, in this series I will give a few tips to those of who want to try picking it up. We’ll learn the basics, what to try to achieve, what to avoid and more. As the series goes on we will cover more advanced concepts. This week we will talk about account types and why you should avoid most mutual funds.
Chances are people who pick up investing early and do it responsibly will have a strong foundation for a comfortable retirement
Disclaimer, I will speak for Canada since it is what I’m most familiar with, I will not give advice on what to buy or sell. Invest what you are not afraid to lose at your own risk.
What account you should open
Self managed investment account: Basic investing account opened at a bank or online. You contribute money to it and are free to invest it as you see fit. Everyone over 18 can open one of these, you can trade even the riskiest products in this account. All realized gains or losses are subject to taxation for the current fiscal year, this means you pay taxes if you make money but you can deduce it from your income if you lose it. There is no minimum or maximum amount you can invest, but you will pay a 5–10$ commission every time you buy or sell something in the account. You can add and remove money from the account whenever you want. As you get more comfortable and if you are willing to take on more risk you can open a dedicated credit line on your trading account which means you will be able to spend more than what is in your account to purchase securities.
There is no minimum or maximum amount you can invest
Tax free savings account: TFSA in English or CELI in French. This type of account is new since 2009 and is a great opportunity for small investors since all capital gains from the account are tax exempt. There is a maximum annual contribution which changes every few years, but it is cumulative, which means you can currently contribute up to 57 500$ in your TFSA. If you remove money from the account, you cannot put it back in before the next fiscal year, however this only applies if you reached the maximum amount and taking money out increases your maximum contribution for later years. This account is the one you should try maxing first because not paying taxes is a big advantage, however you should avoid taking big risks in this type of account since you are not allowed to deduct the losses from your income. The maximum contribution currently increases by 5500$ every year.
All capital gains from the account are tax exempt
Registered Retirement Savings Plans: RRSP in English, REER in French. This category of account contains pension plans and self managed retirement accounts. Any Canadian under 71 can open one and contribute up to 18% of his taxable income from the previous year plus any amount that was allowed previously and hasn’t been contributed yet (called “carry-forward” contribution room). Any amount contributed is deductible from your revenue when you file for your income taxes, however you need to contribute before March 1st of the current year to be eligible for a tax deduction. You will pay taxes not when you realize gains but when you take the money out of the account, unless you are able to put back the exact same amount you took out during the same year. This means you should put money in this account: if your TFSA is reaching the maximum contribution, if you have high income and pay a lot of taxes or if you are receiving bonuses that are subject to higher taxation (commissions, taxable advantages, etc.). In a RRSP you should only contribute money you don’t plan on needing before retirement and you should be cautious with your investments.
Mutual Funds: These accounts are accounts that are managed by third parties, they can be a good option for novices, but you should be careful about fees and management expenses. Most pension plans are mutual funds since you hold a portion of a large pool of capital with your coworkers. Mutual Funds can also be RRSPs or TFSAs so don’t forget to keep track of your contributions. You should try and avoid fees, which is why I recommend taking care of your own investing if you can. That doesn’t mean all mutual funds are bad, some large firms like Vanguard, Fidelity or smaller investment platforms like Wealthsimple offer good services for cheap (under 1%) and some mutual funds do not charge commission fees when you buy or sell them which means you can contribute small amounts regularly without spending too much in fees. As a rule of thumb, you should avoid mutual funds with fees exceeding 0.5%, this disqualifies most funds offered by the big Canadian Banks (some of them have fees as high as 2.5%).
As a rule of thumb, you should avoid mutual funds with fees exceeding 0.5%
Why you should ditch your mutual fund
Two reasons: management expense ratio (MER) and fees. When you go to your local bank branch and you book an appointment with a financial advisor he will be quick to recommend you use one of the bank’s mutual fund, some will even pressure you and make everything look complicated until you cave in. You will also most likely be solicited by insurance company mutual funds. Because these institutions have a fiduciary responsibility they can’t “steal” your money, but they will eat up your investment over time, or at least greatly diminish your returns. To give you an idea here is a table taken from the government of Canada’s website on the impact of MER on a fixed amount invested for the same period.
With an average return of 5% per year on a 1000$ per year investment for 20 years, Fund A has a cumulative return on investment of 23.91%, compared to 46.35% for Fund B and 63.92% for Fund C. You almost triple your return on investment by reducing the fees by a measly 2.5% which really looks like it’s not such a big deal when glanced at quickly. Believe me, the banker WILL say it’s not much and that their returns are better than the competition.
Learn to manage your money yourself!
Here’s a link to a calculator provided by the Ontario Securities Commission (OSC) to help you compare different mutual funds and see the impact of management fees on your investment.
That’s all we’re going to cover this week, next time we’ll cover risk profiles and setting realistic expectations as well as an overview of basic investment products you can buy!