A Realistic Investing Guide for Students and Those Just Starting Out
If you’ve managed to balance your budget, and even save some money while at university or work, you may be thinking about investing. That’s great. It’s never too early to invest. But what if you don’t know much about it? “One of the best ways to learn about investing can be through self-teaching,” says Janine Rogan, financial literacy expert and CPA. She recommends educational information, like books, blogs, or self-paced courses. A key lesson: Building the habit of investing on a regular basis will pay dividends in the future.
So why even hesitate? It’s time to dip your toe into the investing waters. Here’s how:
Let your goals drive your decision-making
Investing is about putting your money to work so you can reach your goals. Research shows that people who set goals are more likely to achieve them. Two factors can help determine the type of investment that is appropriate for your circumstances:
1) The length of time you have to reach your goals, also known as the investment time frame or horizon. As a young adult, you have decades ahead of you, which gives you a huge advantage.
2) Your appetite for risk, or your risk tolerance. You may be very comfortable taking risk, or you may be more risk averse.
Investing for the short- or long term—and anything in between
If you’re saving to go on a trip in a few months or planning to make a big purchase, a high-interest savings account is probably the best investment. Even though interest rates are low right now, the funds are completely safe and liquid, meaning you can “cash out” at any time.
If you have a medium-term goal of one to five years, you may consider buying a GIC (Guaranteed Investment Certificate) with a term that matches your goal. This could be a good option for something like saving for a down payment on a house or car. The longer the term, the longer your money is “locked in,” but the more interest you’ll earn. For example, a five-year GIC pays more than a one-year GIC, which is usually higher than the rate on a savings account. And with time on your side, you can let the magic of compound interest—earning interest on interest, plus the original principal—go to work for you.
If you’re investing for a goal that’s more than 20 years in the future, say a child’s education or your own retirement, you can choose investments with higher risk and higher potential returns. Stocks and bonds are good examples. Here’s a breakdown of traditional investments and how to tell which might work best for you:
Stocks orequities, represent an ownership stake in a company. The owners are called shareholders. Some stocks trade on public stock exchanges where their prices are determined by buyers and sellers.
Stocks pay dividends. Dividends represent a proportionate share of the profits of a company that are paid to its shareholders. You can also make money if you sell a stock for more than you paid (called a capital gain). On the other hand, if you sell it for less than you paid, you will have a capital loss.
Stock prices are unpredictable in the short run. You could double your money, lose your investment, or come out somewhere in between. For this reason, stocks are considered risky. You wouldn’t buy stocks for a short- or even medium-term goal because you wouldn’t have enough time to recover if the stock price fell drastically right before you needed the money.
Simply put, bonds are IOUs—debts issued by companies or governments. When you buy a bond, you earn interest, expressed as a percentage, for a specified “term.” Bonds, especially those issued by the Canadian government, are considered safe investments. But remember, lower risk means lower returns.
3. Mutual funds and ETFs
Mutual funds are baskets of securities. Rather than just owning one stock or bond, you can hold a variety of bonds, stocks, cash, or some combination, in a mutual fund. This strategy allows you to diversify your investments and reduce risk.
Exchange traded funds, or ETFs, are like mutual funds but they trade on an exchange the way stocks do. Mutual funds can be actively managed by a portfolio manager, or passively managed by simply following an index, like the S&P 500. Most ETFs are passive investments, meaning their goal is to mimic an index, which entails less buying and selling than actively managed funds. They are particularly good for young investors with lower amounts of money to invest. Finally, some ETFs and some mutual funds also allow exposure to areas of the market you may have a specific view on, such as certain industries, social causes, or asset classes.
4. Investment Accounts
You need a place to hold your investments. An investment account is like a bag that holds investments for a specific purpose. Some accounts, called non-registered accounts are basic and can be used for any goal. Other accounts, called registered accounts, are very specialized and are designed for a specific goal. For example:
- A Registered Retirement Savings Plan (RRSP) is used to save for retirement. Amounts contributed to your RRSP are tax-deductible and amounts earned are not subject to tax until they’re withdrawn. The amount you can contribute each year to an RRSP is determined in part by your “earned income,” or income from a job or a business. If you’re a student and don’t earn a lot of money, your RRSP contribution room may be low until you start working full time.
- A Tax Free Savings Account (TFSA) is very flexible in terms of what it can be used for, like a vacation, a big purchase or a down payment. You must be 18 to contribute to a TFSA and there’s an annual dollar limit. While contributions aren’t tax deductible, earnings and withdrawals are not subject to tax.
Now that you have a better understanding of the investing landscape—and this can’t be said enough—begin as early as you can even if you can’t afford much. “You don’t need a lot of money to get started with investing,” says Rogan. “If you’re looking at purchasing a low cost mutual fund, you can start with $25,” she adds. If you’re still not sure about how to get going, a financial expert can help you chart out a path to achieving your investing goals.