One of the best ways to grow your wealth over time is through investing. If you’re hoping to build a tidy nest egg, achieve financial independence or meet other money goals, investing is likely your best chance of reaching your objectives.
Investing works especially well for long-term goals, such as college or retirement. With a long time frame, you have the chance to let time in the market work to your advantage, and to overcome setbacks and mistakes.
How to start investing: a beginner’s guide in Canada
In this guide, we’ll take a look at the basics of investing and how beginners like you can take their first steps toward making the most of their money. Below is a comprehensive, step-by-step guide to how beginners can start investing.
1. Choosing the right investing account
There are a number of different types of accounts that you can use as you start investing. Carefully think about your goals, and what you hope to accomplish. The type of account you choose comes with different advantages, so it’s important to consider what options are available.
- TFSA: A tax-free savings account is designed to allow you to grow wealth tax-free. You contribute with after-tax dollars, but the earnings won’t be taxed later. You can withdraw money at any time. However, you’re currently limited to contributing $6,000 a year to this type of account. Still, this can be a great option for saving for medium-term goals, as well as building long-term wealth.
- RRSP: Your registered retirement savings plan allows you to take a tax deduction now, reducing your overall taxable income. However, later, when you withdraw money during retirement, you have to pay taxes on the amount. For 2020, the RRSP deduction limit is 18%, to a maximum of $27,230.
- Non-registered account: It’s also possible to set aside money in a non-registered investing account. The money is more flexible here, and you have more options. However, you’re taxed on your gains as you realize them, so the earnings aren’t as efficient as you’d see with a registered account.
You don’t have to limit yourself to just one type of account, though. It might make sense to open a TFSA as early as possible and consistently contribute to the account to build your nest egg. Later, as you have other goals and your salary increases, you might add an RRSP and even a non-registered account. Carefully think about your overall strategy and when you might need the money as you decide which accounts to use — and how much to contribute on a regular basis.
2. Understand the difference between passive investing and active investing
Do you want to be an active investor or a passive one? Deciding what works for you is also about understanding the type of investing you’d like to do. This section focuses on the two approaches to investing.
Passive investing focuses on letting others do the heavy lifting. Robo-advisors, like Wealthsimple, put together a strategy on your behalf and make tweaks to your portfolio as needed. Usually, with this approach, index funds and Exchange-Traded Funds (ETFs) are used to achieve the desired asset allocation.
Active investing is more about you making the moves. You trade funds and individual stocks on your own, building and rebalancing your portfolio on your own. An online brokerage like Questrade can allow you to make your own self-directed trading decisions.
In many cases, active investing requires more time and effort. This can be smart for use in a non-registered account. For long-term accounts like RRSPs and TFSAs, though, it might be more advantageous to take advantage of more passive strategies that help you take advantage of the market over time, rather than trying to beat the market.
3. Identify your risk tolerance
Your risk tolerance depends on factors like time until retirement, how much money you can afford to have out of the running, and your ability to handle loss. If you have a high-risk tolerance, meaning you can handle a certain amount of loss because it will be made up later, you’re likely to lean more toward stocks and growth funds.
On the other hand, if you know you’ll need the money soon, and you don’t have time to recover from market downturns, you might invest more in income funds and dividend stocks.
4. Choose the right investments according to your risk level
There are several different types of investments out there. In general, the lower the risk, the lower your potential returns. However, with a lower-risk investment, you’re less likely to lose your money. Higher-risk investments come with better potential gains, but you also have a greater likelihood of losing your investment altogether.
- Bonds: Loans to an entity. You’re repaid the principal, plus interest.
- Guaranteed Investment Certificates (GICs): A timed deposit that offers a set rate of return, and the ability to redeem for the face value after a set period of time.
- Stocks: Represent a small portion of ownership in a company. If the company does well, you can sell your share for a gain.
- Exchange-traded funds (ETFs): A collection of investments in one bundle that trades like a stock on a stock exchange.
- Mutual funds: Collections of investments with a similar characteristic. If you purchase one share of a mutual fund, you have ownership in every company or other asset held in the fund.
- Real estate: Actual property, including homes, duplexes, commercial property and more.
- Futures: Bets made on the future prices of different assets.
- Options: The purchase of the ability to buy an asset at a set price at a future date.
- Cryptocurrencies: Blockchain-based digital mediums of exchange like Bitcoin, Litecoin, and others.
Why should I start investing?
Investing is one of the best ways to beat inflation and grow your wealth over time. In a traditional savings account, you aren’t likely to earn enough yield to beat inflation and maintain your buying power.
However, investing is a way to put your money to work on your behalf. If you invest wisely, particularly in medium-risk investments, there’s a good chance that you’ll come out ahead over time.
- Robo-advisors vs. online brokerages
- How to invest in stocks
- Choosing the right TFSA based on your risk tolerance