How to start investing: a beginner's guide
Tom Drake
One of the most effective ways to grow your wealth over time is through investing. Whether your goal is to build a substantial nest egg, achieve financial independence, or meet other financial objectives, investing provides the best opportunity to reach those goals.
Investing is particularly beneficial for long-term objectives like college savings or retirement planning. By having a longer time frame, you can leverage the power of compounding and overcome setbacks or mistakes along the way.
How to start investing: a beginner’s guide in Canada
This guid is designed to help beginners like you understand the fundamentals of investing and take their fist steps towards maximizing their financial potential. Below, you'll find a step-by-step approach to getting started with investing.
1. Choosing the right investing account
When starting your investing journey, it's important to carefully consider your goals and what you aim to achieve. Different types of investment accounts offer unique advantages, so it's crucial to explore the available options.
- TFSA: A Tax-Free Savings Account allows you to grow your wealth tax-free. Contributions are made with after-tax dollars, and the earnings are not taxed when withdrawn.You have the flexibility to withdraw funds at any time, with an annual contribution limit of $6,500 (for 2023). This account is suitable for medium-term goals and long-term wealth accumulation.
- RRSP: A Registered Retirement Savings Plan provides a tax deduction on contributions, reducing your overall taxable income. However, withdrawals during retirement are subject to taxation. In 2023, the maximum RRSP deduction limit is 18%, to a maximum of $30,780.
- Non-registered account: Additionally, you can consider setting aside funds in a non-registered investing account, offering greater flexibility and options. However, gains realized in this account are subject to taxation, making the earnings less tax-efficient compared to registered accounts.
You don’t have to restrict yourself to a single account type. Consider opening a TFSA early and regularly contributing to build your savings. As your goals evolve and your income grows, you can also consider adding an RRSP or a non-registered account. It's important to carefully plan your overall strategy, taking into account when you may need the funds and determining the amount to contribute regularly.
In general, RRSPs are more suitable for high-income earners saving for retirement, a first home, or education. TFSAs can be advantageous for low-income earners and individuals saving for short-term goals.
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.
Wealthsimple Details
For three consecutive years, we’ve selected Wealthsimple Invest as our best robo advisor, and the reasons are quite clear.
Driven by a belief in passive, diversified investing, Wealthsimple Invest allows you to build a custom portfolio based on your risk preference while charging a low management fee.
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.
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 such as time until retirement, available funds, and ability to handle losses. If you have a high-risk tolerance and can recover from losses, you may lean towards stocks and growth funds. On the other hand, if you need the money soon and cannot afford significant losses, investing more in income funds and dividend stocks may be more suitable.
4. Choose the right investments according to your risk level
There are different types of investments available. Generally, lower-risk investments offer lower potential returns but are less likely to result in losses. Higher-risk investments offer better potential gains but come with a greater likelihood of losing your investment.
Low-risk investments
- Bonds: Loans to entities where you receive the principal amount plus interest.
- Guaranteed Investment Certificates (GICs): Timed deposits that provide a set rate of return and can be redeemed for the face value after a specified period.
Medium-risk investments
- Stocks: Represent ownership in a company. If the company performs well, you can sell your shared for a profit.
- Exchange-traded funds (ETFs): Bundle of investments that trade like stocks on a stock exchange.
- Mutual funds: Collections of investments with similar characteristics. Owning one share of a mutual fund provides ownership in all the companies or assets held in the fund.
- Real estate: Physical property, including homes, duplexes, commercial property and more.
High-risk investments
- Futures: Speculative bets on the future prices of various assets.
- Options: The purchase of the right to buy an asset at a predetermined price in the future.
- Cryptocurrencies: Blockchain-based digital mediums of exchange like Bitcoin, Litecoin, and others.
Why should I start investing?
Investing is one of the most effective ways to outpace inflation and grow your wealth over time. Traditional savings accounts typically don't provide enough yield to keep up with inflation and preserve your purchasing power.
By investing wisely, especially in medium-risk investments, you can make your money work for you. This increases the likelihood of achieving favourable returns in the long run.