Investing is not my favourite topic, you guys know that. However, I’m a money blogger and investing is a vital part of managing your finances.
The last couple of months have been loony-tunes when it comes to the stock market. December sucked, January didn’t. And that’s precisely why I had an itch to talk about investing now. Investing risk and market volatility are one of the main reasons I hear for people not investing their money. I get it, watching the value of your portfolio take a nose dive is terrible.
Saving vs Investing
Saving money is great. In fact, it’s more than that; it’s essential. But saving money is not investing.
Saving money is the act of setting money aside for the future. Investing is attempting to grow that money, so you have to save less of it in the long term. Saving a million bucks is very cool, but saving $1,000 a month for 30 years and having it grow to over a million bucks is a downright miracle. Or just the power of compounding, but you get my point. Every dollar your savings grow is one dollar less you have to save.
What does that mean? Instead of keeping your savings in a ‘savings’ account, you want to step things up a notch and invest the money in the market. A typical bank will pay you less than 1% to keep your money in a high-interest savings account. That’s not a bad option for your emergency fund or short term savings but isn’t good enough for long term goals. If you are looking for a high-interest savings account, I recommend the EQ Bank Savings Plus Account. Their current rate is 2.3%*, and you can set up an account for free.
In comparison, the S&P/TSX Composite Index (the most common benchmark for the Canadian stock market) has earned an annual average of 7.9% over the past decade.
What does that look like in real numbers…
$1,000 in a savings account earning 1% would be worth $1,105 after ten years
$1,000 invested earning 7.9% would be worth $2,139 after ten years
I’ll take option two, please! It’s not quite that simple, but you have a much better chance of earning more with your money in the market than you do by keeping it in a savings account.
Keeping your money 100% secure may sound incredibly tempting, especially when the markets are as volatile as they have been recently.
The issue is that the rate of return you’ll earn on a 100% secure investment like cash or GICs can actually mean a loss in purchasing power. Prices go up over time; we know this. Groceries, gas, lattes, etc. are more expensive now than they were ten years ago. To buy something worth $1 in 1986 (the year I was born), would cost you $2.24 in 2019.
Over the past ten years, inflation in Canada clocks in at 16.48%. That’s an average of 1.65% per year.
If the rate of return on your investment isn’t outpacing inflation, then I’m sorry, but your 100% secure investment is actually losing you money.
The fear of losing money is the most common reason why people aren’t investing. Lack of knowledge is up there too, but loss is the big one.
If you’re in that boat, you’re not wrong to be concerned. A significant drop in your investment value will hurt, and no matter how young you are, it will set you back. But I’m talking about a SIGNIFICANT drop in value, think a 20% or more loss in a year. If you’re a millennial like me, then this would be what your parents were freaking out about in 2008. That year the TSX was down 35%. Ouch.
There is always going to be a risk when investing, but you can decrease the risk by avoiding extremes. We already talked about the risk of super secure investments; those are your low extremes. At the high extremes, you have investments like options, futures, penny stocks, leveraged funds, etc. Very few of us have the knowledge (or risk tolerance) to play in those realms. Your best bet is to find a balance in between the two extremes. You’ll be able to ride slightly lower highs and avoid the lowest of lows. There is absolutely nothing wrong with being an average investor.
Volatility vs. Decline in Value
There are two kinds of risk when it comes to investing. The one we all think about is loss. That’s when your investments take a nosedive, and you start stressing.
The second type of investment risk is volatility. In the most basic terms, volatility is how much your investment will go up and down over a set period. Two investment may earn the same annual return over one year, but they might take very different paths to get there. As can be seen in the chart below, the blue and yellow lines represent two different investments. Both earn the same average return (the black line), but the blue line is significantly more volatile than the yellow. At the end of the day you end up in the same place, but the problem with volatility is it plays with your emotions. The more volatile the investment, the more likely you are to get over eager and buy when prices are surging, or sell when prices are in a freefall. It’s way easier to control your emotions when you’re not witnessing such big swings.
I’m not here to tell you exactly which investments to buy. There’s no ‘one size fits all’ option. The best advice I can give you is to know your own personality and how much risk you are willing to take. If a drop in value stresses you the heck out then look for lower risk options that will grow gradually without significant swings. Or, if you can check out and ignore your balances, then you can take it up a notch in the risk department. But remember, no extremes either way!
The worst thing you can do is not invest at all. The second worst is not acknowledging that investing is emotional. No matter how many times you are told to keep your emotions out of investing, it’s next to impossible in practice. Building an investment portfolio that works with your emotions will put you ahead in the long run, and keep you happy in the process.
*Interest is calculated daily in the total closing balance and paid monthly. Rates are per annum and subject to change without notice.
This post was proofread by Grammarly.