Types of Investments
Entering the investment world, you have to decide: do you want to be a passive investor or an active investor? Passive investments are investments that require little extra work or knowledge. Active investments are the opposite, requiring the investor to be hands-on and knowledgeable.
Active investments include things like Real Estate and small businesses. This requires more work than passive investing, even if you hire a property or business manager. Even day trading on the stock market is classified as actively investing. The profitability of Real Estate and small business investments depend on the individual deal, and the markets they occur in. They can be very good investments, but require a lot of knowledge and effort to find a good deal and operate it properly afterwards. One added benefit to these investments is the ability to leverage your money through low-interest loans, such as mortgages. While this does increase your returns on investment, it also increases your risk. If you want to invest in Real Estate, but prefer to remain passive, you can also buy the stocks of companies that specifically deal in Real Estate Investment. These are called REIT’s.
Passive investments require little work and are better for the more hands-off person. Passive investments include: Mutual Funds, ETF’s, HISA, GIC and Loans among others. Choosing an investment depends on how comfortable you are with risk. Typically, the higher the risk, the higher the potential rewards. Private loans and Individual stocks hold the most risk, HISA’s and GIC’s are low risk. Lets go into more depth into these investment vehicles individually.
High Interest Savings Account (HISA): Gives you a specified return for keeping your money in the account for a specified amount of time. Generally around a 2% annual return. HISA’s are similar to Guaranteed Income Contracts (GIC’s), which also provide a return for keeping money in an account for a specified amount of time. GIC’s, however, typically have more penalties for withdrawing the money before the end of term. Some even restrict you from withdrawing the money at all.
Stocks: A share of a company you can buy off the stock market using a stock brokerage such as Questtrade, tangerine, robinhood or many others. Even many banks have their own apps you can use. Depending on the individual stock, risk changes. Individual Stocks fall more under the active investing category because of the knowledge and research an investor should do before picking a stock. Groups of stocks can be bundled together in managed portfolios, however, to provide the most popular passive investments: Mutual funds and ETF’s.
Bonds – A bond is a fixed-income instrument that represents a loan, typically to the government or a corporation. Bonds are generally regarded as safe, lower-earning investments. Bonds are frequently recommended to lower risk in investment portfolios for people closer to retirement.
Mutual Funds: A group of different stocks that are sold together, typically from someone like a bank. Risk varies by each fund, typically less risk than an individual stock, but more than a HISA.
ETF’s: Similar to Mutual Funds, they are a group of stocks that are sold together. However, ETF’s are traded like individual stocks on the stock market. Like mutual funds, risk varies depending on the ETF. Typically less risk than an individual stock, but more than a HISA.
Loans: There is also ways to invest your money by loaning it out. These loans are typically for people that cannot secure one with a bank, and are therefore higher risk. With the higher risk, comes higher returns. Private loans can easily generate a return of over 10% per year. That is unless it turns out to be a bad loan that never gets repaid. Researching and choosing who to loan your money to is also a borderline active investing strategy over passive.
Stocks, Mutual Funds and ETF’s don’t have a guaranteed rate of return, however, the average return of the stock market has been ~7% per year. As previously mentioned, the most recommended and popular choices for passive investing are Mutual Funds and ETF’s. All-in-one funds are as simple as it gets, they contain thousands of stocks and a varying asset allocation depending on what you want whether it be 100% equities (stocks) or 50%/50% stocks/bonds if you want to play it safe. The vast amount of stocks they have also make them very diversified, so you don’t really have to worry about investing into anything else.
Dollar Cost Averaging (DCA): Dollar Cost Averaging is an investment method for things like stocks, ETF’s and Mutual Funds. It is very popular for two reasons. The first being is that it is already the most natural way to invest, and the second being that it helps to lower risk. The basis of dollar cost averaging is that you buy into investments consistently over time. This means if there is a big drop in value, as you continue to buy into the investment over time you will actually have gains by the time the investment reaches its original value position. Why is this a natural way to invest? Investing your extra savings when you get paid is a common thing to do, and this is also dollar cost averaging. For people who used DCA after the 2008 crash, it took them considerably less time to get back to a breakeven point than someone who did not continue to contribute to their investments.
Does this mean if I receive a large lump sum (like an inheritance for example) I shouldn’t invest it all at once? Yes and no. As with everything investing, it is all about your comfort level with risk. The faster you buy into the market the higher the risk. Most years this added risk also leads to increased rewards, but if luck is not on your side it could also be a year with a correction that takes you years to breakeven from. For those with a shorter investment horizon (retirement is coming soon) that received a life changing amount of money, I would definitely suggest an initial buy in of less than 50% of the sum. If your DCA plan is going to take a long time to fully invest (a year or more), consider also using lower risk/lower return options at the start such as bonds or HISA’s for a portion of the fund. This is a better alternative than having a ton of cash you have no short-term plans for sitting around and not gaining anything.