Simple Investing

It may seem like simple investing is an oxymoron.  How can anything as complicated as investing be simple?

Well as I mentioned before, I am not a Financial Planner so I am just sharing with you a simple approach to personal finance investing that makes incredible sense and delivers great results without a lot of risk.

I first learned of this approach out of Money Sense Magazine in an article called "The Couch Potato Portfolio" although, they also credit a gentleman by the name of Scott Burns for coming up with the idea. At any rate, here is a dead simple approach for growing your portfolio (or your 10% account) with low risk. It requires no knowledge of stocks or bonds or bizarre financial instruments and instead follows three basic principles of smart investing, namely:

  • Be highly diversified
  • Pay the lowest fees possible
  • Buy low and sell high

Here is how this works.

The first step is to open an on line discount brokerage through your bank or financial institution. This may be uncharted territory for you but if you use a bank machine or a debit card, this will not be an issue. I suggest using your bank only because they will already have some comfort with you as a customer. The key here is to make sure it is a discount brokerage because you are not going to be paying some financial guy for advice!

Transfer the money you want to invest into your discount brokerage account. The next step is to divide this money into two equal parts and then use half the money to buy an indexed mutual fund or exchange traded fund (ETF) that tracks your stock market S+P 500 or the TSX60 if you are in Canada and the other half to buy an indexed mutual fund or ETF that tracks the bond market. That's it.

Now it is important that you only invest in index funds because firstly, these funds generally have fees of about 0.4% instead of 2.5% for actively traded funds. This makes them very inexpensive to own. (2% over decades can add up to huge dollars).

The other thing to be careful of is to make sure that you are buying funds or ETFs that trade in your local currency, otherwise you are introducing exchange risk and why do that if you don't have to?

Now, once a year or ideally if you are adding funds monthly  - you are going to want to buy either the bond fund or the stock fund so that the balance between them remains at 50%. This is what creates a very, very low cost "Balanced Mutual Fund" and insures that you are buying low and selling high.

On this latter point, consider if you will that the S+P 500 drops by 10% say because of some banking crisis. All of a sudden you'll see that the stock portion of your savings is way lower than your bond portion so not only would you buy into the stock portion to raise it up, you may also consider selling some of your bond portion so you can buy more of the stock portion. In other words, the re-balancing of your portfolio ensures that you sell high and buy low.

The diversification comes into the approach because the index funds tracking the S+P 500 or the TSX60 automatically invest in the largest companies in either market. By buying the index fund, you are automatically investing in the companies that make up the index, in other words a pretty good mixture of the biggest corporations in either the USA or Canada.

Notice as well that this approach has nothing to do with picking the winners or timing the market or worrying about which sector might be taking off or dropping off. Leave that to the people who love to play with stocks and what not. You are just interested in relatively safe, low cost, highly diversified growth over time and that is exactly what this approach gives you. It’s simple, easily understandable and makes sense.

When Do I Buy Mutual Funds versus Exchange Traded Funds?

The main reason for choosing one vehicle over another is the cost of buying them. If you examine mutual funds carefully, you will want to make sure that you buy "no-load" index funds. This means that there is no commission for either buying or selling these funds although the mutual fund company will still charge you something like 0.5% in fees. There are often minimum amounts that you have to buy in mutual funds as well, but these are usually pretty reasonable, i.e. $100 increments.

So, if you are putting money in your 10% fund every month, using mutual funds will likely be cheaper in the short to medium term because it won't cost you any brokerage fees to buy or sell them.

An Exchange Traded Fund (ETF) is like a mutual fund except that it trades on the stock exchange like a stock. So you can buy 1 share or 1000 shares depending on how much money you have to invest. The downside is that the discount brokerage will charge you for each transaction which might be as little as $7 or $10 but could be $30. So, if you are investing $200 a month, you certainly don't want to pay $30 to buy shares in an ETF!

However, often Index EFTs will have a lower fee associated with them, of say 0.2% instead of 0.5% that the mutual fund may charge. So if you don't do a lot of trading or you have amassed a nice nest egg of a $100,000 or so then the ETF approach makes more sense. Either is fine so do what you are most comfortable with.

Other Variations On the Theme

The 50:50 split between an Index Stock ETF and an Index Bond ETF (or mutual fund) is a very conservative approach. This is often where people like to start because the risk is low but so is the possible reward.

Another approach that I like follows the same rules but instead of a 50:50 split, the percentage of your investment devoted to the bond ETF or bond mutual fund is the same as your age. For example, if you were 25 years old, then instead of 50:50 bond:stock mixture you would have 25:75 bond:stock mixture.

Why do I like this approach? Well the bond side of the equation is your "steady" return vehicle while the stock portion represents the growth part. When you are young, you can often tolerate more risk (the stock part) than when you are older. By shifting the ratio of bonds to stocks as you age, you are automatically reducing your risk as you grow older.

Keep in mind that this approach is exactly the same as the 50:50 only, the weighting is different depending on your age. Theoretically this should result in higher gains over time with slightly higher risk.

Another approach is to globalize your portfolio by dividing your cash into thirds and devoting one third to a bond index fund or ETF, one third to a local Stock Index fund or ETF and the final third to an International Stock Index fund that is normalized to your local currency. This last point is key, because you do not want to add the risk of currency variations into your mix.

There you go - a simple, low cost, highly diversified portfolio and investing management approach that forces you to buy low and sell high. Who could ask for anything more?

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