Stock Market for First Time Investors
Investing on the stock market for first time investors can be very overwhelming, there are SO MANY stocks to choose from and also so many exchanges where you can get them from. As a first time investor is very important that you create a plan a stick to it.
The stock market should not be treated as a fancy lotto ticket where you are looking at every stock as the next Amazon with an over 6,000% share price increase since its IPO (Initial Public Offering). Although its very provocative the idea that for every $1 you invested in amazon 20 years ago you get $6,000 this is not very common, and you can loose quite some money if you don’t follow some basic rules!
If you are looking for a get rich quick scheme then by all means avoid the stock market! Investing is a marathon, not a sprint!
How much money do I need to start investing in the stock market?
People tend to believe that you need thousands and thousands of dollars to start investing but this is a misconception. You can start investing with only $1,000 which is the minimum that some brokers requires in order to open an account.
Of course, starting with more money is better, but everyone has to start somewhere and trust me, the adrenaline rush that you get when you buy your first stock will keep you motivated to save money to invest.
Think about investing as a snowball effect, the more money you keep adding and depending your ROI (return of investment) you will get considerable gains.
You don’t believe me? If you invest today $1,000, and keep adding $100 for a period of 10 years, assuming 10% yearly ROI you will have $22,739.50 in the bank, but you only contributed $13,000! that’s almost double your total investment!
What stocks should I buy as a first time investor?
If you are a new investor with little knowledge on the subject, I would strongly recommend that you avoid buying stocks until you have a system and buy instead an ETF that tracks the S&P500
What is this system?
The system is a set of rules to search, analyze, buy and sell stocks when certain variables are meet. This sounds really complicated but its a lot easier once you start learning the basics
Which ETF should I buy and what is the S&P 500?
The S&P 500 is an index that tracks the performance of the biggest 500 companies that are listed on the NYSE or NASDAQ and overall it has performed pretty good.
How good is good? Well, if you bought $1,000 S&P 500 Index ETF (VFV) on 2013, you would have a total ROI of 130% or $2,300 on the bank!
The idea of investing on an Index or an ETF that tracks an index is not new, but as Warren Buffett told to his wife, the easiest way to invest your money on the stock market is by investing in on index. Keep in mind that low risk brings also low returns and this is why some people prefer growth stocks and trading pennystocks (avoid it as a new investor!).
There are many ETFs that track the S&P 500, on the US Stock Market there is the iShares Core S&P 500 ETF (IVV) and Vanguard S&P 500 ETF (VOO) ETF’s .On the Canadian Stock Market there is the BMO S&P 500 Index ETF (ZSP) and the Vanguard S&P 500 Index ETF (VFV).
How to choose which ETF to buy?
For an ETF that tracks the S&P 500 I use the following criteria’s:
- How good it tracks the index
- What are the fees (MER)
- What are the dividends
- What is the average traded volume (you need it to be liquid!)
Let’s use the BMO S&P 500 (ZSP) and see how it performs against this criteria. Since inception on November 2012, the ETF has had cumulative performance of 144.31%, and the S&P 500 a 150.83%, with only a 6% deviation in 5 years is not that bad (VFV had 5% in the same period).
ZSP MER is currently at 0.10% while VFV is at 0.08% (another point for VFV). ZSP currently pays 1.71% dividends and VFV does 1.51% (big point for ZSP). Overall, you would have 0.18% more yield with ZSP over VFV
On the volume side, ZSP trades an average of $2.5M each day while VFV does $1.3M, this is another point for ZSP since you need your ETF to be as liquid as possible. Why you may ask? In the case that something happens to the market and you need to sell your ETF, you want to be able to get rid of it ASAP, and the only way to do it is if it’s being heavily traded on the market.
After analyzing all this criteria, I would favor ZSP over VFV at the time of writing this post. Do yourself a favor and use this criteria’s and see if there’s another ETF on the market that it’s currently better, don’t settle down for my analysis!.
If you are starting with an only ETF portfolio, I would suggest 20% cash and 80% ETF. I would also suggest researching for other types of ETFs like only US Stocks, emerging markets, international markets or even REITS in order to diversify your portfolio.
Start researching possibles ETFs for your portfolio, there are currently 3 major players on the ETF market (at least US and Canadian Market) which are:
If you find this approach way too confusing, you can use a Robo-advisor like Wealthsimple which will build a pretty well diversified ETF portfolio and handle everything for you! They have ultra low fees which are very transparent (unlike mutual funds!). With Wealthsimple all you have to worry is to make sure that you select the type of portfolio that you want and to make sure you are constantly contributing money to your account!
Hedged vs Un-Hedged ETFs?
Look at their ETFs options which usually share the same name, this way it will be very easy for you to compare them. You will probably noticed that there are hedged and un-hedged ETFs for the same index/benchmark. Hedging is the process of removing currency volatility from the fund and if you are buying a fund that holds stocks that are not on your local currency you will most likely be impacted by the currency fluctuations.
There are SEVERAL studies about which one is better and you can dig to it, but personally, I prefer hedged funds, since there’s no way to know which way the currency will go and removing the currency factor will be better on the long run
Since and image is worth more than a 1,000 words, below is the performance of the same fund hedged vs un-hedged
Below is the comparison between S&P 500 Index ETF (CAD-hedged) (VSP) on red vs S&P 500 Index ETF (un-hedged) (VFV) on blue. The purple line is the S&P 500 Index and the candlesticks are the USD/CAD chart. Click on the image to see it at real size
If you invested on both funds on 2013 and see the overall performance, you will be extremely happy to found out that the un-hedged fund had a ROI of 110% and the hedged counterpart only 65%. You might say, DEREK, are your crazy??!?! It’s almost twice the performance! Don’t you like money at all?!
Yes I do like money! You’ve got to understand that at on 2012 the 1 CAD was worth 1 USD and all the way to December 2016 the CAD to USD kept going down up to the point that 1.41 CAD was worth 1 USD. You see it? the ETF performance was due to the low performance of the currency and not to the fund itself
If you invested on both funds on December 2016 at the worst point of the CAD to USD the story would be VERY different. Click on the image below to see it at real size
Since 2016 the CAD vs USD has gotten stronger and on July 2017 1.26 CAD is worth 1 USD, and the total performance since 2016 for VFV (un-hedged, blue line) is 7.5% while FSP (hedged, red line) is 17.50%, twice over the performance.
If you take a close look to both images you will see that the hedged fund tracks the S&P 500 really close, and this is exactly what you need, that no matter what happens, your ETF is constantly following the performance of the Index that it tracks and nothing else! The currency exchange (un-hedged) defeats the purpose.
I hope this post cleared a lot of confusion regarding how to start investing and how to choose which ETF to buy using some simple but very effective criteria’s.
Got questions? Leave a comment! Let’s chat.
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