Diving into direct investing

Personal finance writer Gail Bebee and the winner of our investing quiz, whom we can identify only as Steve, are into their third week of mentoring. This time, Ms. Bebee writes him a letter detailing the joys and pitfalls of direct investing.

Dear Steve,

Direct investing accounts are custom made for people who want to take a more hands-on approach to investing. Instead of just buying funds, you can dig deep into the research offered by most discount brokers to select stocks, bonds, cash equivalent investments such as Guaranteed Investment Certificates (GICs) or even find the best place to keep any spare cash in your account.

Speaking of cash, you need to find a short term home for the $10,000 prize money sitting in your iTrade account without earning its keep. Fortunately, you can easily link your new account with a Scotia iTrade Cash Optimizer Investment Account. While it earns a paltry 0.75 per cent interest, the rate is competitive and it's a safe place to park your cash short term. Your homework this week includes opening one of these accounts and getting your prize money working for you.

Let's take a look at some lower risk asset classes that belong in most portfolios-Guaranteed Investment Certificates (GIC) and bonds.

A GIC is a very safe deposit investment issued by a bank or credit unions. They offer a guaranteed interest rate over a fixed period of time, usually from 1 to 5 years and are insured by the Canada Deposit Insurance Corporation or equivalent credit union organization. Discount brokers sell their own brand of GICs, and often those from other financial institutions. The latter GICs usually come with higher interest rates and are probably your best bet.

A bond is debt instrument. It is a way for institutions such as a government, utility or corporation to borrow money to buy new equipment, pay off existing higher interest debt, pay for an acquisition, etc. You lend the bond issuer a sum of money and it agrees to pay you fixed amounts of interest, called coupons, periodically and repay the amount borrowed (the principal) on a specific future date (maturity). Take a look at my GlobeInvestor article: for details on the ins and outs of investing directly in bonds.

Most discount brokers include an overview on bonds and other fixed income in their educational material. If you hanker after an exhaustive treatment of the bond world from the Canadian viewpoint, In Your Best Interest: The Ultimate Guide to the Canadian Bond Market by W. H. (Hank) Cunningham (Dundurn, 2008) is probably our best bet.

Moving up the risk spectrum brings us to stocks. A stock or equity is an investment, which represents a stake in the ownership of a corporation. Over the long run, stocks deliver higher returns than bonds or cash. Consequently, you'll likely want some stocks in your portfolio. To invest in stocks directly, you'll need to critically analyze each potential stock purchase.

Methods for analysing and picking stocks are legion. I've outlined the approach I use in . Stingy Canadian investor Norm Rothery follows the value investing school of stock-picking, a method pioneered by Benjamin Graham, a finance professor who profoundly influenced the methods of famed investor Warren Buffet. Pat McKeough, editor of several investing newsletters including the very sensible The Successful Investor, has his own proprietary system.

Some discount brokers offer detailed company information and research plus tools that allow you to select stocks based on such factors as company size and industry, sales and earnings growth, dividend yield and debt level. If you elect to go the stock-picking route, before clicking on the buy button for your first stock purchase, spend some time over several weeks reading widely on stock investing. Your goal is to find a stock-picking method, which is logical and practical for you to apply consistently on an ongoing basis. I have posted a list of information resources I have found useful. Here is a sampling of reading lists on investing from other Canadian financial web sites:

• The Dividend Guy blog - 20 All-Time Favorite Investing Books

• Bylo Selhi's web site - Selected Books of Interest to Independent Investors

• John Heinzl, Globe & Mail columnist -

I think you'll agree from the foregoing, that buying stocks and bonds does take some work. You'll need to decide whether you want to expend the time needed to select them yourself, or choose the simpler approach of buying funds.

Next week, in the final article of this mentoring series, we will marry together the various pieces of our discussion to produce an action plan for investing your $10,000 prize.

Gail Bebee is the author of No Hype - The Straight Goods on Investing Your Money. She can be reached at gbebee@gailbebee.com; her website is gailbebee.com