Investing can seem like a quagmire.
With so many mutual funds and stocks available, how do you determine which of those are right for you? And with so many advisers suggesting such different ideas, how do you decide on the optimal investing strategy?
I know firsthand how many options exist because until last year I helped sell stocks and bonds on Bay Street. In doing so, I quickly learned there are some crucial things that ordinary investors need to know about the world of finance.
For starters, middle-income investors are at a disadvantage.
A middle-income, two-parent family might have $100,000 or $200,000 invested in RRSPs and taxable investments, depending on their age. Wealthy families have many times more.
With that amount of money, the wealthy can afford to take risks. They can dabble in risky junior oil or mining names, especially if much of their portfolio is invested in dividend-paying, dependable stocks such as BCE Inc.
If a rich investor loses 20 per cent of a $1-million portfolio, it stings. But it's not the same as losing 20 per cent of the $100,000 you put aside for your kids' education and a bigger house.
Wealthy families win in another way, too. Because they have big accounts, they get preferential treatment from their brokers - more frequent calls, more research on companies they own or are considering buying, better chances of landing a portion of a hot new stock offering.
So what can an average investor do to level the playing field? Here are some tips:
Let the wealthy guys play the new issue game
Some new deals are safe to buy, like Canadian REITs and banks' preferred shares, but some are risky calls. In these cases, retail investors get the short end of the stick.
New issues usually have two order books: one for institutional investors; the other for retail players. Investment banks' sales desks directly call institutional portfolio managers to offer insight into how the deal is selling. Retail investors, however, are typically left in the dark.
That can work against retail clients because institutional players are, on average, more sophisticated. If they pass on the deal, there is usually good reason - maybe it is priced poorly or the growth potential is sketchy. Retail players are more inclined to make a guess during the banks' rush to get a deal sold.
Avoid this world unless there is a new offering for a stock you know a lot about. If an average investor submits a buy order and the big institutions walk away, he or she could be stuck with shares nobody wants. Conversely, in hot deals with strong institutional demand, order preference often goes to the bigger players, so average investors may not get any of the offering.
Keep an eye on fees
Mutual funds are usually touted as a good alternative for small investors, but funds have a catch: embedded management fees. If a fund earned 6 per cent last year and the fees are 3 per cent, you immediately halve your return. And, if you're investing outside a registered account, the remaining portion then gets taxed. The same applies to structured products such as the growing O'Leary Funds family, which can have even higher costs.
Instead, consider exchange-traded funds, or ETFs, that replicate the performance of a certain index, such as the S&P/TSX composite or S&P 500, and usually have fees of less -sometimes far less - than 1 per cent a year.
Middle-income investors who prefer to manage their own money using an online discount brokerage should consider costs, too. Most Canadian banks charge these customers $30 per trade, as opposed to $10 for wealthier clients - and buying and selling the same stock counts as two trades, not one. That may not seem like much, but it adds up if you trade frequently.
Don't forget bonds
Despite all the chatter about stocks, middle-income investors must also remember the importance of fixed-income products. Equity is sexy, but debt is what matters. That is especially true for the aging boomer population.
Debt is crucial for older investors because interest payments provide a stable income stream in retirement. Admittedly, this market isn't very attractive right now because Canadian government debt is offering minimal returns. To get more, look into fixed-income mutual funds that invest in corporate bonds that retail investors usually can't get their hands on.
Spread your money around
Diversify your portfolio. Make sure you invest in different industries and allocate your money among different types of assets. If you're approaching retirement, a plan that puts you in 10 per cent cash, 30 per cent equity, and 60 per cent debt is a good starting point.
If you have many years to spare before retirement and like stocks, look at those with healthy dividends, such as the Canadian banks and utilities like Emera Inc. Also, don't forget to inquire about any free money your employer might offer up. Some companies will match employees' investments in their employer's shares up to a certain dollar value, and even match any money they contribute to an RRSP.
In short, make the little things count because you probably can't play with the big guys. They're in a league of their own.
Plain vanilla, please
Investing rules are different for the rich and for the less-wealthy investor. If you are a low-to-middle income investor, you can still make good money by following plain vanilla rules. Some of them are:
1. Dividend stocks aren't boring. Shares of BCE Inc. are up about 23 per cent in 2010, and their dividend yield is just north of 5 per cent. The S&P/TSX is up 14 per cent year-to-date by comparison. You do the math.
2. Get time on your side. Compound interest is tried and true. Let it work for you. Invest $10,000 over 30 years, assuming a 5-per-cent annual return, and you end up with $43,219.
3. Get smart with your funds. Don't let advisers sell you something you don't need. A structured retail fund that invests in Canadian banks charges 1.05 per cent annually, and costs 5.25 per cent to buy in. BMO's Canadian bank ETF charges just 0.55 per cent annually.
Tim Kiladze
Tim Kiladze