To be a successful investor, you don't need to trade frequently, take a lot of risk or try to time the market's ups and downs.
In fact, you shouldn't be doing any of those things. For most people, building wealth is a long-term process that requires, above all, patience and commitment. If you do a lot of little things right – and let time and compounding do the heavy lifting – you will ultimately be rewarded.
Today, in the first instalment of a two-part column, I'll be focusing on some of these little things all investors should do to improve their chances of success. In the second instalment next week, I'll be discussing some common bad habits that can sabotage investors. What follows are just some basic steps that will greatly enhance your financial health in the long run. Experienced investors will know most of them, but it never hurts to be reminded.
Live within your means
People who look and act rich aren't necessarily the real deal. They may be financing their extravagant lifestyles with debt and hefty lease payments. While borrowing and spending may feel good in the short run, ultimately it constrains people's financial choices and can have devastating consequences if they face a crisis such as a job loss, health problems or divorce. A better alternative – both financially and spiritually – is to spend less than you make and invest the difference in a conservative portfolio of stocks, mutual funds or exchange-traded funds that grow in value over time and pay you a rising stream of dividends. True financial freedom comes from living within your means and not being beholden to anyone.
Contribute to RRSPs, TFSAs and RESPs
Haven't heard this advice before, have you? But are you actually doing it? The beauty of registered retirement savings plans and tax-free savings accounts is that your investments grow tax-free. So, if you have sufficient cash available, you should max out contributions to both. If you need to choose one, the TFSA may be the better option because – unlike with an RRSP – withdrawals are tax-free and contribution room is restored the following year. If you're a parent, contributing to a registered education savings plan is a no-brainer because the government kicks in a 20-per-cent bonus in the form of the Canada Education Savings Grant, which is worth up to $500 annually a child (assuming you contribute $2,500) to a lifetime CESG limit of $7,200.
Keep your investing costs low
Paying a couple of percentage points in investing costs every year may seem like peanuts, but over a few decades it can have an enormous impact on your returns. Let's say you have $100,000 to invest and you can choose either a broadly diversified index fund with a management-expense ratio of 0.5 per cent, or a mutual fund with an MER of 2 per cent that invests in largely the same securities. Assuming the stock market returns 8 per cent annually, the index fund would grow to about $610,000 (before taxes) after 25 years, whereas the higher-cost mutual fund would be worth about $429,000 – a difference of $181,000. By keeping your costs as low as possible, you'll be doing yourself a huge favour in the long run.
Reinvest your dividends
I say this so often people must get sick of hearing it, but reinvesting dividends is one of the secrets to getting rich because it harnesses the power of compounding – one of your biggest allies as and investor. There are different ways to reinvest dividends: You can buy a mutual fund that automatically reinvests distributions for you; enroll your stocks in a dividend reinvestment plan with your broker; sign up for the DRIP with your company's transfer agent (which takes more work but lets you accumulate fractional shares); or just let your cash accumulate and then decide what to buy. Each approach has advantages and disadvantages, but the important thing is to reinvest your dividends so that your money is working for you.
Learn to live with volatility
A bear market is coming! I don't know when, mind you, but I can guarantee it will happen sooner or later. When it does, there's no reason to freak out. Volatility and bear markets are a normal part of investing; they are the price you pay for the solid long-term returns the stock market delivers. If you invest in strong, profitable companies that can endure recessions, bear markets and assorted financial crises, you'll be less likely to panic when the market goes for a belly-flop. In fact, that's often a good time to buy more. (For examples of the stocks I invest in, see my Strategy Lab model dividend portfolio online at tgam.ca/divportfolio). Staying focused on the long run – and doing lots of little things right along the way – is the surest way to build wealth.