Ready to invest and put your money to work but you don’t know where to start and you are overwhelm with all there is to learn about investing?
It’s very understandable and there is no reason not to start investing while you learn all the details and nuances of investing. I know it’s a lot to process but it can be very simple to get started. My kids are doing it, so can you.
One assumption has to be made before building the ETF portfolio and it’s that you have 15 to 30 years to invest and let your money do the work for you.
Risk Tolerance & Emotions
When you start and you don’t have any prior investing experience, you encounter a lot of various financial guidelines all built around managing your emotions.
Investment risk is tied to your emotional response to a drop in value. How will you handle it? Sell everything when it’s down? That’s a bad move and the chart below shows you how markets recover and make new highs.
As you can see, no need to panic. You need to be patient. Just don’t put yourself in a position where you need to sell during a down turn. That’s what emergency funds is for and the cash bucket strategy when you approach or are in retirement.
Building an ETF Portfolio
Throughout my experience as an investor, returns matter – make sure to track your rate of return. Why? Because it can offset lower contributions over time and/or reduce your work years.
As such, market returns across the world is not really appealling. Not to mention that as a Canadian, it’s easier to understand North America’s economies and business practices and I like to invest in what I can understand.
Now, you might be tempted to focus on the Canadian stock market but I find it very limited. It’s predominently financials and energy / basic materials. On the flip side, the US stock market has a really good coverage of all sectors.
The first ETF to build a strong ETF portfolio is using an ETF that tracks the S&P500. You invest in the top 500 US companies operating around the world. The companies do the globalization for you. My go to ETF is the Vanguard S&P 500 Index ETF or VFV ETF.
Since inception, VFV has a return of 18.53%. It fluctuates but over time, it’s a potential return. Imagine what you TFSA can grow too with such a rate of return and that’s why VFV is in my portfolio as well.
| wdt_ID | Year | Yearly Limit | Cumulative | 5% Growth | 10% Growth | Dividend Earner | Spousal |
|---|---|---|---|---|---|---|---|
| 1 | 2009 | 5,000 | 5,000 | 5,250 | 5,500 | Not Tracked | Not Started |
| 2 | 2010 | 5,000 | 10,000 | 10,762 | 11,550 | Not Tracked | Not Started |
| 3 | 2011 | 5,000 | 15,000 | 16,550 | 18,205 | Not Tracked | Not Started |
| 4 | 2012 | 5,000 | 20,000 | 22,628 | 25,525 | Not Tracked | Not Started |
| 5 | 2013 | 5,500 | 25,500 | 29,534 | 34,128 | $41,742 | Not Started |
| 6 | 2014 | 5,500 | 31,000 | 36,786 | 43,590 | $52,820 | Not Started |
| 7 | 2015 | 10,000 | 41,000 | 49,125 | 58,949 | $56,307 | Not Started |
| 8 | 2016 | 5,500 | 46,500 | 57,356 | 70,984 | $70,200 | Not Started |
| 9 | 2017 | 5,500 | 52,000 | 65,999 | 84,034 | $78,900 | $13,308 |
| 10 | 2018 | 5,500 | 57,500 | 75,074 | 98,487 | $96,937 | $58,818 |
| 11 | 2019 | 6,000 | 63,500 | 85,128 | 114,986 | $129,467 | $82,596 |
| 12 | 2020 | 6,000 | 69,500 | 95,684 | 133,030 | $153,993 | $95,906 |
| 13 | 2021 | 6,000 | 75,500 | 106,769 | 152,933 | $181,601 | $113,194 |
| 14 | 2022 | 6,000 | 81,500 | 118,407 | 174,827 | $183,031 | $144,633 |
| 15 | 2023 | 6,500 | 88,000 | 131,152 | 199,459 | $199,648 YTD | $157,213 YTD |
| 16 | 2024 | 6,500 | 94,500 | 144,536 | 226,555 | ||
| 17 | 2025 | 6,500 | 101,000 | 158,587 | 256,361 | ||
| 18 | 2026 | 6,500 | 107,500 | 173,342 | 289,147 | ||
| 19 | 2027 | 7,000 | 114,500 | 189,359 | 325,762 | ||
| 20 | 2028 | 7,000 | 121,500 | 206,177 | 366,038 | ||
| 21 | 2029 | 7,000 | 128,500 | 223,836 | 410,342 | ||
| 22 | 2030 | 7,500 | 136,000 | 242,902 | 459,626 | ||
| 23 | 2031 | 7,500 | 143,500 | 262,923 | 513,838 | ||
| 24 | 2032 | 7,500 | 151,000 | 283,944 | 573,472 | ||
| 25 | 2033 | 7,500 | 158,500 | 306,016 | 639,069 | ||
| 26 | 2034 | 7,500 | 166,000 | 329,192 | 711,226 | ||
| 27 | 2035 | 7,500 | 173,500 | 353,526 | 790,599 | ||
| 28 | 2036 | 7,500 | 181,000 | 379,078 | 877,909 | ||
| 29 | 2037 | 7,500 | 188,500 | 405,906 | 973,950 | ||
| 30 | 2038 | 7,500 | 196,000 | 434,077 | 1,079,595 |
Deposit Strategy
For the first $50K or $100K, consider the following guidelines. At this stage, you are defining and refining your investing strategy – it’s the learning phase. Take it slow and invest once per month or per quarter.
Find a discount broker with free ETFs and low transaction fees. I personally try to keep my stock trade costs to 1% maximum – I invest $1,000 for a $9.95 transaction fee. Questrade has free ETFs and no maintenance fees now.
If you have all of the $50K ready, spread your purchases over weeks to avoid seeing your beginner portfolio go down and not being able to average down. There is nothing like seeing your money go down right after you buy and waiting for months to see it come back.
If you are just starting to save, put $50 or $100 a week and buy the shares of VFV when you have enough cash to cover the price of a share or two. Over time, it will build up and grow.
In this beginner ETF portfolio building stage, it’s not the time to become paralyzed by analysis. The intention is to leverage dollar-cost averaging. The markets move up and down and you can’t predict the movement. Just accept it and be ready to capitalize when it’s time.
What I have noticed is that investors investing in index ETF either feel one ETF is not enough, they are itching to branch out or they buy one index that invest in the world but when you break it down, that ETF invests in 6 different ETFs so you end up paying twice for MER (the one you own and the others – not always huge but know the MER).
Leverage The Investment Accounts
Depending on your personal situation, you will have access to different accounts. You may ask yourself if you should start with your TFSA or your RRSP.
One important concept of RRSP is the tax refund and it sometimes takes time to realize that the tax refund is not a travel bank but your retirement money. An RRSP allows you to defer taxes whereas a TFSA is completely tax-free.
The difference is important and will play a huge role in your retirement and how you withdraw money as RRSP withdrawals are income for the purpose of income taxes and a TFSA withdrawal doesn’t add to your income.
Both accounts play an important role in your beginner portfolio and have different tax advantages and contribution limits (see your TFSA contribution limits).
- TFSA or RRSP – Which account to start with?
- How to maximize your RRSP – Putting your tax refund at work.
- Learn the difference between profit and rate of return.
Beginner ETF Portfolio Example
The initial beginner ETF portfolio starts with 100% in one index – the S&P 500 Index. Let’s use VFV in this case.
Did you expect some fancy model? Boring works.
It’s imperative that you track your portfolio performance to understand your rate of return. I was disappointed with the basic performance metrics from the discount brokers and built a portfolio and dividend tracker to have confidence in the numbers.
What should you expect in terms of performance? Well, the first year can be a roller coaster with up and downs. There can always be short term noise in the markets but after 2 or 3 years, the growth starts to normalize.
More on Risks
What about risks? What is your risk tolerance? Generally speaking, the financial industry ranks the risk tolerance for investors as follow:
- Conservative – 70% bond target
- Cautious – 50% bond target
- Balanced – 30% bond target
- Assertive – 15% bond target
- Aggressive – 0% bond target
One way the financial industry is managing risk is by increasing bonds for a less aggressive portfolio. Here is an investment risk tolerance questionnaire.
University of Missouri – Risk Tolerance Questionnaire
What you will notice from the questionnaire is that it covers emotional responses to portfolio losses (real or not), your growth expectation based on potential loss as well as your confidence and understanding of the stock market.
Whatever may be your risk tolerance, starting with one index ETF will allow you to truly understand what you are capable of as long as you track the performance of your investments and compare.
Using an index ETF is still investing in equity and from a risk tolerance perspective, you are fully expose to equities but you take away the potential stock selection mistakes where you pick a stock for the wrong reasons and lose money.
- Portfolio Tracker – Truly see your rate of return
- Stress Test Your Portfolio – Know Why You Buy
- Investing Lessons – Learn from my mistakes after earning $70K in dividends
Income Tax Considerations
The account selection previously covered may be enough to get started with the basic on investment income taxes but there are fundamentals you need to know about the impact of income taxes on your investments. The choice of investments per account will become critical to keep more of your money.
There are five main buckets where income taxes apply to investments:
- Capital Gains – The tax investors pay on profits outside a registered account.
- Tax on Income – Interest from cash or investments (distribution) or payments from bonds fall into this category
- Dividend Tax – The preferential rate applied to eligible dividends
- Return of Capital – Income trusts and REITs do that and it creates a significant effort on the accounting front
- Foreign Dividend – The tax rate on foreign dividend.
While you may be keen on high yield REITs, taxes on REITs can be complicated in a non-registered account.