A three-model guide on how to structure your investments.
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Where do you start?
You work hard, and your job takes up a lot of your time. Figuring out the best investments, accounts, and strategies might not be your top priority.
So, let's start with the basics. If you’re high-earning and trying to put money away for your future, contribute in this order: RRSP > FHSA (if applicable) > TFSA > non-registered (cash) accounts.
Now comes the fun part - investing that money.
The easiest thing to do is put your money in an S&P500 index fund, and forget about it for decades.
Some considerations here:
- Doing this means you have 100% equity exposure to US large-cap companies
- This makes sense if you have strong belief in: the USA, large cap companies, and the equity market
- If you take this approach, you are assuming that the returns you earn from the S&P500 are fair for the amount of time it would take your portfolio to recover if the market crashed - is this true?
- Just remember, you’re not really investing ‘passively’ - by investing in the S&P500, your fund managers are the S&P500 index committee (who do not manage investments)
The efficient thing to do is build a portfolio of passive funds and rebalance regularly.
- Pick 5-10 diversified passive funds with low correlation to each other. Make sure they have low cost (look at their MER ratio - it should be under 50 basis points generally)
- Do not use mutual funds because they generally have to sell their positions for cash, triggering capital gains tax. ETFs can exchange positions “in-kind” without needing to create capital gains
- You should rebalance the weights of these positions frequently to make sure you’re not creating excess risk. When you rebalance, factor in what the cost of rebalancing vs. not rebalancing:
- Costs of rebalancing: capital gains tax and any trading costs
- Cost of not rebalancing: increased risk and potentially lower expected returns
The smartest thing to do is do an assessment on your life situation, and build your portfolio around it.
Think about your goals:
- If you need to keep some money safe (e.g. for renovations), use your portfolio to invest in discount bonds with a matching maturity so the funds become available when you need them and avoid keeping your money in cash (inflation eats it away)
- If you want a change in lifestyle (e.g. upsizing your home), use your portfolio to invest in high-growth securities and hedge them with sell orders to prevent big losses
- If you have regular expenses coming up (e.g. kids going to private school), use your portfolio to create dividends and cover those expenses. This can also provide tax benefits if structured the right way by having it taxed at your child’s tax rate vs. yours
- You can read our whole investment philosophy here but in short - small and mid-cap companies have greater potential to outperform the S&P500 over the long-term (you can look at historical graphs to see this relationship). This risk needs to be managed by diversifying across asset classes and rebalancing frequently.
What’s the bottom line here?
- If you’re busy, don’t want to spend time thinking about goals, and don’t care to optimize your risk/return profile: use index funds
- If you’re busy, don’t want to spend time thinking about goals, and care a little about optimizing your risk/return profile: do research and make investments using passive funds or individual securities
- If you’re busy, want to consider your goals + tax implications, and also care to fully optimize your risk/return profile: use a professional advisor