Stocks for Dummies
According to an annual BMO RRSP Study, while 77 per cent of Canadians have investments, most are not investing in stocks. In fact, stocks make up just 14% of the assets held in Canadian RRSPs and just under 30% of those held in TFSAs. There are many reasons people choose not to invest in stocks. It may take more time and effort, and there is certainly more risk, but the main reason people don’t invest in stocks, according to one recent JP Morgan Chase study, is that people don’t believe they have enough money to invest.
But stocks are a significant investment. Although there is the potential for risk, there is also a potential for greater profits. If lack of knowledge is holding you back, here is a quick start guide to stock market basics to help you get started.
Table of Contents
How Do Stocks Work?
The stock market basics are actually more straightforward than most people think. Most companies issue stocks to raise funds for future expansion or investment. You essentially purchase a small fraction of a corporation when you buy a stock.
Depending on the type of stock you own, you may be entitled to a proportional part of the profits and assets of the company. However, that does not mean that you physically own a certain percentage of the assets and can do as you want with them.
There are essentially two types of stocks: common and preferred. Common shares generally include voting rights that allow shareholders to vote on the election of the board of directors or the appointment of auditors, for example.
Preferred shareholders do not get voting rights. However, they do receive a share of any dividends the company declares. If the company ceases to operate for some reason, they receive priority over common shareholders when the company's remaining assets are sold off.
Shares are bought and sold in stock markets. In Canada, that includes the Toronto Stock Exchange (TSE), Montreal Stock Exchange (MSE) and the Vancouver Stock Exchange. There are also markets in the U.S., such as the New York Stock Exchange(NYSE) and many other countries around the world, where you can also purchase stocks.
Why Invest In Stocks?
Historically stocks have performed better than other investments and have risen steadily over time, so they are an excellent way to grow your money. Take, for example, the S&P 500, an index of 500 of the largest publicly traded US companies. It has returned 8% to 12% annually to the holders of the stocks on its list. In comparison, savings accounts currently offer less than 2% and even guaranteed income certificates (GICs) rarely return more than 3% per annum on funds locked in for five years. However, with those high rates of return, you also get more volatility. There are years when stocks lose significant value. And specific stocks may never gain at all.
How To Invest in Stocks, For Dummies
Understand your investment goals
Before you invest in stocks, be sure of your investment goals as well as your abil-ity to tolerate risk. While stocks are a great choice as a long term vehicle for growing your money, they are likely not suitable for shorter-term goals. You nev-er want to risk a situation where you must suddenly sell off your stocks at per-haps a far lower price than you might have if you had been able to wait. Your goals include five critical considerations:
- Purpose: What do you intend to do with the money you earn from your in-vestment? What do you hope to achieve with the investment?
- Time: What is the horizon of time you have available to achieve your purpose?
- Risk tolerance: How much variability can you withstand in the market?
- Assets: What is your current mix of assets?
- Portfolio Preference: Are you interested in a more aggressive growth-oriented portfolio? Or do you prefer a balanced portfolio? You will also want to consider your ethics and val-ues here. Do you want to avoid specific industries or others you wish to sup-port through your stock purchases?
Start investing with robo-advisors
Robo advisors offer low-cost entrance into stock trading. They are an excellent way to get started if you're new to investing. Essentially, robo-advisors are auto-mated algorithm-based online financial planners that invest on your behalf. You will be asked questions about your goals, current financial situation and tolerance for risk, usually through an online form. There is little to no contact with humans, and in exchange, you pay much lower fees for the service. The algorithm will in-vest your funds in a portfolio on your behalf that matches your goals and risk tol-erance. Two of the best-known robo-advisors in Canada are Wealthsimple and Questrade (more on these below).
Educate yourself about stocks
Whether you are planning to DIY on your stock purchases, leverage a robo-advisor or tap the expertise of a seasoned broker, you should do some initial re-search. Learn as much as you can about the intricacies of stock purchases. Find out as much as you can about:
- Patterns and trends in the market and economic cycles
- Current indicators for both markets and the economy
- The differences between market corrections and market crashes
- The variety of securities that are available to you
- Diversification strategies for your investments
- Terminology used in executing trades
- Methods to assess a stock's value
There are plenty of free educational resources available online to help you. Research the companies you intend to invest in. Start with their investor pages on their main website. Look at the historical returns for the company's stock over the past years and months and read any recent news reports on the company.
Explore self-directed investing
Self-directed investing accounts are available via banks and brokers, including online brokers. These accounts allow you to buy and sell stocks on your own and charge a fee for each trade. The amount charged can vary widely depending on where you house your account, so do some research to compare. You deposit funds with a self-directed account and then direct the online brokerage to buy or sell stocks on your behalf. These trades can take hours to several days, depending on the stock you are trading. With most self-directed accounts, you will also have access to a knowledge base and a dashboard where you can monitor the value of your stocks and the status of your trades.
Work with a financial expert
Working with a financial expert is usually an option only for high net worth inves-tors with investment accounts worth $250,000 or more. A financial expert will re-search for you and will help guide your investments according to your investment goals. There are free services available through banks and other institutions but be aware that financial experts tied to specific institutions that offer free finan-cial advice may earn a commission to sell their institution's financial products. In-dependent financial advisors and brokers will provide independent financial ad-vice for a fee.
Types Of Stocks To Invest In
There are several ways to invest in stocks, and each offers specific advantages and disadvantages. You can buy common stocks directly or diversify through mutual funds or exchange traded funds (ETF).
As described above, when you buy common stock, you essentially purchase part of a specific company, and you will get to share in that company’s growth. This can occur through a rise in the stock price, dividends or a stock split. Stock splits occur when a stock rises in value, and the company essentially divides each share. For example, if you originally owned 100 shares, you would now own 200 in that company. With individual common stocks, you can also take advantage of Dividend Re-investment Plans or DRIPs, which will automatically reinvest your dividends in additional company shares.
Mutual funds are another way to enter the stock market. These funds are a collection of stocks, so rather than purchasing stocks from a single company, you buy a fund that invests in several companies alongside a pool of investors. Mutual funds can only be traded directly with the fund company, and these trades are generally delayed a day, making it challenging to be an active trader with mutual funds. You will also pay relatively higher fees with mutual funds.
ETFs are a hybrid that provides the diversification of mutual funds and the flexibility of day trading, just like stocks. They are a basket of investments offered by a brokerage or robo-advisor. They might follow a specific market or index such as the S&P 500 or the Toronto Stock Exchange or focus on a particular industry or geographic region. ETF investments are traded just like stocks, so you can buy or sell when it suits your purpose. Some robo-advisors even allow you to purchase fractional ETF shares, expanding your access to specific markets.
Stock Types Compared:
|Common Stocks||Can buy on margin||Can take time and funds to diversify by buying additional stocks|
|Direct control of investment||Takes time and effort to research and track|
|DRIP plans available with some companies||Can expose you to high losses if company struggles|
|Mutual Funds||Instant diversification||High costs either to buy-in or sell|
|Access to professional investment managers||Less transparency in value|
|Potential for high returns||Tax considerations (particularly with capital gains)|
|Less flexibility in terms of buying and selling|
|ETFs||Diversification||Ability to trade easily could lead to over-trading and potentially harm investment returns|
|Lower costs than mutual funds||Difficulty in selecting from the wide variety of ETFs that are available|
|Can purchase fractional shares|
|Transparency in value – shares change throughout the trading day|
|Can buy on margin|
How To Pick Stocks, For Dummies
Choosing the right stocks takes practice and perseverance. Here are some essential metrics you should use regardless of your level of expertise.
First, look at the stock's trends in terms of earnings growth. Is it trending up or down? This isn't the only measure of a company's profitability, but it is a strong indicator.
How do the company's performance and strength compare to industry peers?
Debt to Equity Ratios
High debt shouldn't necessarily be a deal-breaker, but a company's debt to equity ratio should align with others in the same industry.
Price to Earnings Ratios
This measure compares stock price to company earnings and is available for most companies. It will give you an idea of the company's value.
Investigate how the company declares and distributes dividends.
Many companies are made or broken on the strength of their executive leadership. Consider reputation and track records for the executive leadership of any stock you want to purchase.
Are Stocks A Risky Investment?
Stocks are riskier investments, but you must weigh that risk against the potential for much higher profits with stocks. Still, although stocks have generally risen in value over the long term, there is no guarantee that they will gain for any individual stock. You won’t be guaranteed a profit which does make stocks a riskier investment than some other savings vehicles.
Who Should Invest In Stocks?
You should consider investing in stocks if you are willing and able to tolerate additional risk in return for the potential to earn much greater profits. Time and liquidity are also essential considerations. To improve your yield from your stocks, you need to leave your money invested and sell at an optimum time, not necessarily when you need the money.
For example, if you are nearing retirement and will need your investments to fund your retirement, stocks are not the best place for your money. On the other hand, if you have disposable income and plenty of time to recover from price drops or market corrections, stocks offer an unparalleled opportunity to grow your money.
Stock Trading Platforms
Several major banks and other investment firms have robo-advisor subsidiaries. Online brokers, such as Questrade or Wealthsimple Trade, are a great way to get started with TFSA stock trading or ETFs.
For investors who want to manage their stock investments on their own, online broker Questrade offers Questrade Self-Directed Investing. There are no account opening fees, no annual account fees, no commissions on buying ETFs and low commissions on stock trades. You can invest in various products from your trad-ing account, including stocks, bonds, ETFs, mutual funds, GICs and precious met-als. Questrade trading allows you to manage your transaction through both desktop and or mobile applications. They also offer an advanced trading platform for more savvy, advanced investors. To open a trading account, you must invest a minimum of $1000 in your account.
Questrade also offers a robo-advisor version of its investment services in Quest-wealth Portfolios. Questwealth Portfolios include a predetermined basket of ETFs. You can get a portfolio with a total fee of only 0.37%, including Quest-wealth's 0.25% management fee plus the MER of the ETFs held in the portfolio of 0.12%.
Like other robo-advisor options, Questwealth offers portfolio management, real-time balancing and access to agents that can answer your questions about your investments. They also include a mobile alternative so you can quickly check your investments.
Wealthsimple Trade is an online brokerage Wealthsimple's option for self-managing your portfolio. Through your no-commission Wealthsimple Trade ac-count, you can purchase fractional shares, stocks, bonds, GICs or other invest-ments. There is no commission for Wealthsimple trades on Canadian stocks and no account minimums. If you want to trade in stocks, you will pay a 1.5% currency conversion fee, but for $10 per month, you can get unlimited access to USD ac-counts, including access to ETFs and stocks with no conversion fees. You will only pay the conversion fee if you move money between your Canadian and US ac-counts.
Wealthsimple advertises their TFSA Wealthsimple Invest accounts as investing on autopilot. Essentially, these accounts invest your money on your behalf in a wide variety of ETFs. You simply choose your risk level. This type of account also automates other investment actions. You can automatically have dividends rein-vested, and the robo-advisor automatically rebalances your investments as the market changes. Wealthsimple Invest also offers access to several unique portfo-lios for socially responsible investors and Halal investing, among others. The man-agement fee for Wealthsimple Invest is 0.5%.
The Bottom Line
Stocks are an excellent investment option that offers potentially high returns, but be aware of risks with that reward. Start with a clear understanding of your investment goals, and then do your research on the market and the stocks you would like to invest in. Consider beginning your foray into the stock market by investing with a robo-advisor or with mutual funds or, better yet, ETFs.
Frequently Asked Questions
As a beginner investor in stocks, the best place to start may be with a mutual fund or ETF that provides you with diversification and expert management of your investment. However, if you want to invest in individual stocks on your own, try investing in com-panies that operate in an industry you are already familiar with. You could also invest in so-called blue-chip stocks from well-established companies with reliable revenues. Finally, look for value stocks using price-to-earnings ratios or other measures. These are stocks that are currently underpriced compared to their actual value.
Since all robo-advisors offer essentially the same product, a portfolio of ETFs, their performance is essentially the same. However, Wealthsimple is the best robo-advisor for beginners because it provides low or no-commission trading, few fees and no min-imum investment. That means you can begin your adventures in stock trading with as little as a few hundred dollars. Wealthsimple also provides an accessible, easy to un-derstand platform and an extensive knowledge base you can use for additional re-search.
As long as you have enough money to buy a single stock and cover brokerage fees, there is no minimum required to start investing. You can add additional stocks as you can afford to. However, most experts suggest that you should really have at least $200 to $1000 to get started in the best way possible. The more you have available to invest, the more investments you will have available to you and the more options you will have to diversify your portfolio.