There are several myths that surround stock market investing. One common assumption is that investing in equities is difficult for the average retail investor and the other is you need huge amounts of capital to get started. However, there are several ways for retail investors to start investing in stocks and they can begin with even with a few hundred dollars.
Given the low interest rate environment, equities are an extremely attractive asset class right now. In fact, the S&P 500 has generated annual returns of around 10% for the last six decades, easily outpacing the inflation numbers in developed countries. Keeping this in mind, let’s see how you can build a solid portfolio and begin your investment journey with a small amount.
Pay yourself first
In order to start investing, you first require capital. It means you need to save a small portion of your earnings each month. As a rule of thumb, you need to ideally save at least 10% to 20% of your income after tax and allocate it towards investments. In order to achieve your long-term financial goals, it's imperative to save first and spend later.
Invest your tax refunds
There are several tax breaks you might be eligible for that can add up to a substantial amount. For example, you can save over $2,000 by using the Basic Personal Amount non-refundable tax break next year. In case you are eligible for the GST/HST tax credits, you will receive a few hundred dollars each year from the Canada Revenue Agency. The savings from these tax credits should be put to use by Canadians by investing them in the stock market.
Maximize your contribution limits
In case you earn $50,000 annually, you are eligible to contribute $9,000 each year towards your RRSP (Registered Retirement Savings Account). So, you can contribute around $750 each month towards this registered account as well as lower your tax liability.
Now, Canadians can also invest $500 each month or a cumulative amount of up to $6,000 in 2021 in a TFSA (Tax-Free Savings Account). So, a Canadian who earns $50,000 each year can invest up to a total of $15,000 in the above-mentioned registered accounts this year.
Automate your investments
It's always a good idea to automate your savings which will help you benefit from the power of compounding. You can start with small amounts of capital and then increase your investment contributions as you move higher up the corporate ladder. Today, there are several investment applications and web platforms that you can link to your bank account. For example, you can transfer 20% of your savings at the first of each month which will help you achieve financial freedom.
Invest in an exchange-traded fund like the S&P 500
The most famous investors including the great Warren Buffett strongly advocate investing in an exchange-traded fund or an ETF. This investment vehicle provides you with enough diversification that will lower your risk considerably. Generally, an ETF is passively managed and it tracks an index such as the S&P 500. It also means the management fees and expense ratios for ETFs are significantly lower than actively managed funds.
The S&P 500 is among the most popular indexes in the world and gives you exposure to the top 500 companies in the U.S. including Apple, Tesla, Microsoft, Alphabet, Facebook, and Amazon.
The S&P 500 has allowed investors to grow long-term wealth at a steady pace. While the stock market is volatile in the near term it is probably the best asset class that can consistently beat inflation rates over time.
So, you need to take a long-term view while investing in equities. Further, in case you have $1,000 to invest right now, it makes sense to invest $100 over a period of 10 months and benefit from dollar-cost averaging as well as the power of compounding.
For example, if you invest $500 each month for a period of 120 months in an asset that derives annual returns of 10%, your total savings at the end of 10 years will balloon to $103,276. This figure at the end of 20 years will rise to $262,848 and at the end of 30 years, your total investments will be worth close to a million dollars.
How can Canadian invest in the S&P 500
One Canadian ETF that tracks the S&P 500 is the VFV or the Vanguard S&P 500 Index ETF. The inception date of the VFV ETF was November 2, 2012. It has a management fee of 0.08% and its expense ratio is also the same. At the end of March 2021, this fund had around $4.25 billion in total net assets. Since its inception, the VFV ETF has generated annual returns of 18.2%.
Currently, the ETF is traded at a price of $90.28 which means you can buy one unit of the fund for less than $100. You can also enjoy a forward yield of 1.07% by investing in the VFV ETF. The dividends are paid every quarter which can be withdrawn or reinvested to purchase additional units of the ETF.
Another ETF that is part of Vanguard’s portfolio is the Vanguard S&P 500 Index ETF (CAD-Hedged) or VSP. The only difference between the VSP and VFV is that the former hedges its exposure to the Canadian dollar (CAD), insulating the investor from foreign exchange fluctuations.
For example, in case the S&P 500 gains 10% in the next year and the CAD appreciates by 4%, the VSP returns will be pegged at 10% while the VFV will return 6%. Alternatively, if the CAD depreciates against the USD, the VFV will return 14% in the next year while the VSP will remain at 10%.
The final takeaway
We can see how the stock market can help you create massive wealth and even accelerate your retirement if you have a disciplined approach towards investing. You need to take the first step by opening an investing account. Further, you need to automate your savings and keep it simple while letting the power of compounding work its magic.