I’m sure you’ve heard “You can get inspiration from everywhere”. But this was exactly the case this weekend. I got an Uber home from work and I quickly realized my Uber driver had all the personal finance
tea knowledge. It so happens that my new friend, John *real name withheld* is actually a financial planner and we spoke at length (well, for the duration of the ride) about different topics ranging from investing in the stock market, to the real estate market in Toronto. Safe to say that the 35 mins ride home was one of the best Uber rides I have taken in a long time. These are my key take-aways from my conversation with John:
- On selecting stocks to invest in:
Investing in individual stocks can be daunting and also takes a lot of research, that’s if you’re doing it right of course. This is in part due to the fact that there are hundreds of thousands of companies out there that you could potentially invest in. But John and I spoke about returns of stocks. For a stock you invest in to be actually profitable you need to earn a return that covers the following:
- Commission paid to brokerage (could be about $9.99 for each trade)
- Inflation – 1-2% in Canada and 2.5% in the US
- Management expense ratio (MER) if investing in funds – for actively managed funds this is between 2%-3% of the total value of the fund. It represents the management fee plus the funds day-to-day operating expenses and HST incurred by the fund.
- Tax: When you obtain a dividend or sell your investments and make a profit (gain) this is taxable (except in situations where the investments are held in tax free accounts). In Canada the tax rate on the gain is about 17.5% (35% marginal tax rate of 50% of the total capital gain)
So you can see that the expenses quickly add up which increases the lowest return you should expect to gain from an investment (especially in the case of actively managed funds).
Minimizing your cost of investing will positively impact your returns.
Although you cannot predict the performance of an investment or the inflation rate you can manage what you can influence – the expenses incurred to invest. This can be done by paying the least that you can in commission to your brokerage, and also choosing funds that have lower expense ratios. In addition, when possible hold your investments in tax-free savings accounts – TFSA (or ROTH IRA in the USA) or tax deferred accounts such as RRSPs (or 401K in the US) as this income from investments would be taxed when you are older and in a much lower tax bracket (if proper financial planning is done).
On getting advice from bankers
I let John know about the terrible experience I had with a financial adviser when I first tried to get started investing. I had $700 to invest and the banker let me know that I was too poor to invest (well not in those words but that is essentially what the adviser said to me). I took my poor self home, did lots of research online, selected the index funds I was going to invest in and went to another bank to invest. This time around I was telling the financial adviser about personal finance terms he had no idea about. I told him about dollar cost averaging* and why I would prefer to invest about $500 each month in my portfolio and grow this portfolio slowly but surely.
John and I agreed that while financial advisors have a lot of bias when it comes to giving financial advice (they get paid a commission based on the amount of sales they make on behalf of the bank) they do offer a few good services. One such service is the fact that they are pretty much obliged to speak with you regarding investing in the bank if you book an appointment (even though you only have $700 to invest like I did). In addition, they can give you a general idea of the stock market and help you assess your needs, time horizon and risk appetite – which is important information to know before you start investing. Based on this, it would be wise to take any advice you obtain from the financial adviser with a grain of salt and also come armed with information to ensure you are making the right decisions.
On mutual funds:
“I do not really like actively managed mutual funds” I told John. He let me know he has mixed feelings about them. One of these reasons is the information gap between financial planners/ banks/asset management firms and their customers. According to John, “It’s like people being in the dark”. Most people do not know the right questions to ask, they do not know what to look out for and they certainly don’t know when they are being ripped off (can we talk about the ridiculous 2.5% average management expense ratio for actively managed funds in Canada?). In addition, the financial system does not arm people with this vital information, in fact these companies feed off people’s lack of knowledge.
These are all sentiments I shared with John. It was at this point that I told John that I actually run a personal finance website for this same reason: To encourage financial literacy and provide people with the necessary resources to make sound financial decisions and take control of their finances.
That being said I don’t think mutual funds are necessarily bad (bar the high management expense ratios, also refer to point 1.) I just want people to invest in mutual funds after understanding WHY they are investing rather than just investing because your financial adviser told you too.
After speaking about actively managed mutual funds and the really high fees, I asked John what he thought about the rising trend of robo-advisors** in Canada. This is financial technology that has been in the US for YEARS but is just coming to Canada (Canada always finds a way to lag behind when it comes to financial technology). John thought it was pretty cool and innovative but he had some reservations especially surrounding the customer service experience. He shared that a robot can only give you one answer to your question, while speaking to an actual financial adviser will help you sort through your problems and customize your portfolio based on your needs and risk appetite.
I agreed with what he said to an extent. I agreed with the fact that advice provided could be limited however different robo-advisers provide different types of services to clients. So the problem of not getting adequately customized advice is not a huge issue. Some other pros of investing with robo-advisors are the lower fees of about 0.5% compared to the 2.5% MER for actively managed mutual funds. This is possible because robo-advisors mainly invest in passively managed funds and have limited real estate and personnel costs (as they mainly use algorithms and complex software to provide financial advice to customers).
Personally I’ve not ventured into investing with robo-advisors but I would likely do this in the near future.
*Dollar-cost averaging (DCA): This is a technique in investing where one buys a fixed dollar amount of shares/ units on a regular schedule regardless of the price of the stock. In this case, the investor purchases more shares when the price of the stock drops and vice versa. The premise of this is to lower the average cost of the share for the investor over time and eliminate the need to worry about timing the market.
**A robo-advisor is a service that uses specialized software to provide financial advice to individuals
Safe to say I learnt quite a lot from this conversation! I hope you did too. Here’s to having more interesting/ enlightening conversations with Uber drivers in the future.