I often get asked by friends and family about what stocks they should purchase and advice on why their investment went sour. Here is a much simpler way to invest: Exchange Traded Fund (ETF) investing.
Before we get into ETF investing, let’s talk about the current landscape of investing and why they are not the best. From personal experience, most people either:
- Save their money in a savings account;
- Invest their money through a mutual fund via an investor brokerage;
- Trade money on their own.
Debunking Traditional Ways of Investing
Saving Money in a Bank Account
It is the safest way to save your money as most banks are FDIC insured, which means even in the worst-case scenario that your bank goes bust, your money is still mostly safe. However, the interest your money accumulates is meagre, especially in our current low-interest-rate economy.
This may have been a good money-saving strategy a long time ago. Looking at this chart of Deposit Interest Rates in Canada from 1975 to now, interest rates have drastically decreased. This is due to financial derivatives, irresponsible monetary and fiscal policies, and increased economic competitiveness from other international economies.
Hence, interest saving accounts may have helped build wealth for our parents and/or grandparents. It is not the same for us today. However, I wouldn’t completely disregard savings account as some countries do have high-interest rates.
Investing Money Through a Mutual Fund
It is important to note that mutual fund financial products are primarily, if not entirely, promoted by big banks. Banks are notorious for their rapacious reputation and greed: their primary goal is to hit their sales targets and generate profits for their shareholders. Financial institutions have to succumb to pressure from their share-value and shareholders, and their clients’ building wealth is not exactly their biggest concern.
On top of that, fees for mutual funds are exorbitant, and a majority of people are not aware of the significant hidden fees they have been paying for. I recently had a friend show me their mutual fund performance in the past two years, and I was shocked at their bare minimum returns when the benchmark (S&P500) has performed well over the past decade (pre-COVID19 recession). Honestly, how is your fund underperforming when the entire market is doing well? Short answer: fees. The fees drag the portfolio down while the amount of money you have invested in is being siphoned off by the banks.
Looking at a quick overview of the fees TD Bank charges for their mutual funds, it is approximately 2%, which is extremely high. Except for the TD Balanced Index Fund – 1 at 0.89% and the only reason it is much lower is that it is classified as an index fund that tracks a specific index and is not actively managed.
If you look at the TD Balanced Growth Fund – 1 mutual fund, there are even more fees. This pre-authorized purchase plan is $25 and authorizes TD to invest money for you automatically.
Also, Barrons exclaims that Canada’s mutual funds are among the world’s most expensive at a 2% management expense ratio. This is a 2% expense fee per annum to hold your money even if they do not perform well. You have everything to lose in this policy, and the banks have everything to gain.
Trading Money On Your Own
This method is probably only for people passionate about this industry and is willing to put in the extra work. When you’re trading in the stock market, you are competing against many players – many highly educated and backed by millions of dollars to generate huge returns for their clients. It is possible to make money on your own, but it does take a lot of effort and, most importantly, time. However, the average person probably has their own jobs and lives to worry about.
How to Make Money with ETFs
Having gone over a few traditional ways of investing money, let’s look at a method gaining popularity by individuals in the financial independence retire early (FIRE) community and endorsed by Warren Buffet and Mark Cuban.
In a nutshell, an ETF is an exchange traded fund which is a basket of assets that trades like a stock. Prices are in real-time and can be sold at any point.
Many ETFs are out there, but this article will focus on the SPDR S&P 500 (SPY) ETF as it is one of the most popular. It tracks the Standards and Poors (S&P) 500 Index, consisting of the top 500 companies on the S&P index based on the market capital.
The track record shows that since 1927, the S&P 500 index has returned a 7.28% inflation-adjusted return. Despite experiencing specific periods of extreme highs and lows, this index performs consistently well in the long term. Based on the law of large numbers, this index has 90 years of sample points, which gives confidence that the expected mean should hover around a 7.28% value.
The best benefit of ETFs is low expense fees. For instance, the ETF (SPY) has an expense fee of 0.09% versus a 2% offered by most mutual funds.
How big of a difference does this make? Let’s assume you invest $1000 in SPY at the start of the year. At the end of the year, the financial institution will take $0.90 ($1000 * 0.9%) from you. However, with a 2% fee offered by mutual funds, you will be losing $20 ($1000 * 2%). That is a whopping $20 compared to $0.90. This fee also adds up each year.
ETFs benefit you in other ways such as:
- Diversification – the ETF contains various stocks. For instance, if the ETF focuses on the solar industry and one solar stock goes bankrupt, the other solar stocks will safeguard the ETF value.
- Liquidity – As the ETF trades like a stock, it is quite simple to sell the ETF, just a mouse-click away.
Ultimately, traditional ways of investing do not work for today’s generation of investors.
It is not possible to build significant wealth with a 0.05% savings accounts. Mutual Funds are not cutting it for investors due to having value extracted for subpar returns. Additionally, trading money on your own is just not worth the time and effort when most of us have our own lives to live.
Finally, it is your choice to invest in whatever you are comfortable with, but I would highly recommend looking into a low-cost, high-performing ETF.