My Nerdy Life

Investing Part 2: ETFs and Making Your Money Work, So You Don’t Have To!

The best part about putting money into a diverse range of investments, is that they work 120+ hours a week, while you can sit back and work as little or as much as you want. The stock market never takes a vacation, never gets sick, never gets lazy, and never stops working! Previously, I teased you guys/gals with the power of compound growth and briefly introduced exchange traded funds (ETFs). In today’s post I’ll dive deeper and discuss easy and reliable ways to make your money work, so you don’t have to.

The typical person works about 40h/week, but did you know the Toronto Stock Exchange (TSE) only works 32.5h/week?

Wait, didn’t you just say investments work 120h/week?

Jeez, nothing gets past you guys does it, so let me explain. When you invest in ETFs like the iShares Core MSCI EAFE ETF (IEFA) International Index I mentioned last time, you’re not just investing in one particular country or region, you’re investing in the whole world. If you break out of your local bubble (I know, it’s a big scary world out there), you’ll see that every major financial centre around the world has their own stock exchange (e.g., New York, London, Hong Kong, Tokyo).

I hate to break it to all you flat-landers (see amusing video below), but the world is actually round! That means all the various stock exchanges operate in their own respective time zones, which means there’s always at least 1 stock exchange open (except for weekends/holidays of course). So while you’re tucked into your warm comfy bed dreaming about where you’re going to retire, puppies, traveling, drinking cocktails on beaches, and other fun things, somewhere, someone is buying/selling stocks to make you money.

International Investing

It’s important to not only invest in your local economy, but to diversify and include investments from around the world.

That seems like a lot of work, how am I supposed to invest in companies from around the world that I’ve never even heard of or understand?

The key to international investment is to let someone else do the work for you and invest in ETFs. In Canada it’s pretty easy to invest in either the Toronto Stock Exchange (TSE), the New York Stock Exchange (NYSE), or the NASDAQ, but outside of those it gets more complicated. Fortunately, ETFs allow you hold international investments and take care of things like foreign exchange fees and other complexities on your behalf (e.g., paperwork, foreign taxes).

ETFs are a fantastic way to invest in foreign companies that you’ve never heard or can even pronounce. Sure you have to pay a small management expense fee, but it’s well worth it in order to get exposure to the global markets. There are lots of options for international investing, some examples include:

The examples shown are from Vanguard/iShares. Both are large well respected companies that offer good options for international ETFs. You can also buy ETFs for specific countries (e.g., iShares MSCI Japan (EWJ)), but unless you have a good grasp of the economic situation in that country, this would be considered a higher risk approach.

USA Investing

If you’re in Canada, the USA could be considered an ‘international’ market, but it’s also quite unique and deserves it’s own section. Specifically, the USA is home to the worlds (second?) largest economy (China is neck and neck with the USA right now) with a GDP of over $18 trillion, which is equivalent to all of Europe combined! By comparison, Canada only has a GDP of $1.8 trillion. For this reason, most investors are wise to put the bulk of their money into the US market, as it has traditionally been the most favourable for business and has provided investors with the best returns.

Similarly to other international markets, Vanguard and iShares offer a number of options. Examples include:

Canadian Investing

Since the Canadian market is arguably smaller than the US, it makes sense to hold a smaller amount of your money in Canadian stocks. This reduces your risk and volatility as Canada has a heavy reliance on the energy and financial sectors. Examples of ETFs include:

 TD e-Series Funds

Technically the TD e-Series are mutual funds, but at around 0.5% or less, their fees are on par with many ETFs. The biggest advantage with the e-Series funds is that there are no transaction fees for making contributions. Personally, I hold the TD US Index fund in my Tax Free Savings Account (TFSA), and just continuously dump any dividends I receive into the fund. There are few different funds to choose from, and many mimic the ETFs mentioned above. You may notice that the fees can be higher than ETFs, but if you’re only making small contributions (<$1000) they can be a better choice than paying $7-10/trade when purchasing ETFs. The only catch is you need either a TD Canada Trust or TD Waterhouse account to purchase them.

Dividends

Dividends are without a doubt one of the key pillars towards attaining financial independence. The basic premise is that companies share some of their profits with their shareholders by giving you cash for every share that you own. Large reputable companies typically give dividends between 2-5% of the going share price, although some don’t give you anything, instead preferring to reinvest those funds into the company. For example, General Electric currently gives a dividend of 3.23% (or $0.92) per share, so if you own 35 shares they would give you $32.20 USD every year. It requires zero effort on your part besides owning the shares, and the best part is many companies increase their dividend payments every year. So not only do you get paid for doing nothing, but you also get a raise every year for continuing to do nothing! ETFs collect these dividends on your behalf and pass them on to you (usually monthly or quarterly).

Eventually you can build a portfolio of ETFs large enough to start bringing in some significant cash. For example, this year I’m on track to bring in ~$2500+ in dividends. The wise investor will reinvest those dividends in ETFs, which will lead to more dividends, that you can then reinvest again, and get more dividends…. and so on and so forth. The snowball effect can be extremely powerful, and is one of the main drivers behind compound growth.

One of the strategies for picking the best ETFs is to pay attention to the dividend yield. My favourite dividend ETFs target companies that consistently increase their dividends year after year over several decades (sometimes called ‘the aristocrats’). But, you must be cautious against only looking at the dividend yield, as typically ETFs that offer very high yields (>5%) tend to be very volatile and can’t sustain them for very long. It  should also make you wonder why the companies in those ETFs aren’t reinvesting more of their profits into building better businesses. The sweet spot is usually around 2-4% depending on the sector (e.g., technology/telecommunication tends to be around 4-5%). That said, there are some great companies that don’t pay any dividends at all. Not because they can’t afford it, but they rather reinvest the money back into the company (e.g., Berkshire Hathaway; the company of multi-billionare and investing legend Warren Buffet). So don’t judge an ETF purely based on it’s dividend yield (either high or low), but just keep it in mind as a consideration.

So here’s some of examples of ETFs that specifically target companies with dividends:

My Picks for a Model Portfolio

I should preface this by saying there’s an infinite number of combinations, justifications, and strategies for investing. I offer this model portfolio purely to give you an idea of how a total beginner COULD invest their money, but of course everyone’s situation is different, so it may not be appropriate for you. I am personally adjusting my portfolio to mimic this example quite closely.

I’ve allocated quite a bit to small/mid cap ETFs because historically they have outperformed the larger stocks typically found in the S&P 500. This portfolio would allow you to invest in thousands of companies around the world, and would provide long term stability to earn a reliable return (growth + ~2-3% dividend yield). Arguably, you could interchange these with some of the other options I’ve mentioned, but either way this type of distribution would give you a good start. I also snuck in a Bond ETF, which offers fixed, reliable, and stable income. It’s one of those things everyone should have in their portfolio, but often gets missed, especially by younger investors (like myself).

Idle Money

Since the goal is to have your money work for you, it’s best to avoid having idle money just sitting around wishing it had a greater purpose in life besides earning 1% interest (or less!) in a bank account. Assuming your other finances are in order, the easiest solution is to invest as much as you can, as soon as you can. This also means reinvesting your dividends, but if you have to pay $10/trade to buy ETFs, make sure it’s larger lump sums. I like to combine my dividends with my monthly contribution to minimize the impact of the trading fees.

If you opt for the TD e-series funds, you can make contributions >$100 with no transaction fees. They also have the added bonus of automatically reinvesting any dividends you receive from the fund itself. This is optional, but in my opinion advantageous, especially for smaller accounts to avoid having idle money.

Well that’s all for now folks! What other tips do you guys have for setting up an ETF-based portfolio?

If you missed it, check out the other posts in this series:

• Investing Part 1: $1 Saved is $1.07 Earned!
• Investing Part 3: RRSP or Non-Registered or TFSA, Where Should Your ETFs Go?

Disclaimer: I do hold some of these investments, but I do not receive any form of endorsement or compensation for writing this article. I was not solicited to write this article in anyway, and provide this information on a voluntary basis. I hold no formal financial accreditations, so please consult a financial professional and ensure you understand the risks before making any investment decisions.