Investing in stocks is a popular saving strategy among Canadians; almost 40% own stocks. It makes sense when you realize that investing in stocks can help your savings grow much faster than putting your money in a savings account.
While cash savings accounts often provide interest rates that can struggle to keep up with inflation, stocks typically provide much higher returns over the long term. Over the last 15 years, the S&P 500 (the index of around 500 of the biggest U.S. companies) delivered an average annual return of 13.8%, while the S&P TSX (the index of the biggest Canadian companies) brought an average annual return of 8.76%.
Returns from bonds and guaranteed investment certificates (GICs) — considered “safer” investments — rarely come close to these kinds of levels. However, there are risks involved when investing in stocks. While stock markets typically deliver positive returns over time, they also experience periods of declines as well as increases.
The idea of seeing your investments lose value, combined with the challenge of finding suitable stocks to invest in, can make investing in the stock market seem daunting for beginners. In this article, we’ll explain what stocks are and how they work, how the stock market works, how to invest in stocks (and how to make money from investing in stocks), plus we’ll provide some tips to help you invest successfully.
What are stocks?
A stock is effectively partial ownership of a company: when you own stock, you own a piece of the company that issued the stock. Units of stock are called shares, and they provide several key benefits to shareholders:
- You may receive dividends (if the company pays them).
- You can sell the shares (hopefully at a profit).
- You can vote at shareholder meetings to have a say in the direction the company is taking.
Dividends are payments that companies make to their shareholders, usually paid out as a percentage of the value of the stock held, often monthly, quarterly or annually, depending on the company.
This can be a key way of making money from investing in stocks, and dividend income is taxed at a considerably lower rate than interest income (from GICs, savings accounts and bonds, for example). You could use dividend payments as income (particularly useful when you’re retired) or reinvest them, so your savings grow even faster.
The other key way of making money from investing in stocks is through capital gains. This is when you sell your shares at a higher price than what you paid for them.
Income from capital gains is taxed at a lower rate than both dividends and interest income; typically, you only pay tax on half of your realized capital gains (on amounts below $250,000 in any given year), and this tax only applies if you hold the stocks in a non-registered account. A realized gain is the profit you make when you sell the stock; you don’t pay tax until the stock is sold.
Registered accounts include government savings plans, such as Registered Retirement Savings Plans (RRSPs), Registered Retirement Income Funds (RRIFs) and Tax-Free Savings Accounts (TFSAs). For RRSPs and RRIFs, you only pay tax when you withdraw money from the account, otherwise, the money grows tax free. With a TFSA, all income grows tax free, and you pay no tax when you make a withdrawal from it.
What types of stocks are there?
When you begin looking into how to invest in stocks in Canada, it’s important to know that there are two key types available:
Common shares allow shareholders to vote at shareholders’ meetings and to receive dividends (if the company pays them).
Preferred shares do not normally allow for voting rights, however, preferred shareholders receive dividends before common shareholders and are ahead of common shareholders when it comes to a return of their capital if the company declares bankruptcy.
How to invest in stocks: getting started
To start investing in the stock market, you need to first open a brokerage account. This allows you to invest in stocks and other types of investments. Stocks are typically bought and sold on stock exchanges, such as the Toronto, New York and Shanghai stock exchanges, and you need a brokerage account to access them.
You can do this through a financial advisor, or you could go the DIY route and open an online trading account to buy and sell stocks. You first need to decide which kind of account you want to open: either a registered or non-registered account.
To buy stocks with your own money, you’ll need to open a cash account and transfer funds into it (you can do this with a lump sum or with regular payments).
There are several aspects of a brokerage’s services that you’ll need to consider before signing up with one of them:
- Convenience: does it make buying and selling stocks easy?
- Cost: this can vary greatly from broker to broker.
- Choice: does it offer a wide selection of stocks, including international and alternative investment options?
- Customer service: is their response to issues prompt and comprehensive?
- Caring: does it provide useful and actionable resources to help you make better investing decisions?
Once you’re ready to start investing in stocks, how do you decide which stocks to choose? This is the kind of question that can strike fear into the hearts of new investors. Research is essential before investing your hard-earned money in any company; it can help you to decide which kind of stocks you want to invest in, such as:
- Growth stocks: companies that are expected to grow at a faster pace compared to the broader market or their peers (such as Apple and Google have done, historically).
- Value stocks: these are typically more stable stocks that pay dividends and that are often underpriced compared to their true worth.
- Income stocks: these provide consistent and substantial dividends, which can act as an income source.
- Sustainable stocks: these are companies with a strong ESG (environmental, social and governance) performance.
Once you’ve decided on the specific stocks you want to invest in, the final step is to choose either a market order or a limit order.
With a market order, you’re saying that you want to buy these shares right away, at whatever price they’re currently trading at. With a limit order, you tell the broker to buy those shares when they hit a specific price. You then provide the brokerage with the ticker symbol of the company you want to invest in (for example, ENB for Enbridge and SU for Suncor), along with the number of shares you want to buy and your preferred order type.
So, once you’re up and running, there’s one final, ongoing process you need to set up: managing your portfolio. It’s not a good idea to buy or sell stocks on a daily basis; it can become costly and lead to poor returns (find out why trying to time the market is a bad idea). However, you do need to monitor your portfolio on a regular basis to make sure it still fits in with your goals.
For example, when you’re approaching retirement, it could make sense to reduce the risk in your portfolio by selling some of your stocks and replacing them with bonds.
Investing mistakes to avoid
New investors often make similar mistakes, especially when choosing stocks to invest in; these can lead to you losing a substantial amount of your investments. By avoiding these blunders, you’re likely to have a more profitable investing experience:
Ignoring diversification: diversifying your portfolio is designed to reduce your risks as much as possible by spreading out and maximizing the types of investments that you own. By owning a variety of stocks, from a wide variety of industries, asset types, and countries, you’ll reduce the risk level while still maximizing your chances of getting high returns.
Being too risk-averse: while everyone has their own particular level of risk tolerance, it’s important to accept some risk when investing in stocks. If you only focus on low-risk investment options, such as government bonds, the returns could be so low that your savings don’t manage to keep up with inflation. Conversely, if you only buy high-risk stocks, you could see your portfolio plummet in value if there’s a stock market crash. Balance is everything; it pays to maintain a moderate level of risk that will bring decent returns while protecting your savings.
Trying to time the market: attempting to buy when stocks are at a low and sell when they’re at a high seems like a great idea in theory but is almost impossible in practice. What often happens is that these kinds of investors sell when their stocks are on their way down and buy after they’ve already recovered. Staying invested in the market typically delivers better results than trying to time it.
Allowing emotions to dictate your decisions: both fear (when markets are volatile) and greed (when they’re riding high) can lead to poor decision-making when looking for stocks to invest in. Having a long-term investment plan that’s designed to bring you good returns over an extended time period can help you to avoid making these emotional and potentially damaging decisions.
Ignoring fees: there are costs to investing in stocks — which can vary greatly — and these can chisel away at your portfolio’s value. Make sure you’re fully aware of all the costs involved in buying stocks (such as trading costs and management fees) before you take the plunge.
Investing in stocks through mutual funds and ETFs
Mutual funds and exchange-traded funds (ETFs) provide investors with an easy and cost-effective way to invest in stocks that brings immediate diversification to their portfolios. They’re so popular that 61% of Canadian investors own mutual funds and 24% own ETFs.
A mutual fund is basically a collection of investment securities (typically stocks and bonds, and sometimes both) from many different companies. When you invest in a mutual fund, your money is pooled with that of many other investors, and a professional portfolio manager decides which investments to hold in the fund, based on the fund’s objective and the portfolio manager’s expertise.
Mutual funds can provide an excellent way for new investors to start investing in stocks because the immediate diversification reduces your investment risk, and an investment professional with years of experience makes the investment choices on your behalf (which also reduces risk). One survey found that 90% of mutual fund investors felt more confident about reaching their financial goals through mutual funds than any other investment type.
Investing in several mutual funds can bring you even greater diversification; you can invest in funds that cover specific industries, sizes of companies and geographical regions. You can also invest in more niche funds, for example, those which focus on minimizing volatility, companies that pay consistently high dividends or alternative investments (such as infrastructure and private companies).
Exchange-traded funds (ETFs) are very similar to mutual funds, insofar as they can also contain stocks from hundreds of companies. However, they’re traded on stock exchanges (and each has its own ticker symbol), so they can be bought and sold throughout the trading day, unlike mutual funds, which can only be traded at the end of the trading day.
From the point of view of simplicity, ease of diversification and reduced risk, mutual funds and ETFs can make a lot of sense for new investors looking to invest in stocks.
How to invest in stocks in Canada: don’t go it alone
As we’ve seen, there are several ways to make investing in stocks less scary. Understanding the different types of stocks available, making sure your portfolio is diversified, and investing in mutual funds and ETFs can all reduce the risk and fear factor of investing in stocks.
You can increase your comfort when investing in stocks even further by getting a professional on your side. Financial advisors typically have extensive financial training and years of experience in putting together investment portfolios for their clients that fit in with their risk tolerance level and their long-term goals.
IG Advisors go even further. They’ll get to know you and your unique situation (and that of your family) to create a comprehensive financial plan that covers every aspect of your financial life. This includes your investment portfolio, of course, but it also covers retirement planning, being prepared for the unexpected, managing debt, maximizing cash flow and integrating your mortgage strategy.
IG also has exclusive, top-performing investment products that are typically available only for large institutional investors. They’re designed to make investing in stocks less daunting by delivering attractive returns with less risk. Talk to your IG Advisor today about investing in stocks. If you don’t have an IG Advisor, you can find one here.
Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Advisor.
Mutual funds and investment products and services are offered through the Mutual Fund Division of IG Wealth Management Inc. (in Quebec, a firm in financial planning). Additional investment products and brokerage services are offered through the Investment Dealer, IG Wealth Management Inc. (in Quebec, a firm in financial planning), a member of the Canadian Investor Protection Fund. GICs issued by Investors Group Trust Co Ltd., and/or other non-affiliated GIC issuers.
