How to get started in the world of investment

 

With interest rates remaining at historically low levels for years now, a good number of investors are starting to wonder how they can make their nest egg grow to finance their long-term projects. Investing? Why not?

Investment 101

Most investors gain their first contact with the financial markets through buying mutual funds. According to figuresfrom the Investment Fund Institute of Canada (IFIC), close to five million Canadian households currently hold mutual funds, for a value of over $1,000 billion – or 31% of their total wealth. In fact, one household in three uses mutual funds to invest in the markets – without ever having purchased a single stock.

This is because mutual funds have three features that can ease the way into the financial markets:

  • Minimal investment
    In many cases, mutual funds can be purchased with an investment of $500. Pre-authorized contributions can also be set up, sometimes for as little as $50 a month.
  • Instant diversification
    By investing in a mutual fund, the investor acquires units of the fund, which is itself invested in a variety of stocks or bonds. These mutual fund units represent the investor’s share in all of the fund’s investments. Some mutual funds also invest in more than one asset class, which further increases diversification.
  • Professional management
    Mutual funds have asset managers who make the necessary trades based on predetermined objectives, or who directly replicate the market indexes.

In every case, the investor only has to make one decision: which funds to invest in. After that, his or her investment enjoys a degree of diversification and is professionally managed.

But mutual funds have another characteristic that sometimes flies under the radar: they could make it possible to invest in a more disciplined way.

Dollar-cost averaging

When you buy mutual funds on a monthly basis, a principle known as “dollar-cost averaging” comes into play. Just for illustrative purposes, here’s an example that demonstrates the principle. In the following scenario, we assume that the fund posted a return of 6% for the year.

As we can see, someone who spreads fund purchases throughout the year ends up buying units at different prices, thus getting more units for the same cost when the price is down and fewer when the price rises. The theory is that, since the prices are constantly fluctuating, the average purchase price could be lower than if the investor bought all of their units in one transaction. At the very least, the person runs less risk of buying all of their units just when prices are at a peak.

Not a panacea, but…

In reality, some studies tend to show that the impact on returns is more or less significant, depending on exactly how the markets behave after the investment has been made. However, dollar-cost averaging also offers a way of managing one important factor: emotion. No one enjoys watching a large amount of money melt away right after they invest it, due to a sudden market slump. In this respect, making a monthly investment would help to take emotion out of the equation and could even transform a downturn into an automatic opportunity to buy more units at lower prices.

There is still one major decision to be made before putting this dynamic into action: which funds should you choose and in what proportions? How should you structure your own portfolio using a variety of mutual funds, taking into account different factors such as your personal situation, your investment horizon and your risk tolerance? No doubt this is why, according to an IFIC survey, roughly 85% of investors rely on advisors – or mutual fund representatives, to be more precise – when buying mutual funds.*

*Mutual Funds are offered through Desjardins Financial Security Investments Inc.