I think we are finally on the last stretch of the Investing 101 Series.\u00a0 In addition to what we previously covered (compound interest, financial institutions, accounts, funds, fees, etc.) there’s a bit more terminology I want to cover before wrapping this sucker up. For anyone new here, check out the entire Investing 101 Series here<\/a>.<\/p>\n This is your breakdown of how your assets are allocated, meaning your split of stocks and bonds.\u00a0 Which stocks?\u00a0 Which bonds?<\/p>\n There is no right answer as to what your asset allocation should be.<\/p>\n Conventional wisdom is that if you are investing for the long term (10+ years) you should be aggressive and 90-100% in stocks and as you near retirement you would shift into more bonds, be it a 80\/20 or 60\/40 or 40\/60 split etc.\u00a0 Some people do not feel comfortable being 90-100% in stocks even if they aren’t planning to touch their portfolio for years and prefer to be 80\/20 or 60\/40 during their investing years.\u00a0 Some people suggest to take 100 and subtract your age and that should be the percentage of stocks in your portfolio.<\/p>\n The point is, your asset allocation is personal and something you need to decide based off your risk tolerance level.<\/p>\n If you’re 100% in stocks and you see your entire portfolio drop by 20%, knowing it will very likely <\/em>come back up in time (how long exactly? who knows), would you be comfortable with that? What about a 30% drop? Or even 40%?\u00a0 These types are drops have happened in the past and likely will happen again in the future.\u00a0 If you can’t stomach that, you may want some bonds.\u00a0 However, if you understand that you are investing for the long<\/span> term and a price drop in the middle of your investing time frame won’t impact you unless you actually sell it during that dip (noooooo), then you may feel more comfortable being heavily invested in stocks.<\/p>\n Again, it totally depends on both your risk appetite (can you stomach a drop and buy baby buy when the world is panicking?) and where you are time-wise in your journey (10+ years from retirement or less than 3 years from retirement).<\/p>\n Rebalancing refers to aligning your stock and bond portfolio back to it’s designated asset allocation over time.<\/p>\n Say your goal is to be 80% in stocks and 20% in bonds so 80% of the time you buy stocks and the other 20% of the time you buy bonds.\u00a0 If these two assets grew at the same rate, you would never need to rebalance.\u00a0 However, that is likely not going to happen.\u00a0 Some years your stocks may skyrocket and grow much faster than your bonds.\u00a0 This may shift you from an 80\/20 split to say a 90\/10 split as your stocks are performing better and are now making up a larger portion of your portfolio.\u00a0 Conversely, some years your stocks may tank and you end up seeing a better performance with your bonds.\u00a0 This may shift you from an 80\/20 split to say a 70\/30 split.<\/p>\n Rebalancing allows you to get your asset allocation back in alignment with your goals.\u00a0 If you are investing in tax advantaged accounts, rebalancing is quite easy.\u00a0 You can sell your over performing funds and buy the under-performing funds to get you back to your desired allocation without facing any tax implications as long as the net amount is the same.\u00a0 You simply sell the fund you are too heavy in, that will shift over to cash, and then with that cash you buy the fund you are looking for more of.\u00a0 Or you may have a rebalancing option within your financial institution that shows your current breakdown (as a percentage) and you can tell the financial institution what you want the percentages to instead be and it will do the shift over for you.<\/p>\n If you are investing in taxable accounts and don’t want to rebalance using your tax-advantaged accounts to easily get you back to your desired allocation, then the best way to rebalance is to purchase future investments in the under-performing fund to slowly build it back up to the allocation you so desire.<\/p>\n Note that if you are comfortable investing 100% in one fund, rebalancing is not needed as you will always be 100% in that particular fund.<\/p>\n There are some funds out there that do a bit of this legwork for you, but at a cost of a slightly higher fee compared if you did a more DIY investing approach.\u00a0 A lot of Robo Advisors<\/a> are essentially doing the rebalancing for you.\u00a0 Essentially, robo advisors have you fill out a questionnaire to try to help determine your desired asset allocation and will rebalance your portfolio to stay at that targeted amount.\u00a0 Same idea for a target date retirement fund<\/a> in the states except without the robo assistant, you select your fund based off your target retirement date.\u00a0 Or in Canada you could invest in VEQT<\/a> (100% stocks, 0% bonds), VGRO<\/a> (80% stocks, 20% bonds), VBAL<\/a> (60% stocks, 40% bonds). VCNS<\/a> (40% stocks, 60% bonds), or VCIP<\/a> (20% stocks, 80% bonds).\u00a0 These are much more hands off and take a lot of the thinking out of the equation for you.\u00a0 But again, at a slightly higher cost of course. Do the math to see if you would rather do it hands-on yourself or if you are willing to give up some of your gains to let it be handled for you by someone else.\u00a0 For a new investor looking to get their feet wet, these could be a great starting point.<\/p>\n In finance and economics, \u201cnominal\u201d refers to an UNADJUSTED rate or the change in value where as the term \u201creal\u201d expresses the value of something after making adjustments for various factors to create a more ACCURATE measure.<\/p>\n The rate of return is the amount an investor earns on an investment. The NOMINAL rate of return reflects the investor’s earnings as a percentage of the initial investment, whereas the REAL rate takes inflation into account. As a result, the real rate gives a more accurate assessment of the actual buying power of the investor’s earnings.<\/p>\n For example, if we say \u201cthe stock market has grown ~10% on average annually over the past 100 years\u201d – that is a true statement but it\u2019s the NOMINAL rate of return (10%). However, inflation has also existed over this timeframe and has averaged 3% annually over the past 100 years. So 7% is the REAL rate of return.<\/p>\n Another example is if we say \u2018hey if you invest $10,000 today and assume the stock market grows at 10% on average annually, then in 40 years you\u2019ll have $537,006 thanks to compounding interest\u2019. This is not a false statement but it\u2019s just missing another feature. Inflation. That $537,006 is the nominal value. That $537,006 in 40 years will NOT be worth what $537,006 is worth today. If you include say 3% annual inflation then you\u2019ll get the real terms of $163,114. This means that original $10,000 will show as $537,006 in your account in 40 years but it will be worth $163,114 in TODAYS dollars (aka what you can actually buy today with $163,114). So maybe a smaller older home in the Midwest? Not a larger home on the coast like $537,006 may imply.<\/p>\n Similar example would be how your grandparents would say \u201cback in my day bread cost 10 cents\u201d and now there is no way you can find a loaf of bread for $0.10. All commodities have increased in cost over time. Inflation eats at your buying power and when you talk in terms of REAL you take that into consideration.<\/p>\n As we’ve harped on in the past already, fees matter.\u00a0 A LOT!\u00a0 Understand how much you are loosing in fees each year.\u00a0 MER stands for Management Expense Ratio and is essentially another name for fees. The sad part about fees is that these are not explained well to the every day investor.\u00a0 And why would the banks explain these?\u00a0 This is how THEY<\/strong> get paid.\u00a0 Instead they are misconstrued to seem like a small menial number (1-2%) which doesn’t sound too bad on paper but when you look at the math of what 2% does to your portfolio over a 40+ year time horizon you’d want to punch your banker in the face trying to take that much money away from you. It’s honestly highway robbery.<\/p>\n Don’t believe me STILL?\u00a0 Check out all of these articles:<\/p>\n The list goes on and on.\u00a0 Sure, some portfolios with higher fees may out perform the ones with lower fees.\u00a0 But consistently, year over year over year over your entire investing time horizon?\u00a0 Likely not.\u00a0 And that’s what matters.\u00a0 Go read Beat the Bank by Larry Bates or The Little Book of Common Sense Investing by John Bogle if you want to read entire books about how fees will impact your portfolio in the long run.<\/p>\n So many people focus on their income.\u00a0 I’m not saying it’s not important, it definitely is, but what’s more important?\u00a0 Your net worth.<\/p>\n What do I mean by that?\u00a0 Someone making $40,000 and saving $5,000 per year is in much better shape than someone making $100,000 and spending all $100,000 – or even worse, spending even\u00a0more<\/em> than $100,000.<\/p>\n If you aren’t tracking your net worth you should be.\u00a0 At least annually.<\/p>\n Keep striving for that bump in pay, but don’t forget to pay yourself first and put that extra income to use.<\/p>\n Your savings rate refers to what proportion of your income are you saving.\u00a0 It’s a pretty simple concept, yet there seems to be many ways to calculate your savings rate. \u00a0Big ERN wrote an extensive post on the different ways<\/a> so I will send you over to his post rather than recreate the wheel.<\/p>\n My thought is, to each’s own.\u00a0 There is no right way.\u00a0 What’s important is that whichever way you calculate it, you track it.\u00a0 Month over month.\u00a0 Year over year.\u00a0 This really is the most important figure for you to optimize on your journey.<\/p>\n Try and optimize this and boost it a few percentages each year until you are saving over 50% with a goal to be in the 70+% club (if that’s your thang).\u00a0 Once your savings rate is 45%, you’re looking at less than 20 years to retirement.\u00a0 The math really is simple.<\/a> But again, don’t do this if it means you are depriving yourself along the way.\u00a0 Instead make money a game and gamify (sp?) your spending to figure out how to enjoy life by spending less.\u00a0 As you go along, you’ll figure out that a happy life does not need to be that expensive.<\/p>\n Personally, to calculate my savings rate I use my after tax income and add back in any pre-tax contributions I’m making towards my retirement accounts (i.e. 401k or Group RRSP that comes out of your paycheck) and I also add in any company match as that is essentially part of your pay from your employer.\u00a0 Any investments I am making counts towards savings.\u00a0 Any expenditures that depletes my net worth is an expense.\u00a0 Some people argue weather or not paying off debt (mortgage, student loans, consumer debt, etc.) counts towards your savings rate.\u00a0 You can argue all day of what counts and doesn’t – again what really matters is that you use the same consistent formula and see your savings rate go up.<\/p>\n Sequence of Returns Risk refers to the risk an early retiree faces at the beginning of their retirement when they start to withdraw from their portfolio.<\/p>\n The idea behind it is:<\/p>\n The problem is, these are averages.\u00a0 We all know that the market does not grow 7% every single year. Nor does inflation increase by 3% every single year.\u00a0 Some years the stock market may grow by 15%, others years it may only be 1%, or worse off there may be a 20% drop.\u00a0 Same goes for inflation but likely to a lesser degree.\u00a0 The stock market may average 7% returns annually and inflation may eat away 3% of your portfolio annually over the course of your withdrawal time-frame, but what happens in those first 5-10 years is really important. The order in which you earn your returns matters – A LOT.<\/p>\n Again, I am not the first to dig into this topic, so here’s a list of posts specific just to sequence of returns risk when it comes to financial independence:<\/p>\n I suppose we should write an entire post on our withdrawal strategy… luckily for you, dear reader, our amazing friends Ali and Alison from All Options Considered are working on an AMAZING case study analysis on our portfolio which covers in SO much detail our withdrawal strategy. Stay tuned for more on that!<\/p>\n A stock dividend is a dividend payment made in the form of additional shares rather than a cash payout. Essentially, for every share of a dividend stock that you own, you are paid a portion of the company\u2019s earnings. You get paid simply for owning the stock.<\/p>\n For example, let\u2019s say Company X pays an annualized dividend of 20 cents per share. Most companies pay dividends quarterly (four times a year), meaning at the end of every business quarter, the company will send a check for 1\/4 of 20 cents (or 5 cents) for each share you own. This may not seem like a lot, but when you have built your portfolio up to thousands of shares, and use those dividends to buy more stock in the company, you can make a lot of money over the years. The key is to reinvest those dividends!<\/p>\n Let’s use some numbers to look at an example.\u00a0 Let’s say you invest $50,000 in a high dividend stock and each unit of this particular stock costs $20 and pays an annualized dividend of $1 per share.\u00a0 This means you own a total of 2,500 units of this stock ($50,000\/$20=2,500). Over the course of the year, you will get paid $2,500 every year simply by owning this stock (2,500 units*$1=$2,500).<\/p>\n Dividend yield refers to a stock’s annual dividend payments to shareholders, expressed as a percentage of the stock’s current price.<\/p>\n So in the example above, the dividend yield is 5%.\u00a0 How did we get that?<\/p>\n Dividend yield = (annual dividend) \/ (stock price) * 100%<\/p>\n So (1\/20)*100=5%<\/p>\n It’s important to realize that a stock’s dividend yield can change over time, either in response to market fluctuations or as a result of dividend increases or decreases by the issuing company.<\/p>\n Dividends are one component of a stock’s total rate of return, the other being changes in the share price. For example, if a stock’s price goes up by 5% this year and it pays a 3% dividend yield, then your total return is 8%. If you’re investing for the long term, be sure to consider a stock’s total return potential in addition to the yield.<\/p>\n And this is the main reason why I don’t invest in individual high dividend stocks and would rather invest in broad index funds tracking the overall market.\u00a0 From the little research I’ve dug into on dividend stocks, these tend to be steady blue-chip stocks (large company – one of the market leaders in its sector – been around awhile – most people have heard of them – that type of company) which I have found do not have the growth potential as some other companies out there.<\/p>\n A rising dividend yield may simply be masking a money-losing stock. Math and the way dividend yields are calculated is why this happens. Go back to the dividend yield equation.<\/p>\n Dividend yield = (annual dividend) \/ (stock price) * 100%<\/p>\n Why does this equation matter? A\u00a0falling stock\u00a0can make a dividend yield look great.<\/p>\n Let’s go back to our example above. You bought a $20-a-share stock that pays $1 a year in dividends. You might be initially thrilled with your impressive 5% annual dividend yield ($1 dividend divided by $20 stock price). The stock’s yield is ~275% larger than the S&P 500’s roughly 1.8% yield. Go you!<\/p>\n Now, the stock crashes to $10 a share and the company holds the dividend the same. Applying the same dividend yield formula, the stock’s dividend yield doubles to 10%. Looks great. But wait a second, despite the higher yield, you’re worse off because you lost $10 a share on the stock. The stock market as a whole stays steady, but this particular stock takes a tumble.\u00a0 The dividend looks great but the stock itself may not be worthy of investing in.\u00a0 If you are looking into dividend stocks, please do your research! This is just a example and I’m sure there are great high dividend stocks out there but I would much rather not have all my eggs in a few baskets.<\/p>\n This goes back to the notion of zoning out all the noise that you see on the media.\u00a0 The media’s job is to bring in eye balls to their programming so that more viewers see their paid advertisements.\u00a0 Just like any other corporation, their job is to make money. Pair that up with the fact that humans have emotions and things can get crazy.<\/p>\n Today\u2019s investors are bombarded with so much media. The news is received in seconds via smartphone and other devices, and reactions to the negative media often cause negative results for the investor\u2019s portfolio. All too often, money management is influenced by investor’s emotions, emotions that can cause a loss of focus on the financial goals and objectives for both the short-term and the long-term.<\/p>\n When the market is experiencing erratic movements, an investor may panic and sell. On the other hand, if the market is at a peak, an investor may feel elated and buy. This kind of emotional behavior can have dramatic consequences on the performance of your portfolio.<\/p>\n Consumers tend to flock to an item when it goes on sale.\u00a0 Like wait overnight in a fold out chair on Black Friday to get a TV 60% off. But these same consumers panic when the market dips and funds go on sale and sells instead of buys these undervalued products.\u00a0 Our emotions get the best of us and dont let us think properly.\u00a0 Don’t panic!\u00a0 The value of your funds only matters when you actually sell these.\u00a0 If there is a dip, this is a signal to buy.<\/p>\n Phew.\u00a0 Ok we are really getting there!\u00a0 We will have one last post for this Investing 101 Series wrapping everything up.<\/p>\n Any questions for us?\u00a0 Do you feel more confident and ready to invest?<\/p>\n Want to check out the rest of the Investing 101 Series?<\/p>\n If you liked this article and want more content like this, please support this blog by sharing it.\u00a0 Not only does it help spread the FIRE, but it lets me know what content you find beneficial.\u00a0 Writing is NOT my strong suit and it honestly takes me hours to write each post so the more encouragement the better!\u00a0 Engaging in the comments below keeps me motivated.\u00a0 You can also support this blog by subscribing to receive emails anytime a new post is published.\u00a0 Thank you FImily!<\/p>\n We believe in stacking up life hacks to keep your enjoyment levels to the max without depleting your bank account.\u00a0 Here are some ways to further educate yourself and save thousands of dollars over your lifetime by making some simple adjustments:<\/p>\n I think we are finally on the last stretch of the Investing 101 Series.\u00a0 In addition to what we previously covered (compound interest, financial institutions, …<\/p>\n\n
Asset Allocation<\/h2>\n
Rebalancing<\/h2>\n
Nominal vs Real<\/h2>\n
Fees\/MERs<\/h2>\n
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Net Worth vs Income<\/h2>\n
Savings Rate<\/h2>\n
Sequence of Returns Risk<\/h2>\n
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Dividend<\/h2>\n
Dividend Yield<\/h2>\n
Emotional Risk<\/h2>\n
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Support This Blog<\/h2>\n
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