TSX 25

Ask any financial adviser and they’ll say a big part of their job is “talking people off the ledge.” Soothing investor nerves is the psychological contribution they make for all those fees. But why do we freak-out so often? Is it because we’re not always organized in our financial thoughts and at peace with our plan? If so, let’s get organized.

Money can only be placed into four groups: cash, GICs, bonds, and stocks. The most confusing of these is stocks.

Canadian stocks

Canadian stocks come in limited flavours and though we have a TSX 300, you only need to know about 25. The primary sectors are: financials, utilities, resources, and telecommunications.

Financials means banks and insurance companies. Here are the ones to watch:

  • Toronto Dominion (TD)
  • Bank of Montreal (BMO)
  • Royal (RY)
  • Manulife (MFC)
  • Sun Life (SL)

Utilities primarily means pipelines and power companies.

  • Enbridge (ENB)
  • TC Energy (TRP)
  • Pembina (PPL)
  • Fortis (FTS)
  • Capital Power (CPX)

Resources in Canada means oil companies and mining.

  • Suncor (SU)
  • Canadian Natural Resources (CNQ)
  • Cenovus Energy (CVE)
  • Imperial Oil (IMO)
  • Teck Resources (TCK.B)

And our big telecoms are:

  • Bell (BCE)
  • Rogers (RCI.B)
  • Telus (T)

Good companies in other industries are:

  • Canadian National Railway (CNR)
  • Canadian Pacific Railway (CP)
  • Magna (MG)
  • Empire (Sobeys) (EMP.A)
  • Loblaws (L)
  • Canadian Tire (CTC.A)
  • Nutrien (NTR)

Honourable mention goes to Arc Energy, Encana, and Emera. This list gives you a good cross-section of the Canadian economy. So if Canada does well, you do well. And there’s no reason to believe that Canada won’t do well.

If I had a million dollars

The next question is: how should I invest my dough? Here’s what I’d do with a million dollars.

  • Cash – 10%
  • GICs & Bonds – 30%
  • TSX 25 – 60%

You always need cash in the event something goes on sale (i.e., a market correction).

Bonds and GICs give you stability. GICs need to be CDIC insured and laddered over 2-5 years. Bonds should also be laddered and only honoured by quality companies. Note: bonds must pay a premium to compensate for their risk over a GIC (I’d say minimum 1-2%).

When it comes to stocks, own the TSX 25. If you’re just starting out, buy them in order, one industry at a time. For example, if you have only $10K, buy the TD Bank (or your bank). With your next $10K, buy Enbridge, and so on until you own them all.

With only a million dollars there’s no need to go international and involve currency risk. We have plenty of good companies here at home. But if you have an international flair, look to the US and Asia.

Young people

Jordan has a good paying job but nothing for savings. He wants to start investing but doesn’t know where to begin. Here’s what I’d suggest.

The first $10K should go into a 5-year, CDIC insured GIC. The next $10K should go into a high-quality corporate bond. The next $10K into the TD Bank, and the next into Enbridge. Along the way, he’ll accumulate some cash. After stage one, his portfolio should look something like this:

  • $ 5K Cash
  • $10K GICs
  • $10K Bonds
  • $10K TD Bank
  • $10K Enbridge

Summary

Being organized relieves the stress of investing. You needn’t experience emotional pain for financial gain. Substitute companies into this list as desired but remember that owning and watching 300 stocks is unmanageable. It’s best to keep things simple. (Besides, getting rich shouldn’t be that complicated.)

Investing 102

Now that you understand the basic types of investments (from Investing 101), it’s time to explain stocks and the external factors affecting them. 

There are three criteria used to evaluate any individual stock (earnings, dividends, and growth) and three factors that affect the market overall (GDP, money supply, and interest rates).

Earnings, dividends, and growth

Buying a stock typically depends upon:

  • Earnings per share (EPS)
  • Dividends (the portion of EPS paid out)
  • Prospects for growth

If you buy a stock for $50/share and the company earns $5.00/share, that’s 10% equity growth. If they keep $3.00 and pay out $2.00 in dividends, that’s even better because money is always better in your pocket. The question then becomes, can they continue to provide these returns? Or does the future hold even better figures—because they’re growing?

You look at how much the company is making, how much they’re paying out, and what their future holds. It’s always risky because nobody knows the future. Sales and earnings could fall because of competition, new regulations, loss of key management—a number of reasons. And the company could cut its dividend at any time. So holding any stock is risky even without considering external factors, but investors also look at GDP, the money supply, and interest rates because they affect every company’s potential for growth.

GDP

GDP is a general indicator of the world’s (or a specific country’s) growth. Think of it as a measure of adding all companies’ sales together. If the number goes higher, it means companies are growing.

GDP affects individual companies because we typically all grow together. So if Company A’s sales are growing, Company B’s probably are too since we’re all customers of each other. Or Company A’s employees go out and buy Company B’s products, and likewise. 

If the world’s GDP (or my country’s GDP) is growing, that’s generally good for the stock market. If they’re both in doubt, than the potential for growth for most companies is compromised.

Money supply

The money supply is the amount of money out there pursuing goods (thereby causing GDP).

It includes employee wages, consumer cash, consumer assets (e.g., home values, investment portfolios), consumer debt (e.g., credit cards, home loans, car loans), corporate cash, corporate debt, government debt, family inheritances, and 75 other things.

The essence of the money supply is that when it’s increasing, it’s good for the market. When it’s decreasing, the effect is negative.

Interest rates

Interest bearing vehicles like bonds and GICs are competitive options to stocks. Their returns are lower but they come with less risk. For example, if GICs are paying 2-3%, and moderate-risk bonds are paying 4-5%, then investors should expect stock returns to be 6-7% (or greater) because of the additional risk. Make sense? I’m only going to invest in something riskier if I believe I can make a higher return.

As interest rates rise, all three of these values increase. GIC rates go higher, so bonds must pay better, and investors seek greater returns from their stocks. This pressure then drives the price of stocks down since you must now get a higher percentage yield out of the same return. For example, a $50 stock that earns $5/share, yields 10%. If interest rates rise to the point where stocks must yield 15%, the stock price will adjust downwards to $33 ($5 divided by 15%).

Predicting the future of interest rates is always tricky. Initially, they were set up to appropriately compensate lenders for risk, but then the government got involved through monetary policy (see Keynes). Regardless, the effect on stocks remains the same: as interest rates rise, stock prices go down, and as interest rates fall, stock prices go up.

Summary

In addition to evaluating individual stocks based on their own financial merit, investors also look at macroeconomic factors in determining their potential for growth.

The problem today is that all three macroeconomic factors are negative. The US’s GDP is growing but the world’s GDP is expected to fall. The money supply is expected to shrink because consumer and government debt (already at all-time highs) must now be paid back. And interest rates have nowhere to go but up.

Add to this the fact that many Canadian companies have been paying dividends in excess of earnings (essentially, eating their own flesh) to appease investors, and you have general market conditions screaming to fall. This doesn’t mean every stock will fall—but it sure makes investors nervous.

Investing 101

There are four categories of investments:

  • Income
  • Income and Growth
  • Growth
  • Aggressive

Income

Income investments pay you interest. They come in four types: savings accounts, government treasury bills, GICs, and bonds. Savings accounts pay low interest rates, but give you the flexibility to get at your cash. Treasury bills pay a decent return, but lock up your dough for short periods of time. GICs (Guaranteed Income Certificates) pay better than a T-bill, but lock up your money for longer periods.

T-bills are 100% guaranteed by the federal government (which equals zero risk—as long as the country remains stable). CDIC Insured GICs are also 100% backed by the feds, for up to $100K, for 5 years.

Bonds are loans to either governments or corporations, paid and guaranteed only by them. All bonds are rated for quality (the ability of the debtor to repay). High quality bonds are rated between A- and AAA+. Bonds rated below BBB (down to DDD-) are considered junk. The higher the risk, the greater the return should be.

Selling a bond is like selling real estate, the commission is bore by the seller. So the minute you buy one it’s instantly worth 1-2% less, because you have to pay a commission in order to sell it (and this is reflected on your statement). But if you hold bonds to maturity, no commission will ever be paid. As a result, short-term bonds are great since they can easily be held to maturity.

Bonds also fluctuate in inverse relation to interest rates. So if interest rates go up, bond values typically go down. Why? Because if GICs are paying 6%, who wants your 5% bond? Likewise, if GIC rates fall to 3%, everyone is now willing to pay a premium for your 5% bond. But again, this change in value is mitigated if you hold your bond to maturity.

Buying only high-quality, short term bonds avoids the inherent risk bonds have, since holding them to maturity means you’ll always get what you bargained for.

Income & Growth

Income and Growth are blue chip companies that are profitable and pay dividends (e.g., banks and utility companies). These stocks usually pay a 3-5% dividend.

Dividend income is preferable to interest income because it’s taxed at a lower rate. So, from a tax perspective, a 6% dividend is equal to getting 8% in interest.

There is some risk attached to these products since the stock price may decrease (which is the growth component), but they’re usually mature companies within mature industries—so they shouldn’t go broke.

Growth

Growth investments are non-dividend or lower-dividend paying stocks. They’re bought mostly for their share price potential. These companies haven’t yet reached their peak and are still growing. Under the right circumstance, they can deliver solid price appreciation but their stock price can decline just the same. As a result, they contain greater risk than income and growth stocks but they’re not as bad as those categorized as aggressive. Their primary risk lies in them having a bad year.

Aggressive

Aggressive stocks don’t pay a dividend. They only have the possibility of good stock price appreciation. Examples are gold mines or companies bolstering a new technology. Maybe they’re the next big thing, probably they’re not. So they can either boom or bust (and busting is the risk).

The goal of many “new product companies” is just to go public and make the founders rich. Many don’t stay the course and ever realize their potential. It takes more than a novel idea or something cutting edge to create a successful business. You need great management, awesome timing, and a little luck to pull it all off. So, this type of investment can almost be equated to buying lottery tickets. If they make it, they usually make it big. But it’s rare.

More conservative forms of aggressive investments are found in emerging markets (like India). They’re emerging (which offers great upside) but they’re also risky because third world governments are never quite stable (e.g., they can nationalize an industry on a whim).

Rule of thumb

The big myth is that young people should put their savings at risk when in fact everyone should be conscious of risk. And regardless of your tolerance, you should always have at least half of your investments in the categories of income, or income and growth. (This way, you won’t come ask me for money when you’re old.)