Financial Friday #124: To Pick or Not to Pick — How to Buy Stocks?
Let’s assume you have opened a TFSA or RRSP at one of the many online trading platforms available to Canadians and have funded the account with your hard-earned cash. You are now at the point where just a few mouse clicks could have a huge impact on your lifetime financial wellness, so you better make sure you know the facts and understand the risks of any investments you make.
Risk is relative. Holding an individual stock is usually a lot riskier than holding a diversified basket of stocks like those held in a mutual fund or exchange-traded fund (ETF), and cash in the bank has virtually no risk at all (except for inflation!).
A lot of DIY investors choose index-based ETFs or all-in-one ETFs because they offer low fees and a good balance between risk and return. The composition of assets in these funds is continuously balanced to manage the risk and the only control investors have is when to buy or sell the fund. The funds are actively traded, so buying and selling is quick and easy and can be done with a few clicks, although there may be some fees.
This type of investing is called passive investing as it requires very little effort. We sometimes hear “set and forget” investing, but the reality is you should always monitor your investments to some extent and ensure your risk and returns (including fees!) are in line with your investment goals, timeline, and life situation.
There are now more than 1000 ETFs available in Canada and their risk varies greatly. The more focused or specialized an ETF is on a certain industry sector or geographic area for example, the higher the risk. However, even the most diversified, “low-risk” ETFs can be seriously affected by a broad-based market decline like we saw during the pandemic-induced crash in March of 2020.
The opposite of passive investing is active trading. This type of trading can also easily be done online, but (ideally!) requires much more time, effort and knowledge. The investor chooses individual stocks and makes all the decisions on when to buy and sell their holdings.
You can still diversify your portfolio and manage your risk by holding a number of individual stocks, but it is going to be a lot more difficult and time-consuming than holding some sort of ETF. The advantage of course is that you are 100% in control. If you are stuck on a particular stock, you can most likely buy it online in a matter of minutes.
In general, it is very difficult to consistently pick individual stocks that generate a higher return over the long term than a broad-based index fund ETF, and your risk is substantially higher. Even the experts can’t do it on a regular basis
Which Stocks Should I Buy?
. However, many investors like to hold some individual stocks as part of a larger, more diversified portfolio of investments including ETFs, mutual funds, bonds, cash, etc. It really is a case of not putting all your eggs in one basket.
As for which companies to invest in, there are many internal and external factors that move individual stock valuations and plenty of available metrics if you want to dive into the data. For some people, it’s enough to be a fan — they invest in a company based on what they already know or like about it and that they truly believe in.
Enriched Academy doesn't recommend any specific financial products or service providers and we are never going to tell you which stocks or ETFs to buy. We implore you to make sure you fully understand the risk of any investments you make. However, we love to share valuable information and our expertise to help you make more informed financial decisions.