Often I’m asked by people what they should they invest in and I always have the same answer; Purchasing index funds and following the Canadian couch potato strategy (CCP) which was made famous by Dan B of Canadiancouchpotato.com is the easiest way to grow your wealth with minimal involvement.

The couch potato strategy does require some basic research, but once you’re set up it requires no more than an hour of your time once or twice a year. Hence the name couch potato. Even if you have no interest in investing, you’ll be amazed at how well this strategy can work for you.

What are index funds?

Index funds basically track an entire market; think the TSX (Canada) or the S&P500 (USA). So instead of buying individual stocks, you’re buying the entire market. By buying the entire market you’re diversifying your portfolio. You don’t need to worry about picking the right stocks since you’ll own a little bit of everything with index funds.

Most new investors are used to purchasing mutual funds which have a high management fee (MER), whereas index funds can be owned at a very low cost. A typical mutual fund will charge you anywhere between 2-3% but index investing can cost you less than .30%. This may not sound like a lot but imagine that 2% compounded over 30+ years. That could literally be hundreds of thousands of dollars you could be saving.

Related: How I got my deferred sales charges waived

It has been proven many times that the majority of actively managed funds do not beat the returns of the index. Of course some mutual funds do beat the index but it’s a guessing game at best. Remember, past performance is not indicative of future results.

Equities and fixed income

I’m going to simplify things here but when it comes to investing the two main things that make up your portfolio are equities and fixed income.

Fixed income investments are things that are safe, so think bonds, GICs, and treasury bills. Since these investments aren’t very risky, the return on them is low.

Equities e.g. stocks offer higher returns, but they could also lose money. So with risk comes reward, or in other words there is no such thing as a safe investment that will give you high returns. When switching to index funds, beginners really need to understand this relationship.

Related: Money terms you need to know

Asset allocation

Asset allocation is the mix between your fixed income and equities. The balance depends on your age and risk tolerance, but as a general rule I suggest subtracting 10 from your age and that should be your fixed income portion.

So if you’re 25 you should have 15% (25-10) in fixed income and 85% in equities. The younger you are, the more risk you can take, hence the higher allocation towards equities. You won’t need this money for many years so you can afford to ride out any market corrections. On the other hand, as you approach retirement you need more fixed income investments since you’ll need that money to fund your retirement years.

Of course if you’re the worrying type and you would freak out every time the markets swing, it might be a good idea to increase your fixed income portion just so you sleep better at night.

index funds for beginners

Implementing the strategy

Tangerine funds
Index funds for beginners is incredibly easy with Tangerine’s investment funds.

Equity Growth – 100% Equities, 0% Fixed Income
Balanced Growth – 75% Equities, 25% Fixed Income
Balanced – 60% Equities, 40% Fixed Income
Balanced Income – 30% Equities, 70% Fixed Income

Choose the fund that suits your your profile and start investing. The MER is reasonable at 1.07% and you don’t need to worry about anything since they automatically re-balance for you. This is a great solution for those who want to reduce their fees.

Related: Tangerine investment funds review

TD e-Series
If you’re a client of TD you can purchase their e-Series index funds. The 4 main funds of the CCP are as follows.

TD Canadian Index E (TDB900)
TD US Index E (TDB902)
TD International Index E (TDB911)
TD Canadian Bond Index E (TDB909)

The main advantage of e-Series is the flexibility, since you buy and sell the funds yourself you can set your allocation however you want. The other advantage is the cost; the MER is .44% which is .63% below Tangerine. Remember, reducing your costs can save you big in the long run

TD doesn’t make it easy for you to buy these funds. In fact most of the tellers / FSRs at the branch level probably lack much knowledge about the funds since it doesn’t earn them much of a “commission”.

These funds also don’t rebalance automatically so at least once a year you’ll need to buy/sell or switch around your funds to get back to your original target. Don’t be scared off by this, it literally takes a few minutes to do and there are spread sheets available to help you figure out how to rebalance.

You can ever further reduce your fees if you invest in ETFs but that’s a conversation for another day.

Rebalancing

Once a year you should review your portfolio and rebalance if your asset allocation is getting away from your original plan.

 Original AllocationCurrent Allocation
Canadian Index25%20%
US Index25%25%
International Index25%30%
Canadian Bond Index25%25%

As you can see in the above example, our original asset allocation was spread evenly 25% across the 4 major indexes. Over the year the international equity has increased by 5%, while the Canadian index has decreased by 5%. To rebalance we would simply “switch” 5% of our international equity into Canadian equity (you would have to sell and then buy if using ETFs). By sticking to this strategy we’re essential selling high and buying low.

You can also rebalance by simply using any new money that you add to your account. To make things easy, Canadian Capitalist has a simple spreadsheet to help you rebalance your portfolio. This whole process shouldn’t take more than 30 minutes a year.

Final word

As complicated as this all sounds; index funds for beginners is easy once your accounts are set up. The fees you save in the long run will make a huge difference when it comes to your retirement years. This strategy can be implemented in any of our accounts e.g. RRSP, TFSA, RESP

If you’re looking a step-by-step guide on how to invest then pick up a copy of The Value of Simple by John Robertson which I recently reviewed.

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Image courtesy bronx. / StockPholio