DIY Investing: What type of investor are you?

It takes courage to become a DIY investor. Kudos to you for choosing this path. But before you start buying stocks, it’s important to understand your investor personality type. We’ll take you through the various factors that will help you create a balanced portfolio. 

What are your financial goals with investing? 

Knowing what your purpose is when you invest your money is essential to your financial success. When you envision your future lifestyle, what does it look like? Perhaps you want to travel to different countries, become a homeowner or save for retirement. You can also separate them between short-term (three years or less), mid-term (three to five years), and long-term (more than five years) goals.

Take a few minutes to write down your financial goals. Make sure that they are SMART goals. Here are a few examples:

• Short-term: I want to go on a four-night trip to Bermuda next year which will cost me $2,500. I will save $156.25 per month for the next 16 months. I will have a separate savings account to save for this family vacation.   

• Medium-term: I plan to save $8,000 annually for the next five years towards the new First Home Savings Account (FHSA). This will total $40,000 to go towards a down payment on a one-bedroom condo. 

• Long-term: I plan to retire in 35 years. I will need $1.5 million to retire comfortably and become financially independent. I have an initial investment of $150,000. By contributing $255 per month for the next 35 years and with an annual compound interest of 6%, I will have a stock market portfolio worth $1.5 million.

Once you’ve decided what you want in your life, you can make a plan to achieve your financial goals. Becoming a DIY investor can help you achieve your financial goals faster. 

Calculating your time horizon

First, you’ll want to figure out your time horizon, which simply means how much time you have to invest your money before you need it. You can determine this by selecting an end date of when you want to reach your financial goal. For instance, if you want to build your retirement nest egg by the year 2058, then you will have 35 years as your time horizon. The longer you have to invest, the more you’ll be able to benefit from compounding interest. 

Assessing your risk tolerance

Another factor to consider is your risk tolerance. This is how much risk you’re willing to take when investing your money. The stock market constantly fluctuates. When it goes up, it may seem like it’s all sunshine and rainbows. 

But the real test is when the market starts tumbling down. How will you handle this situation? Can you stomach losses of -5%, -10% or even -30%? Looking back to March 2020, we witnessed steep declines in the -37% territory. When this happens again, will you panic and start selling your investments at a loss? Or will you “keep calm and carry on”? 

Your risk appetite will fall into one of these categories:

• Conservative/Low-risk: These are relatively stable and safe investments. They will have a slow and steady growth. You may have to lock up your money for a specific timeframe to receive interest payments. Examples include bonds and Guaranteed Investment Certificates (GICs).
  
• Moderate/Medium-risk: These are middle-of-the-road investments. They could have double-digit growth and losses. Examples include blue chip stocks and dividend stocks.
  
• Aggressive/High-risk: These are highly volatile and it’s not wise to put all your money into a single stock or sector. Yes, you can earn significant gains, but you could lose all your money overnight. Examples include speculative stocks, meme stocks and cryptocurrency. 

You can take this online quiz to see what your risk profile is. 

Determining your asset allocation 

Based on your time horizon and risk tolerance, you can choose your asset allocation—the ratio of stocks and bonds in your portfolio. Let’s take a look at a few scenarios.

David is a conservative investor who is nearing retirement in a few years. His portfolio has 40% stocks and 60% bonds. 

Lauren is a moderate investor with another eight years left to invest her money. Her portfolio contains 60% stocks and 40% bonds.

Kyle is an aggressive investor who is in his early 20s. His portfolio consists of 80% stocks and 20% bonds. 

Each person has a unique scenario and investor type. Ultimately, it’s trying to find the balance between taking on some risk—but not any more than you need to. 

Canadian Couch Potato model portfolios 

An excellent resource that provides asset allocation ETF examples is the Canadian Couch Potato website by Dan Bortolotti. 

About a decade ago, you would’ve had to choose several index funds or ETFs to create your portfolio. In recent years, all-in-one ETFs have been introduced in Canada. Dan explains how they work and how you can simplify your portfolio by owning these ETFs. It’s worth considering if you’re looking to simplify your portfolio, save fees, and the time it takes to rebalance your portfolio. We’ll explore this in more detail in the later part of this series. 

If you’re looking for a discount brokerage where you can start investing with low fees, consider opening a Qtrade Direct Investing account where you can get up to $150 in bonus cash.

Target rate of return 

Although no one can predict how the stock market will perform, when we look at the historical track record, the average annual rate of return is between 6% to 8%. Of course, past performance does not guarantee future returns. Even though the stock market has trended upwards over the years, you may want to be conservative with your estimates in case anything happens.

By investing today, you can reap the benefits of compound interest and enjoy higher returns than you would compared to keeping your money in a high-interest savings account or sitting in cash. That said, using a high-interest savings account such as EQ Bank is good for short term savings.

What is the difference between active vs. passive investing? 

Active investing is when you try to pick individual stocks in an attempt to outperform the market. Passive investing is when you build a portfolio of low-cost index funds or exchange-traded funds (ETFs) that follow the market or a benchmark.

Humans have egos and it’s not uncommon to believe you can select the best stocks. In reality, it’s difficult to outperform the market year after year. No one has a magic eight-ball to predict how the market will perform. So you can tune out all the news because it’s merely a distraction. Plus, actively trading stocks requires time to research and follow specific companies. I’m sure you’d rather spend your time with family and friends. 

That’s why instead of putting all your eggs into one basket, you should consider spreading them into many baskets. This strategy is called diversification. By doing this, the historical annual rate of return is between 6% to 8% per year. It’s a decent amount of growth where you can sleep well at night. 

ETFs and index funds are available from various providers, including Tangerine, Vanguard, TD, and more.

What is the difference between investing vs. speculating? 

How can you tell when something is an investment versus speculation? When people try to find that one stock that will outperform the market and benefit from enormous gains (remember, cannabis stocks, cryptocurrency, or Gamestop?), it’s a red flag and a sign that people are speculating. The rewards can be high, but so are the risks. When everyone is talking about it, it’s already too late to invest in that particular stock because the price will probably be at an all-time high. 

As boring and un-sexy as it may sound, plain vanilla index funds will suit most investors. Even Warren Buffet said, “By periodically investing in index funds, the know-nothing investors can outperform investment professionals.” Having a diversified portfolio and a long-term approach will help you withstand the ups and downs of the stock market and come out ahead.

But if you can’t shake off that feeling of trying your hand at stock picking, you can consider allocating a small portion of your investment portfolio (less than 5%) and call it your “fun money”. Then you can choose a stock to buy and see how it performs. Make sure that you’re willing to lose all of this money and not sweat it. 

What is your investor type? 

Whatever your financial goals are, you can reach them by investing in the stock market over the long term. Now that you understand your time horizon and risk tolerance, you can better formulate your portfolio’s asset allocation. 

Stay tuned for part 3 of the DIY Investing Series, where you’ll learn how to assemble your stock market portfolio.