Basics of Investing with Dustin Dinis | E011
Full Transcript:
Jason Pereira: Hello, and thank you for joining me for The Wisdom of Wealth, a show where we help educate Canadians about fundamental financial literacy topics to help you make better and more informed decisions. And to know when and where to reach out for help. I'm your host, Jason Pereira. Today on The Wisdom of Wealth, we're going to talk about the basics of investing.
Jason Pereira: There are lots of options out there for how to invest your money, but in the end, just about every investment falls into one of a handful of categories, specifically, cash, fixed income, equities or stocks, commodities, real estate, derivatives, or alternatives. These categories are known as asset classes, and I'm going to review what all of these are and what they mean today.
Jason Pereira: The first class is cash and cash equivalents. This is an asset class, including everything from physical cash that you keep in your wallet and bank account, to cashable GICs, high interest savings accounts and money market ETFs and mutual funds. What all of these things have in common is that they're easily accessible or liquid, come with no risk and have generally low rates of return relative to other asset classes. While cash is important, as we need it to transact daily, leaving too much of it lying around can cost you a lot in the long run. So try to keep enough cash on hand to support your life and lifestyle and for more immediate plans, but make sure that you're making the most of your money.
Jason Pereira: The second asset class is fixed income or commonly known as bonds. When you buy a bond, you're basically lending money to a borrower in exchange for interest and a return of your principal at the end of the loan. While bonds pay higher interest rates than cash, they also come with more risk. So, how much interest? Well, that depends on several factors, including the risk of the borrower and the length of the bond. Generally, higher risk and longer term bonds pay higher interest rates. As for how risky they are, that generally depends on the risk of the borrower. Both governments and companies that issue bonds, are rated based on how likely they are to pay back those loans. When very secure bonds are invested in, they pay low interest rates. The higher risk bonds pay higher rates.
Jason Pereira: The other risk that bond investors face is that unlike cash and GICs, bonds fluctuate in price. So if you want to sell your bond before it matures, you could end up selling it for more than you paid for it or less than you paid for it, and receive more or less than you would have received if you had held it to the end of the term. So why did these pay more than cash? Well, because they have to. After all, because if you're going to take any form of risk, you're going to be rewarded for that risk, otherwise you can just play it safe. Overall, bonds are generally invested in to provide better than cash return with relatively low risk and provide security with investors' portfolios.
Jason Pereira: The next asset class is known as equities or better known as stocks. When you buy a stock, you're buying a share of ownership in a company that issued it. And as an owner, you get the benefit in two ways. The first is that if that company's value goes up, it will be reflected in the stock price. And you make a profit. The opposite is also true, where if the company performs poorly, the stock price will suffer and you can lose money. The second way is that if a company chooses to pay a share of its profits to shareholders you're entitled to receive a portion of that. This is what's known as a dividend. So just how risky are stocks? Well, that depends on several factors, including the company, the industry, economic factors, and several other conditions. Overall, however, in general, stocks are more risky than bonds and cash. Single companies can often go out of business, leaving its shareholders with nothing for their investment. But the market as a whole continues on, because as long as companies exist and continue to make money, the stock market will persevere.
Jason Pereira: So how much can you make? In one year anything can happen. Large swings in the market are not uncommon, but over the long run, ups and downs start to average out and with very few exceptions throughout history, stocks outperform cash and bonds by a significant margin. This is again because of the risk. In order for investors to take a chance of losing money in order to make money, the market sets prices at a level where over time, the long-term expected return is positive and rewards them for the risk they take. This is what's known as a risk premium. Overall historically, most of the growth in people's portfolios has come from stock ownership.
Jason Pereira: The next asset class is commodities. Commodities are real hard assets that include everything from gold to grains, minerals, to oil. Basically, these are physical items. In general, the average investor doesn't spend much time in these markets with maybe the exception of purchasing gold, and frankly, there's little reason for them to do so. Commodities markets are generally the domain of large companies and manufacturers who purchase and use these products. The risk depends on the product and can be affected by weather or politics, cartels, you name it. As for returns, they can be highly unpredictable.
Jason Pereira: The next asset class is real estate. Now we cover real estate investing in detail in a previous episode. So today, I'm just going to summarize. You can earn return on real estate in one of two ways. From rents and from price changes. Everyone knows you can invest in real estate by buying a house or a condo or a building, but many don't realize that you can buy shares in companies that professionally manage large diverse portfolios of real estate. These are called real estate investment trusts and can be bought on stock markets, making it easy for anyone to get started in real estate investing. In terms of return, despite the last 15 years or so of growth in the Canadian real estate market, which has seen explosive market growth, this is not normal. Over the last a 100 to 200 years, real estate prices have tended to return roughly close to inflation. So don't count on double digit returns in this space being a thing of the future for a long period of time.
Jason Pereira: This recent growth has made people not care about the yields that they're making off these rents. But that's not wise from a long-term standpoint. If you're looking to invest in real estate, you want both possible upside growth, but also something that pays you while you own it. In regards to the risk of real estate, the same can be said. Now we've not seen a major correction in this market since the late eighties, but this again is not really normal. Let's not forget what happened in the US in 2008. Corrections do happen and it's important that you don't put yourself in a bad position with too much debt if things go wrong, because you can be forced to sell at the wrong time when there's also correction in the stock market.
Jason Pereira: The next asset class is derivatives. Derivatives can be complicated, so bear with me. Derivatives are basically contracts where one party agrees to pay another party on a certain date if the price of something else that they're betting on changes as per the contract agreement. This something else could be the price of a stock, a commodity, a currency, or several other things. There are many types of derivatives out there, including forwards, futures, options, and swaps.
Jason Pereira: One way you can use derivatives is to protect yourself from price changes. This is something known as hedging. Here's a quick example. Let's say I'm a farmer and I grow wheat and I want to sell the wheat, that's going to be ready in three months. I'm worried about the price changing. I can enter into an agreement today to deliver that wheat at a set price in three months when it's ready, thereby eliminating my risk. If the price goes lower, I still get the original price we negotiated. However, if the price goes up, I lose the upside. Now who's going to enter into the other side of that deal? Well, a company that uses wheat like a flour mill. They're afraid that prices could go up in three months, making it more expensive for them to make flour. By both of them agreeing to a price now, they have both eliminated risk by creating certainty.
Jason Pereira: Something similar can be done with the stocks that you own. You could enter into different derivatives contracts to limit or eliminate the risk you have without selling your stock. The other way you can use derivatives is to bet on the direction of price alone. You don't have to own the underlying asset, you can just buy the derivative, and it will pay you if the price of that asset moves up or down. This is called speculation. So, what is the risk with derivatives? Overall, high, because you can lose everything that you invest in them, or make several times your original investment in a very short period of time. However, like many things in life, it's how you use them that matters. If derivatives are used to speculate, it's hugely risky. If you use them to hedge your entire portfolio, you can eliminate the risk of your total investment. Like I said, a little complicated.
Jason Pereira: Every other type of investment generally falls into the category known as alternative investments. These include many diverse types of investments. Everything from infrastructure like dams and highways, to private deals, to complicated investment funds known as hedge funds. The risk of these asset classes is often misunderstood as they don't have daily pricing like the stock market provides. Depending on the investment type, returns can be better or worse than stocks. But one of the big reasons investors find these appealing, is that they are often marketed with claims that their prices don't move the same way or directions of stocks or bonds. And therefore can reduce your overall risk, that may or may not be the case depending on the investment.
Jason Pereira: So which asset class should you invest in? That depends on several factors. Most importantly, your personal ability to tolerate risk. If you are someone who panics when prices go down, you probably shouldn't be exposing yourself to too much risk. The other key factor is your timeline. If you need to access your money shortly, you just don't have the timeline to accept risk in your investments. If you're investing for the longterm, say over 10 years, for instance, you can afford to take more risk as long as you can tolerate it. But in the end, there is no one asset class that you should be betting on. By investing in several specifically the easier to access, less complicated asset classes like cash, fixed income equity, and real estate, all at the same time, you can reduce your overall risk. This is because asset classes are generally not correlated.
Jason Pereira: That is to say that they don't generally move in the same direction at the same time. If they all provide you with return in the long run, but don't move in the same direction at the same time, putting them together can provide a smoother ride that prevents you from suffering large drops. Now, we've discussed a lot today about broad asset class categories. But one thing we haven't talked about is how to best put together a comprehensive portfolio. To help cover this topic, I have asked my friend and colleague, Dustin Dinis to join me in the studio today to help discuss this topic.
Jason Pereira: Today, I brought in Dustin Dinis of CI Investments to help explain the best way to go about starting to get invested. Dustin, thanks for joining us today.
Dustin Dinis: Thank you, Jason. Thank you for having me.
Jason Pereira: My pleasure. So tell us a little bit about what it is you do in the company you work for?
Dustin Dinis: So I currently work for a company called CI Investments. We are Canada's largest independent manufacturer of investment products. We're actually going through a bit of a rebranding right now because of our global scale. We're changing it to CI Global Asset Management, but it's still the same company. What I do specifically, is I am a VP of sales for CI. And what I do is I work with financial advisors, all across Ontario, and we have other sales members that work all across the country and we help them determine what types of products are suitable for different types of portfolios.
Jason Pereira: I spent some time talking about asset classes. And one of the things I want to get investors away from is the idea of just trying to pick individual winners, like individual securities. Because if you look at it historically, less than 5% of all stocks over a 10-year period produced most of the returns on the market. So, the odds of you getting that right are very slim. So, really the goal should be to buy something or get invested in something that gives you a lot of exposure to the asset class we're talking about. There's different products on the market that you can just make one transaction and get exposure to an asset class or a market. Can you tell us what those products are, generally?
Dustin Dinis: Definitely, Jason, I completely agree with what you're saying. People should not be playing roulette with their life savings by just betting on one number.
Jason Pereira: Yeah. Like investing is either people think it's risky. Well, it's like the poker player, professional poker players say, "Poker is not gambling when I do it." Right? Because they're at a different level. So you can either make it a casino or you can make it a smart long-term decision.
Dustin Dinis: Exactly. And so that's what our company aims to do, is we hire individual portfolio managers and there's multiple different types of products, but I would say the most diversified way to get exposure to the largest number of these options would be either through mutual funds or ETFs.
Jason Pereira: Okay. And can you explain to us what each of those are?
Dustin Dinis: Absolutely. So either a mutual fund or an ETF they're extremely similar.
Jason Pereira: Mm-hmm (affirmative).
Dustin Dinis: To speak broadly, they are a basket of securities. Now, they can be baskets of stocks. They can be baskets of bonds. They can be baskets of whatever asset class you have spoken about prior. But the premise is by basketing multiple of these together, you're diversifying the portfolio. So instead of just betting on one, you're getting a basket of anywhere between 20 to 52, it could be 100 different securities so that you know that you're well-diversified.
Jason Pereira: Yeah. So I don't have the risk one stock. I have the risk of the market or closer to it or a segment of the market. And therefore it's a little bit more predictable than Tesla stock going up and down by hundreds of dollars like we see in the news all the time.
Dustin Dinis: Exactly.
Jason Pereira: Yeah. So basically they're very similar. How are they different?
Dustin Dinis: So they would be different in their administration. So a mutual fund versus an ETF, they're both baskets of securities, but a mutual fund trades daily. So what that means is regardless if you have purchased it at 10 o'clock in the morning or one o'clock in the afternoon, everybody will get the same price at the end of the day, that daily NAV. An ETF is a little bit different because it trades on the exchange. That's why it's called an exchange-traded fund. So what that means is there's a daily price that's constantly fluctuating depending on what the underlying securities are doing.
Jason Pereira: So then it depends on what time of day I actually transact that, right?
Dustin Dinis: Exactly.
Jason Pereira: Okay. So I want to come back to those in a minute. There's kind of really two different kinds of camps or thought on how you invest. One of them is called active investing and what's called passive investing. Can you explain what the difference between the two of those are?
Dustin Dinis: Absolutely. It's something that we deal with very commonly. So the way that I would describe active versus passive is how the underlying securities are chosen. So when you're buying a passive product, as the name suggests, you are just getting exposure to whatever that either index or that asset class is offering. So you would get the same ride as whatever that index is doing.
Jason Pereira: So if I go online and I see that the S&P 500 in the US is up 1%. If I bought an S&P 500 passive fund, I can expect to basically make about 1% minus the fees?
Dustin Dinis: Exactly.
Jason Pereira: Okay.
Dustin Dinis: You will be following whatever the index is doing.
Jason Pereira: Got it.
Dustin Dinis: The active management side is where they try to use different factors, different research, different methods to be able to pick which ones are going to be the winners.
Jason Pereira:
Mm-hmm (affirmative).
Dustin Dinis: And so theoretically by choosing which ones are winners and avoiding the losers, they're hoping to have a better chance of outperforming those passives products.
Jason Pereira: So one is basically taking the chance that they're either going to outperform or do better than the market, of course there is risk there. The other one is basically saying, "I'm just going to take the market." Which in the long run is kind of the average of what everybody does, right? So two different approaches. If you want to try to do better than the average, go right ahead. If you want to take the average, go right ahead. Now, this is where I want to come back to the mutual funds and ETFs, because there's a real kind of misunderstanding about this. In Canada, in general, in the marketplace, people hear mutual fund, they think active and they hear ETF and they think passive. Is that the case?
Dustin Dinis: Yeah, it is a very common misconception. And that was more likely to be the case several years ago.
Jason Pereira: Mm-hmm (affirmative).
Dustin Dinis: Where we've come today in the investment landscape, that's definitely no longer the case. So you can actually have passive funds that are very closely following the index. You can have passive ETFs, but the change has happen where you can actually have very active ETFs, where there is portfolio manager, they're picking and choosing the individual securities exactly the same way as there is in an active fund. Just to give you an example of that, at CCI, we have several products that are available as either a mutual fund or an ETF. And it's the same manager picking and choosing the same securities in both portfolios.
Jason Pereira: Yeah. At the end of the day, it's just a legal structure of how they're organized. I've done this when I was teaching at York, I would basically ask the question, "What do you think these are?" And this was a financial planning course. And people would say the exact same thing. "Well, this one I'm buying the index, this one, I'm buying a manager." And then I put up a slide basically showing what the actual difference was, and like, you understand now, it's just how they're legally organized, right?
Dustin Dinis: Yeah.
Jason Pereira: So, yeah. So I would also say too, that there's also passive mutual funds that buy just the index too. So really, you can't just look at the sticker of what it is and know what it is you're getting, you have to actually go beyond the first sticker and say, "Okay, well, this is a fund that does X." So one area is the differences in fees. Can you speak to the what difference in active versus passive fees looks like?
Dustin Dinis: Yes, definitely. So, as you know when you're talking about an active product, there is work that goes into picking and choosing those stocks as we have discussed. When you're choosing a passive product, you are just following index. So naturally the fees on passive investments are significantly less than the fees on active investments.
Jason Pereira: Now, one of the things I do want to cover too, it's a big misunderstanding. There is a lot of data out there that says that the Canadian mutual fund industry's one of the most expensive in the world. This is not necessarily... This is actually not true. And I know people who actually worked on this study who say it's not true. And the big reason is... And people will often compare fees on ETFs and say, "Oh my God, these things are so cheap compared to the mutual fund." What's the difference between them in terms of what's included and what's not?
Dustin Dinis: Yeah. And that's a very important point to make a distinction, because when you are buying an ETF, if you're buying a passive ETF, you will be getting a lower fee than buying an active mutual fund. But if you're buying an active ETF, you'll be paying roughly the same fee as if you were buying an active mutual fund. Now, the differences in-between them are, inside the mutual fund, you are getting the manager who is actively picking and choosing which securities are going to that, but it's not just the manager, he has a full team of analysts.
Jason Pereira: Mm-hmm (affirmative).
Dustin Dinis: Or you can use an ETF doing the exact same thing.
Jason Pereira: But that fee in the mutual fund typically pays for two people. Right? Because it's also paying the advisor, right? And this is where the differences is. Is that ETFs don't include advisor compensation. So the advisor is going to charge you something outside of that fund or that [inaudible 00:20:22]. So when you look at the ETF and think, "Oh, it's that cheap." And you go to your advisor and say, "I want to buy that." Well, the advisor is still going to charge you something. You're just not seeing it buried in that fee, whereas in the mutual fund, oftentimes depending on the mutual fund, they're connected.
Dustin Dinis: Absolutely. You're a hundred percent right. Fees are important and we should just break that up. So the MER, the Management Expense Ratio of a mutual fund includes the management fee, which the ETF also has.
Jason Pereira: So that's for the management of the funds itself?
Dustin Dinis: Exactly. Fund or ETF regardless, they both have a management fee, taxes on both of them. And then
Jason Pereira: [crosstalk 00:20:55].
Dustin Dinis: ... Exactly. And then the mutual fund, as you mentioned, has what's called an advisory fee or a dealer service fee, a trailer. Now the mutual fund lumps all of those three together and packages it together as one fee. So that's why it looks as if it's inflated, when in reality, the ETF fee is just missing that third component.
Jason Pereira: And this is where the difference is and why they say that Canada is so expensive is because a lot of countries don't bundle it together like that. So I always say when you carve out HST and you carve out the advisor compensation, our costs are very similar to that of the US which we're often compared to. So, don't necessarily believe the flashy headline, and know that if you're working with an advisor, you have to pay them one way or another. Right now you should absolutely know what it is you're paying for.
Dustin Dinis: Yes.
Jason Pereira: ... and know that you're getting service for that. But if you're a do-it-yourselfer, you absolutely should not be paying an advisor fee and there has been court cases about that. So, okay. We've covered a lot. We covered all these asset classes. We covered different vehicles for buying large pools of assets, mutual funds, ETFs, different structures. And when we look at the marketplace in general, there's tens of thousands of choices, right? Like tens of thousands of mutual funds. I don't know if the ETF numbers are there yet, but they're getting there. So, we're telling people, instead of picking from thousands of stocks, pick from tens of thousands of other options. So let's talk about putting together a portfolio and how that works. So what should be considered when putting together a portfolio? When I'm trying to figure out what goes into my bucket here.
Dustin Dinis: So it's very similar to when we were talking about individual stocks and diversification. The same thing can be said for our products. So you can have either mutual funds or ETFs or multiple different types of products that are very geared towards a certain sector, are very geared towards a certain asset class, as you mentioned. So I think when you're putting together a complete portfolio, it's very important to consider diversification for sure, but also correlations. So when you're talking about a complete portfolio, you should have a portion of that, that is in Canadian equity, a portion of that, that is in US equity, real estate as you mentioned, liquid alternatives. And so what manufacturers as CI have done is we have created portfolios that include all of these asset classes for you. So that you can buy a one ticket solution that completely diversifies you, not just across one index, but across multiple indexes, multiple geographies and multiple asset classes.
Jason Pereira: So, a couple of things there. First off, let me go back to what you talked about, geography. One of the biggest mistakes I see a lot of investors and even a lot of advisors doing is not focusing outside of Canada. People don't realize Canada's 3% of all global stock markets. When you say, "I'm uncomfortable just investing in Canada." You're saying, "I am willing to ignore 97% of the options available to me." That just doesn't make sense to me. Also, Canada's its own economy, right? There's more diverse economies in the US and internationally, you get better exposure to things you don't get in Canada. So that's just my one point there. I want to come back to what you said about the buying of these portfolios. So, I can literally go on and I can buy a mutual fund or an ETF that gives me a fully diversified portfolio, but what if my risk level is super high or super low or average? What are the slate of options available to me?
Dustin Dinis: Yeah, absolutely. And that's a good question. We're talking very broadly, but if we want to get specific to an individual client as yourself, what we would generally suggest doing is speaking to an advisor, figuring out what that risk tolerance is, and then it will help guide you into choosing which portfolio there is. So generally when we're speaking about these products, you can have a diversified portfolio that is either a growth, which is more aggressive or an income or conservative portfolio. And so there's a full spectrum of those that individual clients can fit in-between, depending on your risk tolerance.
Jason Pereira: So the riskiest client can go and buy the riskiest basket of a diversified portfolio, the most conservative can go and buy the most conservative and at all points in-between.
Dustin Dinis: Exactly.
Jason Pereira: And that does take a lot of stress out of it because now you're kind of delegating the job of not only picking the stocks, whether it be active or passive, but also picking the assembly or the composition of that portfolio. So besides the fact that we want to be diversified in all this, what did these portfolio managers who put together these bundles, what do they look at in consideration of creating them?
Dustin Dinis: Yeah, it's a great question. I feel like you could do a whole show just on that, because there's so many different factors that they look at.
Jason Pereira: We've only got 20 minutes total and we moved most of it already. So please, [crosstalk 00:25:16].
Dustin Dinis: Yes. Yeah. But again, one of the things that I would say for sure that they do look at is the diversification, the correlations, risk metrics. So to say that an individual has a portion of their portfolio, let's say 60% of their portfolio in risky assets and 40% of their portfolio in conservative assets. Well, as you mentioned before, generally stocks will outperform bonds over time. So if you just leave that portfolio static, your risky assets will start to grow, which will take you outside of your risk tolerance. So one of the things that the managers are very keen on is what's called rebalancing. So making sure that you stay within that risk bucket by gradually taking some of the risk assets and moving them into the fixed income assets or vice versa, depending if the portfolio is offside.
Jason Pereira: Yeah. And it's funny, rebalancing is one of those things where sometimes clients will push back and say, "Well, it's doing good, just let it keep doing good." And it's funny because the old adage of how you succeed in the stock market is lost upon people. The old buy low, sell high, right? By rebalancing, that's exactly what we're doing. We're taking money from the thing that's doing well, selling it high and buying the thing that's not doing as well, buying it low. But everybody wants to be winning all the time. That's just not how it works, unfortunately.
Dustin Dinis: Yeah. It's extremely hard to remove the emotions out of it. When you have something that is doing very, very well, you want to put all of your chips in that basket, which could be disastrous.
Jason Pereira: [crosstalk 00:26:41].
Dustin Dinis: Yeah.
Jason Pereira: And that's one of the things I like about these single ticket solutions is that, you just see one line, you see one return. It's not... Because I always say with these things. It's never sexy, it's never going to make you panic either because the market may be up in Canada 20% and you're going to to get some of that. You're not going to get all of it. And the market may be down like it was when COVID hit 30, some odd percent around the world and you open up your statement and you're like, "Oh, I'm a risky investor, I'm down 12. I'm a conservative investor, I'm down four." So, you give up some of the upside, but you sure as heck give up the downside in the long run, you're better off. So thank you very much for this. So very much appreciate you coming in and talking about how it is people can assemble their portfolios. Where can people find you and your company?
Dustin Dinis: Very easy. You can find us on ci.com. There's a wealth of information there. You can also look up articles on our tax retirement and estate planning website, ci.com, the TREP Team and then I would highly recommend, we mentioned it earlier in the program, but if you're just starting out, it is very important to speak to a financial advisor.
Jason Pereira: Yes.
Dustin Dinis: Trying to figure out a lot of these things on your own can be very complicated. There are people who know this, who do this every day, just like yourself. And I would recommend speaking to one of them to make sure that you're in the right portfolio.
Jason Pereira: Yeah. And one of the things we cover very heavily on this show is that the world of finance is not just about investing. This is a part of it. And frankly that advisors should be doing a lot more for you than just telling you where to invest.
Dustin Dinis: Absolutely.
Jason Pereira: Excellent. Dustin, thank you very much.
Dustin Dinis: Thank you, Jason.
Jason Pereira: Thank you. And thank you for joining us yet again for The Wisdom of Wealth, where we help improve and better your financial literacy. Until next time, take care.