How I Lost $16,128 by Not Getting Started in Investing Earlier

Episode Links:

Canadian MoneySaver Magazine: Discount & Bonus

How to Invest in ETFs in Canada (Your Complete Guide to Index Investing)

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Article Version of Episode:

One of the biggest things that held me back from getting started in investing earlier was my definition of “risk”, and from associating “investing” with picking stocks.

I remember growing up and hearing about companies going bankrupt, and hearing from friends and acquaintances about the money they lost by buying shares of a company after hearing about a hot stock tip.

Others that I talked to would buy cheap penny stocks hoping that their value would skyrocket, only to have the company fail and be worth next to nothing now.

We see and hear such stories all throughout our lives whether we’re in high school, university, college, or out in the work force.

Looking back at these experiences, it doesn’t surprise me that my initial perceptions of investing in stocks was seen as extremely risky.

Now here’s the part that prevented me from getting started in investing earlier, which in turn resulted in me missing out on earning an extra $16,128. The mistake I made, was my definition  of “risk”.

Sounds weird right?  But hear me out:

Based on the experiences I just mentioned which involved seeing people lose money picking stocks, I began to perceive investing in stocks as having only two potential outcomes:

You either “hit the jackpot” by investing in some stock that ends up making you loads of money (ex. Blackberry in the early days), or the investment doesn’t work out and you lose most or all of your money.

In other words, I mistakenly defined “risk” as the probability that I could lose all my money. When looking at it this way, I started being extremely conservative with my money.

I was afraid to invest in stocks at all, and the only thing that I felt safe “investing” in was using my disposable income to pay down the mortgage quicker. I thought, “Why would I put my money in something where I can lose it all, when I can instead just pay down my mortgage which essentially  guarantees me a small rate of return”.

Aside: I should point out too that this decision happened when I was fresh out of university and amidst the 2008 financial crises, which for a beginner and uneducated investor was a very scary time to start investing in the markets. It’s hard to have confidence and see the drop in markets as a buying opportunity when you don’t fully understand what is going on, and all you hear is noise about how others have lost money by solidifying their losses when they panicked and decided to sell off their investment right after the drop.

Now don’t get me wrong, choosing to pay down your mortgage instead of investing isn’t necessarily a bad decision. It really depends on a multitude of factors, and the correct answer can be completely different from one person to another.

But the bottom line is that I shouldn’t have automatically just assumed that any sort of stock investing has a decent chance of me loosing all my money and therefore the only somewhat “safe” thing to do is pay off the mortgage quicker.

What I know now through a ridiculous amount of research over the years, is that there is actually a middle ground.

What is that middle-ground?

The answer is index investing (and for all the readers who are already a little versed on this subject, what I am specifically referring to and what I actually personally do and teach others to do is broad market index investing by buying low cost ETFs). If you don’t know what that is yet then don’t worry, we’ll go into that later.

If you’re just starting out in learning about investments then this definitely sounds like gibberish, and can sound very intimidating as there are companies that spend millions in advertising to make this all sound very complicated. This way instead of learning about this yourself, they hope that you instead seek them out, give them a lot of money, and let them do everything for you.

Then decades from now you wonder why your retirement savings aren’t as big as they told you they would be, when the real answer is that your paid them well over $100,000 in hidden fees over your lifetime (yes this does actually happen and is very common in Canada).

Of course there are great companies out there and many great financial advisors too, but my main goal here is to give you the knowledge you need so that you don’t get tricked into handing your hard earned money over to a salesperson disguised as an “advisor”. This happens way to often in Canada, and over your lifetime can actually cut the wealth you earn from your investments by almost half.

Think about that for a minute. Imagine having $500,000 in your retirement portfolio instead of $1,000,000 because you’ve been unknowingly paying hidden fees on your investments for the past 30 years.

Ouch!

But I digress…

The reason that you need to think about risk different when buying “broad market indexes”, is that you are not investing in a single company that can one day go bankrupt, or lose most of its stock price never to recover again.

Instead, if you do index investing properly, you are literally buying thousands of companies all at once, all over the world (ideally you’re doing this by buying low cost ETFs). Therefore even if some of those companies go bankrupt or drop in value, then those losses are offset by the thousands of other companies you have that have actually done great and made you money.

Just as an aside: I’ll have another episode soon defining ETFs and indexes for you if you’re just getting started in investing, but for now just know that I keep suggesting buying ETFs because they are an asset that you can buy just like a stock, which if you buy the right ones will mimic the broad stock market indexes. For example there are ETFs that you can buy where one ETF contains thousands of companies that represent 99% of the entire US stock market. This is what I am referring to when I say “buying the index” or “buying the entire stock market”.

The reason I often say “broad market indexes” (with emphasis on “broad”) is because I am referring to only buying the ETFs that mimic the broad market. For example, those that mimic almost the entire Canadian or US market, as opposed to mimicking only a small segment of those markets like mimicking the technology sector, or the financial services sector. Not all ETFs mimic the broad stock market so that is why this is an important distinction to make.

So what is the actual definition of risk?  While there are many definitions when it comes to investing, risk usually refers to the how large the standard deviation is for a particular investment.

To put it simply, standard deviation refers to how much the value of an investment can fluctuate.

For example, if you’re investing in a stock market index, then the value of those stocks will fluctuate a lot more than bonds.

The extreme example is if you just put all your money in a savings account at your bank or credit union. In this scenario, that money won’t fluctuate at all. You’ll just earn a really small interest payment that gets added to your pot of money.

What do I think about these ultra safe places to invest your money like savings accounts?

With them, you’re almost guaranteed to lose money because of inflation. So while your savings account won’t go down and won’t fluctuate which feels “safe”, when you factor in inflation you’re generally losing money over the long term.

This is why for long term you don’t want to be holding cash under your mattress, or in savings accounts.

The only debatable thing when it comes to this is your emergency fund. This is because you want your emergency fund money to be very safe and easily accessible if for example you get in a car collision, your roof starts leaking, etc.

So, if you actually end up investing in indexes properly, can you actually lose most or all of your money just like if you were investing in one particular stock?

While we should generally not use the word “guaranteed” when talking about investments, we can see that historically, the stock market has always recovered. Could we have a doomsday scenario where everything is lost never to recover again?  Sure. It could happen. I however personally feel comfortable in investing in entire indexes just because historically so far, they have always recovered even when we look at the last major financial crisis in 2008.

As of today, even if you bought the S&P 500 broad market index at the peak right before the 2008 crash happened, then if you held onto them until today, it would have fully recovered from the crash and have actually made you money.

This is an important point because we sometimes talk to people who have completely swore off the stock market after the crash. They say they lost half of their retirement in the crash, sold everything off, and have convinced themselves that the stock market doesn’t work, and wouldn’t touch it with a 10 foot pole.

Years later we now see from the actual data that there was actually an incredible recovery after the crash, and that if they actually owned and held broad market ETFs over this time, they would be net positive today.

Now of course some will say that they couldn’t wait that long for the markets to recover and they had to withdraw that money, but then the question becomes: If you needed the money in the short term,  then why would you invest it in the stock market when you know that over the short term, its value can fluctuate greatly.

If you were willing to wait a bit (i.e. medium term but not long term), then the question is: Was your asset allocation correct based on your life circumstances? In other words, if you need the money midterm, then a portion of your entire portfolio should be in investments that won’t fluctuate drastically like the stock market so that you can take that portion of your portfolio out if there is a crash (without losing a ton of money).

But fine, don’t take my word for it, let’s see what Warren Buffett has to say who I think we can agree knows a thing or two about investing.  🙂

If you don’t know who Warren Buffett is, he is a legendary investor that at time of this article is the 3rd richest person in the world with a net worth of around $60.8 billion which he earned being a professional investor.

When creating his will, his instructions to the trustee that is to help with investments going to his wife was to “Put 10% of the cash in short-term government bonds and 90% in a low-cost S&P 500 index fund”.

Buffet is known as being a stock picker, and at the top of his game when it comes to investing. So, isn’t it interesting that when deciding what a non-professional investor should do, he still says to put a majority of the funds in a broad market stock index, and a portion of it into bonds so that you can ride out the storms if you need the money in the medium term.

Now we can debate and analyze his decision at length, and I’m definitely not saying that all Canadians should adopt the same strategy by having such an aggressive asset allocation and by only buying the S&P 500 index for the stock portion of their portfolio. Your allocation should of course be based on your specific situation. But, my point for now is that if you need the money in the short or medium terms, then don’t put all your money into a stock index due to how much it can fluctuate during those short and mid-term periods.

Alright, so let’s get back to the title of this episode and answer why do I say that I lost $16,128 by not getting started in investing early enough?

Well like I said earlier, due to my definition of risk and a few other factors, upon graduating university my wife and I moved to the greater Toronto area (GTA) and optimized our lifestyle and finances in such a way that we were able put away around half of our household income into either paying off our mortgage quicker or investing it for retirement.

As an aside, if you’re interested in how we did it, you can listen to it in one of the earliest episodes of the build Wealth Canada Show, or you can read about it in any of  main personal finance magazines in Canada as it was published in both of them too.

In fact you can get the whole magazine that has the article from Canadian MoneySaver by going to buildwealthcanada.ca/deal. It’s on page 32, and you can just download the whole issue for free to sample the magazine and you don’t have to provide your email or credit card information. Then while you’re there you can subscribe to Canadian MoneySaver Magazine if you want, and you’ll get the bonus and discount that’s exclusive to Build Wealth Canada listeners.

Alright so based on all the fear and lack of education about investing, we decided to pay down our mortgage quickly which we did in around 6 years (it was fully paid off when I was 29). While there are many advantages to doing that, the disadvantage was that if we instead invested the money to buy the indexes using low cost ETFs, we would have been ahead by around $16,128 over those 6 years (FYI: For simplicity, here I’m using the average historical return of the S&P 500 index which is one of the main indexes that track the US market).

In other words, while we saved around $6,552 in interest by doing accelerated payments on our mortgage over that time period, we could have actually expected to make $22,680 if we instead invested the money in broad market ETFs that for example track the S&P 500 index (among others). When I did the rough math, the difference between those 2 numbers is $16,128 which is what I say I “lost” by doing the safer accelerated mortgage paydown vs investing in our retirement.

Now there are amazing benefits to having a paid off mortgage such as increased cashflow and financial stability. But the trade-off is that our net worth is not as high as it could have been. 🙁

Now once again I’m not saying that what we did should or shouldn’t be done by anyone reading this. What I am saying is that it is important to consider the numbers like this, analyze your situation thoroughly, even seek the advice of a fee-for-service financial planner who is in expert in these matters and can help you decide based on your goals and specific situation, where you should put your extra money.

Of course remember to use a qualified advisor, and one that doesn’t get a bonus, commission, or potential promotion at work by selling you investments like mutual funds.

Bonus Tip: If they say their financial planning services are “free”, then that’s typically a dead giveway that they are being compensated on the back-end through things like hidden fees which you don’t even see but are definitely paying for.

My point in all this, is that you shouldn’t let you’re fear of “losing it all” drive you to not even evaluate all the options available to you. It’s a big move, and one that should be based on your goals, ambitions, personal situation, and actual math as opposed to emotions such as fear.

I hope you enjoyed the episode!

Don’t forget to:

Have a great week!

Cheers.

Kornel

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