Here are some guidelines given to a 24-year-old novice investor with $10,000 in her bank account who asked about penny stocks (like junior mines), because they’re so cheap, but who is also nervous about investing in them.
My advice is to avoid penny stocks for now. Even before you start researching stocks as potential investments, you have to start with the basics. First, remember that there is no free lunch. If you are serious about investing, then you will need to start from ground zero and build from there.
Here are my six rules for getting started:
It’s all about getting a grip on your income and your outgo. Live within your means, and do not spend more than you earn. Simple advice, and something you’ve probably heard a thousand times. Yet, many people just seem unable to follow it. That’s where planning comes in.
Most people benefit from a written plan—somehow that makes your goals seem more “real.” You do not need to make a six-figure salary to become a successful investor, but you do need to set out a diligent savings goal and investment plan that will span decades.
Understand the power of compounding. This is the principle that any earnings from an asset will in turn generate their own earnings. Compounding allows your original investment amount to grow faster when earnings are reinvested than when earnings are paid out.
Most people will have heard about “compound interest,” which is simply the principle of compounding applied to interest-bearing assets, like guaranteed investment certificates (GICs), where the interest earns interest.
Start early. The more years you have to invest, the more manageable your plan becomes. For example, let’s say you place that $10,000 in a non-registered investment account that returns 8 percent annually. Let’s also assume you can contribute $5,000 at the start of each and every year for 35 years.
At the end of 35 years, you would have accumulated $728,226, but you’ve paid an eye-popping $271,774 to the Canada Revenue Agency along the way.
This is because the growth on your investments is taxed annually at your marginal tax rate (in this case, using a 31.15 percent tax rate), leaving you an after-tax rate of return of 6.4 percent.
The CRA has collected $270,000 from you for absolutely no reason! That’s why Rule Number Four is so important.
Make full use of tax-free, tax-deferred, and tax-efficient investment plans and products. To see what I mean, take the same example I used in Rule Number Three above, except apply it to a tax-free savings account (TFSA).
Using the same investment plan described above, after 35 years, you will have accumulated $1,067 412 in your TFSA. And it’s all yours—without paying a cent of tax on that growth ... ever.
Always pay high-interest debt off (like credit cards) first, before investing. If your credit card charges you 19 percent in interest and your expected market return on investments is 7 percent to 9 percent, it only makes sense to pay the higher rate off first.
Be flexible. Your life will change and evolve, and your savings and investment plan must grow with you.
Once you understand the rules, the rest falls into place. Create an investment plan that matches your risk-tolerance level. If you need help, consult a fee-for-service certified financial planner.
For example, it makes absolutely no sense to say you’re a conservative investor and then jump into trading penny mines on the TSX Venture Exchange.
Once you’ve set your investment plan in motion, track it weekly or monthly. You’ll be surprised how fast your investable assets can grow when you take control.
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