Frequently Asked Questions (FAQs)

Many new investors are unsure of their investing abilities, and post similar questions on investing fora. Some of these questions and their answers are discussed below.   

  1. Should I invest in shares of ABC Company? Answer 1.
  2. Should I invest in shares of ABC Company?  Answer 2.
  3. What is my most important investment decision?
  4. Which way are interest rates going?
  5. Should I buy bonds now or wait for better interest rates?
  6. Why should I buy bonds at all?
  7. I want to buy a house in three years. Should I invest in the stock market?
  8. Should I buy gold?
  9. How do I arrange my investments in a tax-efficient manner?
  10. I don't have room for all my fixed income allocation in registered accounts. Is there an alternative?
  11. My advisor tells me that fees don't matter when selecting a mutual fund, only performance matters. Is he correct?
  12. What is a "currency-hedged" fund?
  13. Can the average person be a successful do-it-yourself (DIY) investor?

External Links


Investors wishing additional information should consult the Wiki or Forum.


  1. Should I invest in shares of ABC Company? Answer 1.

    This is one of the most common questions asked by a new investor, where "ABC Company" may have been touted on an investment forum, on television, or in the press. However, in asking this question, the new investor is often focusing in the wrong place:  considering what instruments to purchase ("tactics") without having an overall investment plan ("strategy"). See Creating a Financial Plan - finiki, the Canadian financial Wiki and Portfolio Design and Construction - finiki, the Canadian financial Wiki for reading on how to set up an investment strategy.

  2. Should I invest in shares of ABC Company?  Answer 2.

    The honest answer to this question is that nobody really knows.  Markets are very efficient, meaning that by the time you've heard about an event affecting ABC Company, the stock price has already changed to account for the effects of the event. You have no advantage to invest in this company. (See Efficient Market Hypothesis (EMH) Definition | Investopedia).

    If, on the other hand, you are an experienced (rather than an inexperienced) investor, it is better to do your own due diligence rather than to rely on other sources (see All The Wrong Stuff).

  3. What is my most important investment decision?

    In my opinion, the most important investment decision is the allocation between stocks and bonds, which is the primary determinant of risk. See Asset allocation - finiki, the Canadian financial Wiki, Risk and return - finiki, the Canadian financial Wiki, and Portfolio Design and Construction. A realistic assessment of risk tolerance, and appropriate portfolio design to match that tolerance, is one of the major steps required by any serious investor.  Unfortunately, most new investors overestimate their tolerance for risk until after they have experienced a major market drop.

  4. Which way are interest rates going?

    This is another question to which nobody knows the answer. Although central banks can set short-term rates, longer term interest rates are set in the bond market, which is both very large and very efficient. Accordingly, everybody's idea about where interest rates are heading is already included in the current price. 

    It is possible to determine, by comparison to historical values, whether interest rates are high or low. But when - or if - the valuations will change is anybody's guess.

  5. Should I buy bonds now or wait for better interest rates? 

    Since nobody knows where interest rates will go, establish an investment plan (see Creating a Financial Plan) with asset allocation (see Asset allocation) and rebalancing (see Rebalancing - finiki, the Canadian financial Wiki) strategies. Then make purchases in accordance with this plan.

    For example, if your investment plan includes a fixed income ladder (see Fixed income ladder - finiki, the Canadian financial Wiki), in which you purchase a new "rung" each time one matures, the best strategy is generally to make the planned purchase, rather than trying to time interest rates.

  6. Why should I buy bonds at all?

    Bonds serve three purposes in a portfolio: to reduce volatilty (i.e. manage risk); to provide income; and to serve as a source of funds since bonds nearing maturity can be sold for cash. Even if the income provided is very low, the other two reasons - particularly risk control - are still important. Investors who have insufficient fixed income in their portfolios may well discover during a stock market crash that their risk tolerance has been exceeded (see Risk and return).

  7. I want to buy a house in three years. Should I invest in the stock market?

    Funds required for specific future purposes within a few years - house downpayment, college education, etc. - should not generally be invested in the stock market. Instead, consider utilizing either a high-interest savings account (see High-Interest Savings Accounts - finiki, the Canadian financial Wiki) for needs in the immediate future or, if the time period is known exactly, a fixed-term instrument such as a Guaranteed Investment Certificate (see Guaranteed Investment Certificate - finiki, the Canadian financial Wiki) that matures just prior to the funding requirement.

  8. Should I buy gold?

    This is a question for which there is no universal agreement on the answer.  Some sources advocate holding a small amount of gold - say, 5-10% of the total portfolio - whereas others do not.  Gold prices are volatile, but can act to stabilize a portfolio by reacting in a different way to other portfolio components.  Nevertheless, over the very long term (millennia), gold can not be expected to give a real after-inflation return that is significantly different from zero (see What is the Very Long Term Return of Equity?).

    Investors who include broad Canadian index holdings in their portfolios should be aware that they already have some gold exposure via Canadian gold-mining stocks.

  9. How do I arrange my investments in a tax-efficient manner?

    The usual approach is to fill the RRSP with fixed income, then, if there is room left, add equities in the following order: US; world; and Canada. The TFSA should hold emergency funds or fixed income, and Canadian equities, but US equities will suffer an unrecoverable tax withholding of 15% of paid dividends and should be held elsewhere. Anything left goes in the non-registered account. See Tax-Efficient Investing - finiki, the Canadian financial Wiki.

  10. I don't have room for all my fixed income allocation in registered accounts. Is there an alternative?

    Some people used preferred shares in non-registered accounts as a fixed income alternative, although not all analysts agree on whether preferred shares are "fixed income". Investors choosing this alternative can expect to require additional diligence in selecting securities, and may wish to consider paid advice or reviewing dedicated preferred-share sites such as PrefBlog.

  11. My advisor tells me that fees don't matter when selecting a mutual fund, only performance matters. Is he correct?

    When the total market is considered, funds charging fees must, as a group, underperform the total market by the average amount of the fees (see The Arithmetic of Active Management). Although these calculations do not preclude outperformance by individual funds, the fees present a barrier which must be overcome before outperformance can result. Additionally, ongoing fees are corrosive to the investor's total return (see Bequeathing Your Assets to Your Broker). Nevertheless, individuals not willing or able to manage their own assets may benefit by utilizing low-fee mutual funds. High-fee funds should generally be avoided because of the greater barrier to returns.

  12. What is a "currency-hedged" fund?

    If an investor buys securities denominated in another currency - say, US dollars - he or she is exposed not only to changes in the valuations in the securities in their native currency, but also to changes in the currency exchange rate - for example, the US-Canadian dollar exchange value. Some mutual funds or exchange-traded funds use financial engineering to remove the effect of exchange-rate fluctuations.  These funds are termed "currency-hedged".  Although the cost of the financial engineering is not great, currency-hedged funds often have significant tracking errors, which can add substantially to the costs (see Currency-Hedged S&P500 Funds: The Unsuspected Challenges).  Since currency changes tend to even out over the long run, investors concerned with minimizing costs generally avoid currency-hedged investments.

  13. Can the average person be a successful do-it-yourself (DIY) investor?

    Unfortunately, many people are unable to successfully manage their own investment portfolios without the assistance of an advisor. The skills required may not be difficult if a simple portfolio design is used, but those skills may be quite hard for the average person to acquire. William Bernstein argued in The Probability of Success that only 1% or less of the populace was capable of successful DIY investing - that is, totally without skilled assistance.


External Links

finiki

Creating a Financial Plan
Portfolio Design and Construction
Asset allocation
Risk and return
Rebalancing
Fixed income ladder
High-Interest Savings Accounts
Guaranteed Investment Certificate
Tax-Efficient Investing

Other links

Efficient Market Hypothesis (EMH) Definition
All The Wrong Stuff
What is the Very Long Term Return of Equity?
PrefBlog
The Arithmetic of Active Management
Bequeathing Your Assets to Your Broker
Currency-Hedged S&P500 Funds: The Unsuspected Challenges
The Probability of Success