Once your finances are in order, and good habits are in place, you are ready to invest wisely and speculate carefully. Investing is the purchase of an asset that, over a period of time, will produce income for its owner. On the contrary, betting on future prices is the definition of speculation. Hold a focused portfolio of companies, so that you can understand how they produce their earnings. The better you understand the company, the more easily to can attach a value and find buying opportunities in the market. It’s also easier to ignore market crashes and not panic when the price dips below the true value. You may want to focus on companies that pay out their earnings as dividends. It allows you to decide, instead of management, where that capital can best be allocated. It may also fund your income, such as in retirement. Companies that have no earnings are speculative. Speculation is not wrong, but it is very different from investment. Do not confuse the two and do not speculate with money that you can’t afford to lose, unless you have the knowledge and skill. Investing wisely can have a great impact on your financial position, as your investment income grows over time.
Investment decisions are fun and exciting, but if you have a small sum of money, it’ll grow faster through deposits than investment returns. This is not a licence to make bad choices. Losing all your capital is going to set you back, no matter the amount. It means that you can save the cash in your mattress, in a term deposit, in a bond fund or in a stock-index ETF. As long as the chance of permanent and total loss is minimised (speculating or gambling).
The priority you give different account types depends upon your situation, but I have provided a guideline. The pension is the simplest and usually most rewarding, due to employer contributions. If your income level puts you in a higher tax bracket, and you have contribution room and additional funds, you would maximise your contribution to your tax deferred (RRSP/IRA) account. An education saving plan, if applicable, makes sense up to the limit that you receive matching. A tax-free account is most flexible and especially useful for investment accounts where it can shelter tax otherwise arising from transactions. Finally, debt repayment is important, but usually the least financially beneficial. The exception is in the case of high, non-deductible interest costs (eg. consumer loans, credit card debt).
The two-steps of the automatic success plan are:
1. Have a home, with a mortgage that will be paid off by the time you retire.
2. Have a defined benefit pension plan.
As long as people always spent less than they earned, this automatic plan allowed them to retire as soon as they were eligible to draw a pension. This is why our parents and grandparents didn’t have to be concerned about financial planning and investing.
These days, we can still benefit from paying down a mortgage, living within our means and either enrolling in a savings plan offered by an employer or setting up our own. As long as it’s automatic, the probability of success is increased.