How to start investing with ETFs in your 20s

Teaching kids how to invest

I think it is great you want to teach your daughter about investing, Marv. One word of caution, though, is that not everyone wants to be taught. I have seen cases where parents want to give money to their kids to invest, and the kids actually decline it. That said, I will offer up some advice and raise some considerations so that you can teach her well—instead of her having to rely on advice from Reddit. 

Where to invest in your 20s

It has never been easier for investors to do it themselves. Commissions to buy and sell are declining, and information about investing is plentiful. However, sometimes access to too much information can be overwhelming. 

DIY investing and ETFs

My advice to a new DIY investor would be to stick with exchange traded funds (ETFs) over individual stocks. Stock picking is tough enough for the professionals, let alone someone trying to learn it part-time. Furthermore, you probably need 15 or 20 stocks at minimum to have a properly diversified portfolio. You should not just buy a couple stocks because then you end up with sector risk (exposure to only one or two sectors of the market) as well as individual company risk. 

ETFs vs mutual funds

An ETF is like a traditional mutual fund because it is an investment that owns several other investments. However, unlike most mutual funds which actively buy and sell investments within the fund, ETFs tend to be passive, as they track an index.

For example, you can buy an ETF that tracks the S&P 500, which means it simply buys the 500 stocks that make up that index. An actively managed mutual fund might only buy 50 or 100 of those stocks and try to beat the index. The costs are higher for an active fund due to the research involved and the analysts required to do that research. Which brings me to another major benefit: ETFs tend to have lower costs than mutual funds. 

That said, there are actively managed ETFs, but most are passive. There are also passively managed mutual funds (called index funds), but most are active. 

ETFs to know about

Here are a few ETFs that may be worth your daughter’s consideration:

iShares S&P/TSX 60 Index ETF (XIU)

iShares S&P/TSX 60 Index ETF is one of the most liquid and largest ETFs on the Toronto Stock Exchange (TSX). The first ETF in the world, this investment product has net assets of almost $13 billion and started trading in 1990. It seeks to replicate the S&P/TSX 60 Index and owns 60 large Canadian companies, like Royal Bank, TD Bank, Enbridge, Bank of Nova Scotia and Canadian Natural Resources. Given that three of the top five holdings above are banks and represent 19% of the ETF, it is a diversified portfolio of Canadian stocks, but not necessarily a diversified portfolio on its own. A diversified portfolio should likely include bonds and foreign stocks as well. 

Vanguard Balanced ETF Portfolio (VBAL)

An example of a single ETF that does have a balanced portfolio is Vanguard Balanced ETF Portfolio. It is the largest balanced asset allocation or all-in-one ETF trading on the TSX. It has 60% in stocks and 40% in bonds—a good example of a so-called “balanced” portfolio. The stock allocation is made up of Canadian stocks, U.S. stocks, developed market stocks and emerging market stocks. The bond allocation is made up of Canadian bonds, US bonds and global bonds. This single ETF gives exposure to nearly 14,000 stocks and 18,000 bonds. An investor could buy this as their sole investment. 

The best way to invest when you’re young

You likely already know this, but the advantage of investing when young is that you have time to let those investments grow. But fees should still be top of mind. There are several discount brokerages charging no fees to buy ETFs, but even those that are charging fees typically cost less than $10 per trade. 

If someone wants to build their own portfolio of ETFs, they can buy the individual components. In other words, they can buy a Canadian stock ETF, a US stock ETF, international stock ETFs and various bonds ETFs. There are ETFs that track certain stock sectors, commodities, real estate, cryptocurrencies and even ETFs that go up when stocks go down. This can make things more complicated than is necessary, especially for a new investor. 

The well-known Canadian couch potato portfolio and variations of it provide good examples of how to build a relatively simple DIY portfolio. 

Online advisors, often called robo-advisors, have made it easier for investors to own ETFs without having to build their own portfolio. Using a risk tolerance questionnaire that is generally supplemented by a discussion with a portfolio manager, they can develop an ETF portfolio that is automatically rebalanced when there are deposits, withdrawals and when the holdings fluctuate in value. 

What to consider for a small portfolio

In your daughter’s case, Marv, there are considerations beyond which ETFs to use and whether to go DIY or use a robo-advisor. I think you need to help her determine the purpose of these funds. Is this money she may need to use for schooling or in the short-term, or is this money she may not need for a longer time period? If she could be done school in a couple years and she may need the money for an apartment or a car or some other purpose. So, there may not be a lot of time to invest the money into stocks that could be down when she needs to withdraw from it. Arguably, contributing to a savings account, like a high-interest savings account or a tax-free savings account (TFSA), or only allocating a small amount of funds to ETFs that contain stocks may be more appropriate for her at this time in her life. 

She is 20, so will have at least $18,000 of TFSA room accumulated. TFSA room accumulates from the age of 18, and if she turned 20 this year, Marv, she will have 2020, 2021, and 2022 TFSA limits of $6,000 each. If she is 20 and turning 21 this year, she may have an additional year—2019—which also had a $6,000 TFSA limit. So, she may have up to $24,000 she could put into a TFSA, if she has never contributed before. 

A registered retirement savings plan (RRSP) is probably not appropriate if she is a university student with little to no income. RRSP contributions are more beneficial when your income is higher for the tax deduction savings. She could withdraw from her TFSA to contribute to an RRSP in the future if it made sense at that time.

I hope this helps you to guide your daughter, Marv. Good luck and good on you for trying to pass down good financial habits to her. 

Read more on student money:

• How to invest as a teenager in Canada
• The MoneySense Student Money Guide
• Which type of ETF investor are you?
• How to use ETFs in your child’s RESP
• A year-by-year guide on using RESPs

About Jason Heath, CFP

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.

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