Hi everyone!
Welcome to the final part of the Q&A! To recap, on Instagram– I shared that I would have a Chartered Financial Analyst (CFA) charterholder answer your investing questions just in time for the new year and TFSA limits refresh. With that, here is the Q&A below.
Before we get into the Q&A, I’d like to state that the answers are just my opinion. It should not be deemed actionable advice without your due diligence. The answers are rather broad observations and insights I’ve picked up over the years.
From those questions, there were three key themes: how much should they save/need to retire, how much risk can they assume, and asset classes (real estate vs. stocks vs. ETFs, etc.) This post answers the questions around asset classes.
Asset Classes
I’ve heard a lot about call options, what are they, how can I use them, and should I use them? Right now, I plan to use my investments for retirement. Currently, I have some ETFs and stocks.
Funnily enough, this question was asked before last month’s insane market activity with GME, AMC, and other meme stocks – so it’s a rather timely question.
Options are considered an alternative asset class as its value is derived from some other underlying asset (not the actual stock itself). They’re complicated and likely not suitable for most investors.
You can buy or sell options. And within that, you can buy the right to buy (call) or sell (put) options. And you can sell the right to buy (call) or sell (put) options. You can read that again if you need it!
You can use them in various ways, but typically, it can be advantageous to use them for risk management. If you are a Gamestop shareholder and believe the price run-up may end, and share prices might come down, and you want to protect yourself, you can buy a put option. This would mean you would have the right to sell your shares are a specified price.
A ‘simple’ example:
- You bought Gamestop for $50 per share
- The current price is $150
- You believe the price might drop below $100
- You purchase a Put option, so that you have the right to sell your shares at a strike price of $145
- You have insured against sharp losses by purchasing a Put option, which guarantees the maximum loss of $150 – $145 = $5, plus the cost of the Put.
On the flip side, you can purchase Call options if you have strong conviction that a stock will increase in value, and you do not want to purchase the shares outright.
Keep in mind that if your options expire “OTM” (out-of-the-money), they expire worthless, and the cost of your options is a realized loss.
As options are considered an alternative asset class, it’s typically associated with a high risk/reward ratio, which makes them unsuitable for most people looking to protect and grow their money.
They’re more catered towards people looking to manage risk from existing positions (like a concentrated single asset position that makes up 90% of the person’s wealth).
Should I invest in the market or in
real estate?
I’d love to know if there are any tips regarding those wanting to get into real estate as an investment piece! Tips or dos/don’ts that would help.
I’m going to try and answer both questions here. The answer is not intended to decide for you, but rather provide some context into your decisions with how you want to invest your money.
Because Real Estate exhibits different characteristics than stocks and bonds, it is considered a different asset class in the context of investing.
The heterogeneity of properties (no properties anywhere can ever be the same), high transaction costs (commissions, fees, taxes), illiquidity, and valuation subjectivity make real estate vastly different to traditional asset classes like stocks and bonds.
You can invest in real estate in two ways: direct ownership or indirect ownership. Direct ownership is owning a piece of real estate. Indirect ownership is owning a publicly listed company that invests in real estate.
Believe it or not, directly investing in property is extremely high risk. You’re exposed to tenant risk, interest rate risk, market risk, property/operational risk, bankruptcy, liquidity risk and more.
But, if you’re from Vancouver or Toronto, we’ve seen that with high risk, comes the possibility of extremely high returns.
People choose to invest in direct real estate mainly because of the available leverage (you can mortgage 80% of a property value, but it’s unlikely you can open a margin brokerage account for more than 50%). You have full control on what you would like to do with your property.
You can build, renovate, live in or rent it out in order to extract a positive return. If your goal is to rent it out, the idea is that someone else is paying your carrying costs (mortgage payments, taxes, etc.), and the equity at the end of it is all yours.
So all in all, it’s not a bad idea to build your net worth via rental cash flow and high leverage from the bank.
However, you can replicate just about all of the financial benefits of directly owning a piece of real estate with indirect ownership through publicly listed REITs, with added benefits of liquidity and diversification. Rental income can be replicated through the income that REITs are obligated to pay.
Property values go up, share price goes up with it, and you still benefit. The downside of investing in a REIT is that you have no control of the property.
Liquidity is a massive benefit of indirect Real Estate investing. Liquidity is how quickly or easily you can convert your asset into cash. Are transaction costs low? How deep is the market breadth? Is price discovery easy?
For example, if you need to pay for your kid’s braces one year, and you didn’t plan for the expense, you can’t sell off part of your investment property to pay for it.
Sure, you could apply for a HELOC or refinance your mortgage, but if you have ever gone through the process of loan applications, you know that process isn’t the quickest solution.
On the extreme end, you would need to liquidate the entire property. Whereas indirect investment into publicly listed shares of a real estate company offers you the flexibility of selling whatever percentage of ownership you wanted within seconds (when the market’s open).
In terms of diversification, you can diversify your money with the asset class, the sector, and the market. For example, you can spread your money across commercial REITs, and multi-family properties REITS, and you can invest a bit in the S&P to gain some exposure to the broad index.
The old, played-out adage still holds very true in 2021: don’t put all your eggs in one basket.
The other major consideration I would like to highlight here is your time. When you are a direct real estate investor in the conventional sense, you aim to generate monthly cash flows, as I described above.
Consider if you are okay with becoming a landlord and the added time constraints this may have on your day-to-day life, tax implications, and of course, your long-term financial goals.
If I don’t want to DIY invest, what should I look for in a financial professional?
If you like shopping for deals, this will be highly relatable. What else can you do besides shop around?
Do your rigorous research and self-evaluation to get a sense of where you at with this investing thing. If you think you rather hire someone, meet at least a handful of professionals.
Truly get to know them as a person and as a professional. You do not want to hand over your life savings under any other circumstance besides having your complete trust in the individual.
The Portfolio Management Association of Canada (PMAC) wrote these extremely helpful guides for anyone navigating the investment management landscape:
This link details the differences between the overwhelming types of professionals out there.
This is a great resource if you are just starting your hunt for the right partner.
• https://pmac.org/wp-content/uploads/2011/04/Selecting-Investment-Counsel.pdf
This brochure is a short and tidy summary of what you should look for in a Portfolio Manager.
This is a comprehensive guide for things to ask yourself, and things to ask when you meet with potential professionals.
• https://pmac.org/wp-content/uploads/2011/04/PMAC-Is-A-Portfolio-Manager-Right-For-You-October-2016.pdf
Final Thoughts:
Thanks to Michelle for allowing me to share my thoughts around your questions on investing, and thanks to you all for submitting your questions. I found it quite difficult to succinctly answer these questions; but I tried to keep it short, yet informative. I can talk for days about this stuff.
In parting, I want to say it is by no means an easy task to do this on your own, for the results you won’t see for many years (even decades). Based on the questions I have seen, the strongest theme appears to be ‘where do I start’? Where do I start with investing, with RRSPs or TFSAs, with stocks or savings accounts or options or real estate, and so on.
If you are asking these questions, my belief is that you should be starting with yourself and your personal goals (beyond the financials), and then determine what financial moves will help you achieve that. Once you have explored and clarified that with yourself, executing on your vision should fall into place over the long run. Sure, there will be hiccups along the way, but whatever those goals may be, they’re very unlikely to happen overnight, so be patient and be smart with your next move.
About the author:
Trevor Lee, MSc, CFA, is a registered Portfolio Manager at a discretionary portfolio management firm based in Vancouver, BC. He focuses on building high-quality investment portfolios for investors of all sizes.
Disclaimer:
The content in this post is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained in this post constitutes a solicitation, recommendation, endorsement, or offer by myself, my firm, or any third party service provider to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction.
