Investing 101

When I started my career in finance, one of my first big assignments was delivering a 45-minute Investing 101 talk to employees at a local tech company. I got good feedback on the talk and I was invited to keep coming back every month, which I did for years. In many ways, those talks early in my career were a precursor to this YouTube channel. I'm going to cover that same Investing 101 information in this video. I'm Ben Felix, Chief Investment Officer at PWL Capital, and I'm going to teach you Investing 101. I'm going to cover why investing matters, what stocks and sensible approach to investing looks like, and what tools you should consider using to implement these ideas. At the most basic level, investing is important because inflation is a real thing. Inflation means that stuff gets more expensive measured in dollars over time. Central banks and countries like Canada and the United States target low but stable inflation rates for reasons beyond the scope of this video. The important thing to understand is that inflation should be expected, meaning that dollars held under your proverbial mattress should be expected to lose purchasing power over time. The same number of dollars will be able to buy less stuff in the distant future than they buy today. This isn't a grand conspiracy, and the solution is actually pretty simple. Don't hold dollars that you plan to use in the distant future under your mattress. That is, at a baseline, why investing is important. Rather than under your mattress, investing your dollars into assets with positive expected returns can generally offset the effects of inflation, and then some. Stable investments like treasury bills and high interest savings accounts should generally be sufficient to keep pace with inflation, not always but generally, and investing in riskier assets with higher expected returns can help you on your way to becoming financially independent. Financial independence means that over your working life you save a portion of your income, converting your human capital, your ability to earn income by working, into financial capital, the ownership of financial assets, eventually reaching a state where you do not need to work for money. Financial independence. Let's look at a couple simple examples to see why investing matters. If you're 30 today, saving 10% of your income, and expect to earn a 7% rate of return on your investments, you could retire at 65 and replace 60% of your pre-tax income from your savings until age 95. That's not including government pension benefits like CPP and OAS in Canada, or social security in the US. If instead of earning a 7% expected return, you earn 2%, which is a number in line with the inflation rate in this simple model that we're playing with, you would need to save a little more than 50% of your income. The difference between saving 10% of your income and 50% obviously has huge implications for your lifestyle today. One way to think about this is that by taking on some risk to earn higher expected returns with your investments, you're letting the financial markets do a lot of the heavy lifting toward funding your financial independence. That is the main premise of investing. At a minimum, you need to keep pace with inflation, and if you're strategic about taking the right kinds of risk at the right time in your investing lifetime, you can use financial markets as a very powerful tool on the path toward financial independence. The next important concept is understanding what I'm talking about when I say things like taking risk and investing in higher expected return assets. I'm not talking about trying to pick winning stocks or getting ahead of the next market trend. Two of the largest and most practically relevant types of assets, investments, for long-term investors are stocks and bonds. Stocks and bonds are both financial assets. A financial asset is not a physical asset like a house or a piece of gold. It is a contractual claim on expected future cash flows. I'll explain what that means, don't worry. A stock is a piece of ownership in a company. When you invest in a stock, you're buying an asset whose value today is based on the expected future profits of that business. As a shareholder, you participate in the ups and downs of the company's successes and failures. If a company does well, you can earn high returns. And if it does poorly, you can lose money or even lose your entire investment. Stocks in aggregate have performed well historically. Global stocks have returned a little more than 8% annualized before inflation or a little more than 5% after inflation for the last 125 years. The stock markets of some individual countries have performed much better than the global average, while others have performed worse. It's important not to read too much into this when deciding where to invest. For example, the U.S. stock market has delivered huge returns in recent history, but this will not necessarily always be the case. The Japanese stock market is a cautionary tale. From 1970 through January 1990, Japanese stocks more than doubled the annualized return of world excluding Japan stocks. Over so many years, that means that $1 invested in Japanese stocks grew to $53.56, while investment in rest of world stocks grew to only $6.72. Japan had become a dominant stock market at the time, and it might have seemed crazy to invest anywhere else. There were narratives about Japanese innovation and efficiency making them economically unstoppable. However, if you had invested in Japanese stocks in January 1990, after that period of crazy good performance, you would have $1.90 in August 2025, while the cost of purchasing $1 of stuff that people need had increased to $2.54. This means that you lost money after inflation over this period investing in Japanese stocks. An investment in rest of world stocks would be worth $22.94 over the same period. That Japan example is for sure an extreme outcome, but given the challenges in selecting which country will perform well in the future, holding a globally diversified portfolio of stocks covering a cross-section of the world's stock markets is generally wise. It's common for investors to want to invest in countries that have recently performed well, or avoid investing in ones that have performed poorly, but this performance-chasing behavior is more likely to do harm than good. Past country performance does not tell us much about future country performance. Figuring out how much to put into each country is another interesting problem, but the good news here, and this gets really interesting, is that the market has answered that question for us. The is shorthand for the huge amounts of buying and selling of stocks that occurs around the world every day. Each transaction in the stock market contributes a little bit of information into the price of a stock. All that buying and selling ultimately determines the value of the companies traded on the stock market. The market pricing machine assigns value to companies based on things like their expected future profits, their riskiness, and how they behave relative to other stocks in the market. In general, more profitable and less risky companies become more valuable, all else equal, earning them a larger weight in the market. Similarly, the combined size of the companies in each country determines that country's weight in the global market. Those are called market capitalization weights, and they're a very, very good starting point for an investment portfolio. In simple terms, this means that you can look at the relative size of each country's and allocate your portfolio accordingly, and you need a good reason to be different from those weights. Today, that means a large portion of a market capitalization weighted stock portfolio is invested in the US market. All that said, taxes, costs, and the currency that you spend your money in could all be reasons to somewhat increase the weight of your home country relative to its market capitalization weight. Too much home country exposure is generally not a good thing, but some overweighting of home country stocks relative to their market capitalization weights can be sensible. This will come up when we look at some sample portfolios later in the video. While global stocks collectively have done well historically, individual stocks have been very risky. Many of them performed poorly, often going to zero, while a relative few of them have performed exceptionally well. Picking those exceptional winners ahead of time is really, really hard to do. Similar to not picking countries, it generally makes sense to hold a diversified portfolio of many stocks. Again, market capitalization weights are a good starting point. The good news is that today there are low cost investment products that make it easy to buy a globally diversified market capitalization weighted portfolio of stocks. It's important to mention that even a properly diversified portfolio of stocks can have violent ups and downs. When your stock portfolio represents your financial future, your financial independence, it can be very hard to watch its value swing wildly, which makes stocks difficult for a lot of people to invest in. Somewhat paradoxically, that difficulty or riskiness is exactly what makes stocks good long term investments. If stocks were safer and their prices didn't change much day to day, they would have lower expected returns. Not everyone can comfortably hold a portfolio of 100% stocks. This is where bonds come in. Bonds are loans made to companies and governments. Instead of buying a piece of ownership in a business, like with a stock, with bonds you're effectively making a loan to a business or a government. Unlike a stock, if a company performs better than expected, its bonds won't change in value much. And if a company does poorly, its bonds still won't change in value much. Even if a company goes bust and its stock becomes worthless, its bondholders may be able to recoup some, not all, but some of their value. Government bonds tend to be even more stable. Bonds are still not guaranteed investments, and they come with their own unique risks, but they generally do not change in value from day to day as much as stocks do. In finance jargon, finance speak, they are less volatile. Bonds are less volatile than stocks. While bonds are less volatile than stocks, they also have lower expected returns. That's the risk-expected-return tradeoff with stocks and bonds. Bonds are also sensitive to inflation. Periods of high inflation can reduce the purchasing power of money invested in bonds, which is a problem for long-term investors. Stocks aren't inflation hedges, but they do tend to perform better after inflation than bonds over long periods of time. Using these two asset classes as building blocks, you can create an investment portfolio that matches your desired levels of expected return and volatility. A stock-heavy portfolio should be expected to be more volatile and have higher expected returns, while a bond-heavy portfolio should be less volatile and have lower expected returns. I am being intentional about referring to stocks as being more volatile rather than more risky than bonds because risk is a pretty ambiguous term. Volatility is certainly one way to think about risk and commonly how it's framed for investors. The risk of not being able to meet your long-term financial goals is another way to think about risk. Some research has suggested that from the perspective of meeting your long-term goals, stocks may be safer than many types of bonds despite their higher volatility as long as you can handle the ups and downs. Okay, so these broad asset classes, stocks and bonds, exist, and their expected returns are useful tools to plan for the future. It's not terribly complicated, but many people have been taught that investing means guessing and predicting, predicting which stocks or markets will do well, or predicting when to get out of the market to avoid a crash. This general concept of following the market really closely in an effort to gain an edge by guessing and predicting is typically referred to as active management. At the most basic level, active management is the idea that you can use your knowledge, your information, to outguess the market resulting in improved performance. The problem with this idea is that the market's main function is aggregating all available information, including expectations about the future, into the prices of stocks and bonds. The idea that any one person or even team of people can consistently outguess the combined information production of all market participants is kind of far-fetched. An economist named Eugene Fama shared the 2013 Nobel Memorial Prize in Economic Sciences for his work on the efficient market hypothesis, which formalizes the idea that prices are pretty good representations of all available information about stocks and bonds. From the perspective of investors, the people probably watching this video, one of the best tests of market efficiency, as Fama explained to me when he was on my podcast, is whether professional active managers can consistently beat the market. If prices do not reflect all available information, if markets are not efficient, a savvy active manager should be able to learn things about a stock that are not currently reflected in the price and profit from trading on that information. What we see in practice is that only a small percentage of professional active managers are able to outperform the market, and even the ones that do outperform over one period rarely go on to continue outperforming in the future. This makes it very hard to pick winning managers before the fact. I would also say that this extends to individuals trying to devise their own active investment strategy. Sometimes active managers get thrown under the bus, people make excuses like well they can't because of their fees or they can't because their funds are too large, but very few individual investors beat the market. I think the same concepts apply to both professional active managers and individual investors. The alternative to active management is typically referred to as index investing. An index is a representation of a stock market. In Canada we have the S&P TSX composite index. The US market has a whole bunch of different indexes tracking it, but most people are familiar with the S&P 500 index. These are groupings of stocks that have been put together by a research firm, in these cases by S&P, to be a representation of a country's stock market. These indices are market capitalization weighted, meaning that larger companies get a larger weight in the index than smaller companies. Since they simply hold stocks as they exist in the market, they're often used as the benchmark for active managers. It's basically like an index is like what if you just did nothing? What if you just took the market values of stocks and held them like that? So it's an obvious comparison to an active manager who's trying to do something. So the index are used as a benchmark for the active managers. Now an index is not itself an investment, it's a representation of a market, but there are funds that rather than trying to beat the market simply invest in the stocks, in the index, in an effort to capture the market's returns. Index funds were first created in the 1970s based on the observation that active managers were not delivering index beating returns. The other issue that I haven't mentioned yet for active management is that to do all of the analysis and other work that's required to run an actively managed fund that tries to beat the market, these funds have to charge higher fees and even small fees in investing matter a lot due to compounding over long periods of time. If we think back to the earlier example of saving 10% of your income for retirement and earning a 7% expected return on your investments, if you pay an extra 0.64% in fees, that's the average fee difference between fee-based active funds and index funds in Canada, and you don't earn higher returns in exchange for the higher fees, you would need to save 12.5% of your income or 25% more to have a similar long-term outcome to the cases I talked about earlier. If the active fund that you choose underperforms by more than its fees, which is often the case since it's so hard to pick winning stocks before the fact, the numbers will look worse still. When you sit down with a financial advisor, they may well be able to show you a list of actively managed funds that have outperformed, making active management seem compelling. But the problem here is that over any 10-year period, for example, less than half of actively managed funds survive. The remainder close or get merged with other funds. Funds that merge or close tend to be poor performers that have failed to attract investors, which is why they are closing or merging. This creates a problem of survivorship bias. The sample of actively managed funds that exist at any point in time are not a good representation of the performance of actively managed funds in aggregate when survivorship bias is accounted for. The other problem is that funds that perform well and survive in one period are no more likely to continue winning in future periods. Index funds take the guesswork out of investing and make it accessible to anyone. You don't need to know how to analyze companies or predict the economy or identify a successful active manager before the fact to be a successful index fund investor. You don't even need to be interested in the stock market. You just need some baseline knowledge about index funds and enough conviction in your chosen strategy and your chosen portfolio to stay disciplined through inevitable difficult market conditions. That point is really important. You have to be able to stick with whatever you decide to invest in. To put this information into practice, as opposed to just talking about it from a theoretical perspective, we need to talk about investment products. In 2018, Vanguard launched the first asset allocation ETFs in Canada. An ETF is an exchange traded fund, which is a fund that you purchase on a stock exchange like you would purchase a stock, but it gives you exposure to a diversified portfolio of assets and you pay a fee to own it. Asset allocation ETFs are now offered by a ton of different financial companies in Canada. We're going to look at one of Vanguard's ETFs so that you can see what I'm talking about. VGRO is the Vanguard growth ETF portfolio. It holds a US total market index ETF, a Canadian total market index ETF, a developed markets excluding North America index ETF, which covers countries like Japan, the UK, France, Germany, Switzerland, Australia, and a whole bunch of others, and an emerging markets index ETF covering China, Taiwan, India, and a whole bunch of others, and also three bond ETFs covering Canadian, US, and global excluding Canadian and US bonds. The overall portfolio consists of 80% stocks and 20% bonds. Canada in this portfolio receives a much higher weight in the fund than its market capitalization weight. Canada is about 3% of the global market and it makes up about 30% of the equity portion of this portfolio. Now that is a deliberate decision by Vanguard reflecting an intentional home country bias, which may be appropriate for Canadians. I've got a video on that if you want to learn more about why that is. Vanguard has also created asset allocation portfolios for more conservative and more aggressive asset allocations, allowing investors to choose the product that makes sense for them. Since Vanguard had success with those products, BMO, RBCI shares, TD, McKinsey, and other companies too have launched similar asset allocation products. An important point is that these asset allocation ETFs are rebalanced for you. Rebalancing is the action of keeping your portfolio's asset allocation targets in check as markets change over time. For example, if you were to build your own ETF portfolio with the same underlying ETFs as VGRO, you would need to keep an eye on the weights of each fund. If the US market does particularly well over some period, it would end up making up more of your portfolio than you had initially intended it to. To resolve this, you need to buy more of the other ETFs or sell some of the US equity ETF or whatever. Rebalancing is not insurmountable, but it's work. It's real work that needs to be done. It often requires some math and a spreadsheet. Asset allocation ETFs take that off your plate and they do the rebalancing for you, which is pretty incredible. It makes investing just that much easier and that much more accessible. VGRO is just one example, but each individual would need to choose an asset allocation or an asset allocation product that has the mix between stocks and bonds that makes sense for their behavioral loss tolerance, their ability to take risk, and their financial goals. I've also got a video on asset allocation if you want to learn more about that. Investing is important because it combats inflation at a baseline, and when some risk is taken, it offers the expectation, not the guarantee, but the expectation of growing your wealth above inflation for your future financial independence. The two main asset classes to think about, at least at the 101 level, are stocks and bonds, both of which are financial assets. Stocks are more volatile and have higher expected returns, while bonds are less volatile and have lower expected returns. Depending on your goals and your ability to withstand the volatility of your investments from day to day, you can arrive at some mix of stocks and bonds that makes sense for you specifically. People tend to believe that successful investing requires understanding the stock market, the economy, and individual companies in order to guess and predict what to invest in and when to get in and out of the market, but decades of research suggests that these are fool's errands. Successful investing simply requires capturing the returns that financial markets have to offer, which can be accomplished using globally diversified, low-cost index funds. This is achievable in Canada today with the many low-fee asset allocation ETFs that we have available to us. Thanks for watching, I'm Ben Felix, Chief Investment Officer at PWL Capital. If you enjoyed this video, I discussed the same topic in episode 381 of the Rational Reminder Podcast with Dan Bortolotti, aka the Canadian Couch Potato, the OG of index investing education in Canada, you should check it out.