Invest Wisely: Strategies For Profitable Returns

Investing is a powerful way to make your money work for you. It's less intimidating than you may think, and you don't need to be a finance expert to understand the basics.

There are several types of investments, including stocks, bonds, mutual funds, exchange-traded funds (ETFs), and more. Each has its own level of risk and potential return, so it's important to understand the basics before investing your money.

One of the most important things to remember is that investing is typically a long-term game. Very few people make money in stocks overnight. By adopting a buy-and-hold strategy, where you hold stocks or other securities for a long time instead of engaging in frequent buying and selling, you can increase your chances of seeing strong annual returns.

Additionally, diversifying your investments across different types of assets and industries can help reduce risk and boost returns over time.

Finally, choosing the right investment account is crucial. Some accounts offer tax advantages, like tax deductions or tax-free withdrawals, while others allow for more flexible withdrawals but may have higher tax consequences.

By understanding the basics of investing and adopting a long-term perspective, you can put your money to work and potentially build wealth over time.

Opt for funds over individual stocks

When it comes to investing, you may be wondering whether to put your money in individual stocks or opt for funds. Here's why the latter option is often the better choice:

Diversification and Risk Reduction

Mutual funds and exchange-traded funds (ETFs) offer instant diversification. Instead of investing in just one company, these funds spread your investment across a variety of stocks or other securities. This diversification is a powerful risk-reduction strategy. By investing in multiple companies, you lower the chances of losing money if a single company underperforms or fails.

Professional Management

Mutual funds and ETFs are professionally managed. This means that a fund manager, supported by a team of experts, makes the day-to-day investment decisions, such as which stocks to buy and sell, on your behalf. This can be especially beneficial if you don't have the time or expertise to research and select individual stocks.

Lower Costs

With mutual funds and ETFs, you benefit from economies of scale. The cost of trading is spread across all investors in the fund, resulting in lower costs per individual investor. While these funds do charge management fees, they are often relatively low, especially for passively managed funds.

Convenience

Investing in funds is a convenient option, especially for beginners. You can defer the responsibility for investment decisions to financial experts, who will construct and monitor a portfolio that aligns with the fund's stated goals and strategy. This saves you the time and effort of having to research and select individual stocks yourself.

Easier Access to Specific Industries

Funds, particularly sector funds, provide an easy way to invest in specific industries or sectors of the economy. For example, you could invest in a fund that focuses on technology, healthcare, or raw materials. Trying to replicate this level of industry exposure through individual stocks would be much more time-consuming and challenging.

Long-Term Wealth Growth

Funds, especially those that invest in stocks, have the potential for strong long-term returns. Historically, stock funds have delivered annual returns of around 9% to 10%. This means that your investments can grow significantly over time through the power of compounding.

In summary, opting for funds over individual stocks can provide you with a more diversified, professionally managed, and cost-effective investment strategy. It's a convenient way to access the expertise of financial professionals and benefit from their industry knowledge and experience.

Reinvest your dividends

Reinvesting dividends is a powerful way to build wealth over time. Dividend-paying stocks can be a great addition to your investment portfolio, and reinvesting the dividends you receive can further enhance your returns.

Here's how it works: when a company you own stock in pays dividends, you can choose to collect the dividend as cash or reinvest it to purchase additional shares of the company. By reinvesting your dividends, you are using that cash to buy more shares of the company, which can increase your overall position size and dividend payment over time. This is a form of dollar-cost averaging, where you are investing a fixed amount at regular intervals, in this case, each time you receive a dividend payment.

There are several benefits to reinvesting your dividends:

• Enhanced returns: Reinvesting dividends allows you to purchase additional shares, increasing your overall position size. As you own more shares, the total amount you receive from dividend payments also grows, as dividends are typically paid on a per-share basis.
• Compounding: Reinvesting dividends brings the power of compounding to your investments. Not only do you earn returns on your original investment, but you also earn returns on the additional shares you accumulate over time through dividend reinvestment.
• Cost-effectiveness: Reinvesting dividends is often a low-cost or no-cost option. Many brokers offer commission-free dividend reinvestments, and some companies may even offer discounted share prices for dividend reinvestment plans.
• Convenience: Setting up automatic dividend reinvestment is usually a straightforward process. Many brokerages provide the option to "reinvest dividends" when you purchase a dividend-paying stock.
• Flexibility: Dividend reinvestment plans (DRIPs) often allow you to purchase fractional shares, which is not typically allowed when purchasing shares on the open market.

While reinvesting dividends can be a powerful strategy, it may not always be the right choice for every investor. Here are a few situations where you may want to consider taking the cash instead of reinvesting:

• Retirement income: If you are at or near retirement and need the income, you may want to take the dividends as cash. However, be sure to consider your other sources of income, such as Social Security, pensions, or annuities, before making this decision.
• Poor stock performance: If the underlying stock is performing poorly or consistently declining in price, reinvesting dividends may not be the best option. In this case, you may want to consider diversifying your portfolio or investing in other opportunities.
• Portfolio balance: If reinvesting dividends causes your portfolio to become unbalanced, with a high concentration in a few investments, you may want to take the cash instead. This will allow you to diversify your portfolio and manage your risk more effectively.

In conclusion, reinvesting dividends can be a powerful tool for building wealth over time. However, it's important to consider your individual circumstances and seek advice from a financial advisor to determine if this strategy aligns with your investment goals and risk tolerance.

Choose the right investment account

Choosing the right investment account is crucial to achieving your financial goals. There are two main categories of accounts: registered accounts and non-registered accounts. Registered accounts offer government benefits such as tax sheltering, income tax deductions, or tax-free capital gains. On the other hand, non-registered accounts don't provide tax advantages but usually have more flexibility regarding deposits and investments. Here are some popular types of investment accounts:

• Registered Retirement Savings Plan (RRSP): This is a specialised account for retirement saving. You can't generally withdraw from an RRSP until retirement without facing early withdrawal penalties. The main advantages are tax-deductible contributions and tax-sheltered earnings. However, there are limits to how much you can contribute annually, and you may need to pay taxes upon withdrawal during retirement.
• Tax-Free Savings Account (TFSA): The TFSA is a flexible account that offers tax advantages. You won't get a tax refund upon depositing, but you also won't pay tax when you withdraw. The money in the account grows tax-free, and you can use it for various financial goals like buying a house or paying for a wedding. There are limits to how much you can contribute annually, and it's essential to ensure you have room for contributions.
• First Home Savings Account (FHSA): The FHSA is designed to help first-time homebuyers save for a down payment on their first home. It offers tax advantages similar to RRSPs and TFSAs. Contributions are tax-deductible, and you can transfer funds to an RRSP without penalties. Withdrawals are not subject to withholding tax or counted as taxable income if used for a qualifying home purchase. However, there is a time constraint of 15 calendar years or until you reach 71 years of age.
• Margin Account: This is a non-registered account that allows you to borrow funds from a brokerage to invest. Benefits include no contribution limits, short selling, and leverage. However, you will pay capital gains tax on profits, be charged interest on borrowed amounts, and may face margin calls if your position falls below the minimum margin requirement.
• Cash Account: This is a simple and flexible investment account where you invest using deposited funds without borrowing. It offers quick and easy account setup, automatic currency conversion, and no account interest charges or leverage-related risks.
• Individual Retirement Account (IRA): IRAs are standard brokerage accounts with access to a broad range of investments. The two most common types are Traditional IRAs and Roth IRAs, offering different tax advantages. Eligibility depends on having earned income or a spouse with qualified earned income, and there are income limits for certain contributions.
• Custodial Brokerage Account: This account is set up for a minor with gifted money, controlled by an adult custodian until the child reaches the "age of majority." There are two types: UGMA and UTMA, differing in the types of assets allowed. Money in these accounts can be used for any purpose but may affect financial aid eligibility if the child applies for it.
• Education Accounts: These include 529 savings plans and Coverdell Education Savings Accounts (ESAs), used to save for education expenses. Contributions are not tax-deductible, but qualified distributions are typically tax-free.
• ABLE Accounts: These accounts are similar to 529s but designed for individuals with disabilities. They offer tax-advantaged savings and protect access to public benefits such as Medicaid.

Manage risk by managing market exposure

Managing market exposure is a key aspect of investing and making a profit. Market exposure refers to the dollar amount of funds or percentage of a broader portfolio that is invested in a particular type of security, market sector, or industry. It is a tool used to measure and balance risk in an investment portfolio.

• Tiered Approach: A tiered approach to market exposure involves adjusting your investment portfolio based on market conditions. For example, during a strong uptrend, you may have 80%-100% exposure, while during a correction, you might reduce exposure to 0%-20%. This approach helps to gradually increase or decrease your investments based on market trends.
• Diversification: Diversifying your portfolio across different asset classes, industries, and geographic regions can help manage market exposure and risk. By spreading your investments, you reduce the potential for large losses if a specific area of the market is affected.
• Asset Allocation: Consider your financial goals, risk tolerance, tax situation, and time horizon when allocating assets across different investments. For instance, if you are pursuing growth, you may allocate 80% of your assets to stocks and 20% to bonds.
• Dollar-Cost Averaging: This strategy involves investing a fixed amount of money regularly, regardless of market conditions. By doing so, you buy fewer shares when the market is high and more when it is low, helping to build wealth over time and reduce the impact of emotional investment decisions.
• Risk Management Tools: Utilize tools such as ETFs (Exchange-Traded Funds) and futures contracts to manage market exposure and risk. ETFs can provide exposure to a diverse range of investments, while futures contracts allow for further leverage and the potential for significant profits or losses.

By implementing these strategies, you can effectively manage your market exposure and reduce investment risk, ultimately improving your chances of making a profit.

Focus on big earnings growth

Earnings are a primary measure of a stock's value. Earnings refer to a company's net income, or the money it makes after costs are deducted. Investors often use a statistic known as the price-to-earnings (P/E) ratio to help determine a stock's value relative to the rest of the market. This is the ratio of the current price of a stock compared to the company's earnings.

When assessing which of two stocks offers the best investment opportunity based on their P/E ratios, it's not always a straightforward comparison. "Determining fair value has a lot to do with the underlying growth rate of the industry in which the company competes," says Rob Haworth, senior investment strategy director for U.S. Bank Asset Management.

For example, investors may be willing to bid up prices based not on current earnings, but on expectations of future profitability. This is often the case with stocks that invest in new technology that may not have an immediate payoff but offer the potential of future strong earnings if they succeed.

Other stocks may have lower P/E multiples but generate steadier earnings, so the payoff on the investment needs to happen within a more compressed timeframe.

Earnings and Stock Valuations

With S&P 500 P/E ratios based on projected earnings exceeding 20 times earnings, the market may look expensive. However, Haworth notes that "we're in a different state now. Interest rates are still somewhat elevated, and inflation has come down significantly, so higher market multiples (P/E valuations) may be justified."

Technology-related stocks make up more than one-third of the S&P 500's valuation in today's market, and these companies are generally expected to realize faster, long-term growth rates, justifying their higher multiples.

Earnings Trends Going Forward

U.S. companies appear well-positioned for continued earnings expansion, and a key factor is the ability of the U.S. economy to maintain solid growth. Consumer spending remains strong, and this is the biggest economic growth driver.

If current economic trends continue, it may benefit a broader stock universe. In recent times, technology-oriented stocks dominated market performance, but a broadening of the market is being observed, with a globally diversified portfolio putting investors in a position to capitalize on a broad array of opportunities.

How to Find Growth Stocks

To find great growth stocks, you'll need to identify powerful long-term market trends and the companies best positioned to profit from them. Narrow your list to businesses with strong competitive advantages and large addressable markets.

• Identify trends and the companies driving them: Companies that capitalize on powerful long-term trends can increase their sales and profits for many years, generating wealth for their shareholders. For example, the shift to online shopping benefits companies like Amazon, Shopify, and Etsy, while the rise of artificial intelligence will require vast amounts of computing power that cloud providers like Amazon and Google can offer.
• Prioritize companies with competitive advantages: It's important to invest in growth companies with strong competitive advantages; otherwise, their competitors may pass them, and their growth may not last long. For example, Meta's Facebook benefits from network effects, where each new user makes the platform more valuable. Amazon, meanwhile, benefits from scale advantages, with smaller rivals finding it difficult to replicate its massive global fulfillment network.
• Find companies with large addressable markets: The larger the market, the larger a business can ultimately become. Industry reports from research firms like Gartner and Insider Intelligence can provide valuable insights into market sizes, projections for growth, and market share figures.

Final Thoughts

While focusing on big earnings growth can be a sound investment strategy, it's important to remember that investing carries risks. Growth stocks, in particular, can be much more volatile, as seen in 2022 when they took a beating in the market. Additionally, high inflation can pressure growth stocks by reducing the future value of their expected earnings.

When assessing potential investments, consider seeking professional advice and conducting thorough research to understand the risks involved and ensure that your investment strategy aligns with your financial goals, risk tolerance, and time horizon.

Frequently asked questions