The Decibel - How to invest when the economy is on the rocks

Episode Date: February 16, 2023

Investing your money can grow your wealth faster than just saving it— or shrink it, if you put your money in stocks that fail, or have to withdraw your money from the market while it’s down.Erica Alini, the Globe’s personal finance reporter and author of the newsletter MoneySmart Bootcamp, shares her tips for how to think about investing wisely.Questions? Comments? Ideas? Email us at [e-mail]

Housing is expensive, inflation is high, and the stock market is uncertain. But we know that investing is essential to growing your finances. In this environment, how do you decide where to put your money or if you should rent or buy? What we're dealing with in pretty much every aspect of our financial lives right now is uncertainty. Erica Alini is the Globe's personal finance reporter. She's also the author of Money Like You Mean It, a book of personal finance tactics for the real world. Erica covered the ripple effects of the 2008 financial crisis, a crash which she had to guide her own finances through. So today, Erika is here with tips for investing in turbulent times.

I'm Mainika Raman-Wilms, and this is The Decibel from The Globe and Mail. Erika, thank you so much for joining me again on the podcast. Thank you so much for having me. We are in a different place right now than we were a year ago, for sure, right? Because I think a lot of people even made money over the first few years of the pandemic, but now we see the Dow Jones, the S&P 500, the TSX, they're all way down from their peaks about a year ago. So Erica, should people be more conservative or cautious in their investment choices right

now? I think that depends on where you're coming from and what your investment strategy is. But what I would say that holds across the board is this is a great time to make sure that you understand the basics of long-term investing, which is how to invest money that you can't afford to lose, which for most people is your retirement money. So investing has become really easy. It's easy to put money in the stock market. You can do it on your own. You can do it low cost. And that's great. There are some amazing options, but that also has made it easier to make some big mistakes. And so what you really need to do is understand how it is that you manage risk.

So you want to be spread out, not just sort of several companies, but also several sectors, and ideally, possibly several countries. Okay, that's a really good, clear first tip then. So what's next then? So most of us need the kind of returns, expected returns that are associated with investing in the stock market. Unless you have a plush workplace pension or some kind of family wealth, and then you need that kind of growth. You can just stick your money in a very safe investment because those generally have lower expected returns. And so if you are investing in the stock market, then it's really important to understand the stock market goes up and down, but over time, the stock market trends up. And so the key to long-term

investing is time in the market versus trying to time the market. Timing the market means trying to put your money into the market when the market is on its way up and then take money out when the market is on its way down. We'd all like to do that, of course. The problem is that it's very difficult to do that consistently over a very long period of time. So say the 30 years that you're going to be working or more, even for the pros, it's very, very difficult to consistently beat the market and time the market well. So don't worry about timing the market. You're saying just give it the time to grow. Give it the time to grow.

Exactly. And I often use the metaphor of a roller coaster, right? Like you're on a roller coaster and you have to choose the ride that you can stick with, where you're not going to be tempted to jump out because you got scared. Okay. That's a good way to think about it then. Yeah. And so I would imagine it's a little difficult though, especially when you're starting out to figure out your own risk tolerance, right? You're still kind of feeling things out for yourself. Can I just ask Erica, like, how did you start? How did you figure out your own risk tolerance for this stuff? I have an interesting story, I think. I didn't

start investing until quite late. I didn't start investing until my early 30s. I kept moving around early in my career. Like, I was in US, like it was between the US and Canada. And so I did not have in practice the long time horizon that people normally have in their 20s because I would have had to take my money out. Like there was so much uncertainty about where I was going to live. And so I held off investing. So then I started in my 30s thinking, I know everything there is to know. I am super confident. I am young. I'm going to be 100% stock. And then I was lucky that the stock market took a small beating.

And I was like, I don't like seeing my life savings drop. The drop was a bit too much. And it bothered me. And I was really surprised that it bothered me because rationally, I knew that I was perfectly fine being in a well-diversified stock portfolio. And so I tweaked my asset allocation a little bit. I switched it to 10% bonds and 90% stocks, and I've been fine ever since. Okay, so it's a little bit of personal learning here, then, it sounds like, for what is good for you, and everyone's going to be different.

Yes, I would say if you're working with a financial advisor, with an investment advisor, they will usually gauge your risk tolerance, your time horizon, and they will take care of helping you to, you know, evaluating your risk tolerance. If you invest with a robo-advisor, there's a similar process where you sort of answer a few questions that are aimed also at assessing your risk tolerance. If you're doing it on your own, Vanguard, the investing giant, has a handy investor questionnaire, and that can be a start.

But for sure, there's going to be some learning about what is your own risk tolerance. Okay. And I think when we talk about investing, we know that it has to grow over time, so it has to have that time to sit there. When is the right time to start investing then? Like, should people start investing as soon as possible and get into the market as soon as they can? So it's been really interesting to see how young people's attitudes have changed towards investing. Because when I started out, and also I lived in the U.S. during the financial crisis and immediately after, and I would say the financial crisis, more so in the US, but in general, has really kind of scarred the older millennials and made them quite risk averse. And so there's a bit of reluctance or insecurity about investing. And I feel like for younger millennials and Gen Z, the pendulum has

completely swung to the opposite extreme. Yes, investing is super important and it has to be part of your money management skills. It's not a sort of an advanced add-on, but it's not the first thing you need to do. Before you start investing, make sure that you have a solid handle on your day-to-day finances. Like you have to have money set aside that you are very confident you're not going to need, right? Like you have to have long-term savings. And before you have long-term savings, like it can be a little bit. I think that's a kind of a reassuring message, Ashley, for a lot of people to hear because we do hear about the urgency sometimes. So it's good to balance that. And I just want to ask one more question practically about investing in this environment. And it's about crypto,

because crypto companies in general were all the rage for a while, and then we saw them plummet. Is investing in crypto something that people should be looking at? Yes, I think there's also that idea of life is so expensive, houses are so expensive, wages have been stagnating for a long time. I'm not going to be able to make it unless I do something very sophisticated or, you know, and make my money, my savings grow really fast. So I think that is to an extent a little bit the allure of crypto, the appeal of crypto. But crypto is an extremely risky and volatile investment. It's considered a speculative investment, right?

So if you think of stocks as a roller coaster, crypto is bungee jumping. That's a memorable analogy. Okay. So it sounds like with crypto, I mean, your own risk assessment, you have to be ready to deal with a high amount of risk then, it sounds like. Yes, I would say there's also the question of money that you are investing for retirement, which you can't afford to lose, and then money that you're investing for fun. This was also a very popular concept during the pandemic. And so crypto could be the investing for fun just to see if, you know, it's a bit like playing the lottery, like maybe you'll win. Maybe you can, you know, maybe you get lucky and you time it right and you make a bunch of money.

But it is difficult to maintain that discipline, right? Like maybe you set aside some money to invest for fun, but if you lose a bunch of money, will you be tempted to take money out of your, you know, what should be for retirement in order to make that up? Or if you make a bunch of money where you get overexcited and then do the opposite, like put more money in crypto and neglect your retirement savings or pull from your retirement savings. There is a psychological element to this that can be really tricky. I'm glad you brought up retirement savings, though, because I want to ask you about this next. We've been talking a lot about new investors, but what about people who are

getting close to retirement or starting to think about retirement? Because I can imagine it would be scary to look at your retirement portfolio at a time like this when markets are uncertain, when everything is uncertain. So what should people in that position be thinking about? So for people who are sort of approaching retirement, but it's still a few years into the future, one piece of advice I've heard over and over from financial planners is it's a really good idea to set aside a few years of worth of cash buffer. So some people say three years, some more conservative advisors will say five years. And the idea is not to use it in an emergency, but so that if the market takes a beating, you have that cash set aside and you don't have to pull from your investments when they're down. Why five years of living expenses? Five years is because it can take that long for the stock market to recover. It took roughly that long, for example, for the S&P 500 to fully recover from the dip of the financial crisis in 2007, 2008.

Okay. So that's your buffer then. That's your buffer. Okay. We'll be right back. So let's talk about another market now, Erica, which is the housing market. The rise in interest rates, which the Bank of Canada has recently set to 4.5%, led to price decreases when it comes to real estate. And if we're looking at Toronto, for example, one metric called the house price index is down 19% from the peak pricing in March of last year.

So some people may be wondering if now is the time to buy a house finally. What should they consider? It's interesting because we're starting to hear from mortgage brokers and real estate agents that the market, at least here in Toronto, is starting to heat up again a little bit. You know, maybe not the frenzy that we saw during the pandemic, but certainly the kind of frost that came over the market in the past few months seems to be thawing. I would say in terms of what you can afford, here's some questions to guide you. So first of all, you have to plan,

apart from the cost of buying a house, the down payment, depending on how much you're putting down, the mortgage insurance, the legal fees, taxes, all of that transaction costs, moving costs, there will be surprises. Definitely you want to have a little bit of cash set aside for those home emergencies or again, things you're going to need to fix or adapt or, you know, when you move in. And then you want to, because of the specific time that we're in and the uncertainty in the economy, you also want to plan for income uncertainty and income emergencies. So definitely I would say this holds at any point in time, but especially now do not buy a house if you don't have a beefed up emergency fund. At least three months of living expenses to set up in cash, if not six.

It often takes six months to find another job, if not more. I want to ask you about the renting argument, though, right? Because we always go back and forth to talking about when is a good time to buy a house? Is it better to just rent? Some argue that renting is just giving money to the landlord, essentially throwing money out the window. So I'd like to push back against that and point out that owning a house also involves throwing a lot of money out the window. There are a lot of sunk costs that come with homeownership and a lot of money. Those are costs that don't increase the value of your property. Don't increase the value of your property, don't increase your equity in the property, which means like, you know, when you're paying off your mortgage, some of that money

increases how much of your house you actually own versus the bank. But not all of it, right? Because you're essentially, you know, you're paying interest to the bank, you're essentially renting money from the bank. And so your cost of borrowing the money, that's a sunk cost. Then there are repairs that don't maintenance, that don't increase the cost of your property. There are taxes, there are all kinds of sunk costs. And so if you want to look like purely from a mathematical point of view at the renting versus the sunk costs of owning a home, there's like a handy general rule in personal finance, which is called the 5% rule. It involves looking at two comparable properties. Say, you know, you're thinking, should I rent a two-bedroom apartment or should I buy a similar two-bedroom apartment? So look at how much you would pay

over one year in rent. So let's say that's $2,000 a month, so $24,000 over the year. And then look at how much it would cost you to buy a similar unit, similar home. And if the cost of a year of rent is less than 5% of the value of the home, then renting is, financially speaking, an attractive proposition and vice versa. So if you're under the 5% rule there, it sounds like there's a financial ease to stay in your rental unit and just invest any extra money that you can save. But I guess I'm wondering, do the numbers add up here, Erica, or how do you make them add up? How do the rates of growth compare between the housing market and the stock market? So the argument that's then built into sort of the 5% rule is that

it's completely fine to be a forever renter. And it challenges this idea that you need to be a homeowner to build wealth. That's all well and good, but the reality is rents have become so expensive that a lot of people are facing the situation where there's no way they can buy a house and they're renting, but the rent is so high that they can barely put anything aside. Yeah, that's a good point. I want to ask you too, though, about people who already own their own house. Is there something that they should be thinking about now that interest rates and housing prices are where they are? What should be on their mind? Yeah, so one thing that I know is on a lot of homeowners' mind is upcoming mortgage renewals.

Canadians are used to, you know, when the mortgage comes up to renewal, the payment is going to go down. And that has been in part because, you know, as you pay your mortgage, you're gradually paying off your mortgage, you owe less money. So your payment goes down, but also because interest rates have gone down for such a long time. We're really used to that now, and now it's not true right now. They've gone up so much that even if you are several years into paying off your mortgage, you may find that your payment is going to go up at renewal. Wow, that would be a shock, I would imagine, for a lot of people. Yes, and so it's a really good idea to contact your lender and ask them for an estimate of how much your payment might be based on today's interest rates. Okay. And just lastly here, Erica, what's your kind of overall

message for people who are investing in this economic environment that appears a little bit unstable? What's something that they should just keep in mind? So I would go back to the keyword here is uncertainty. So what you want to do is manage that uncertainty. And that doesn't mean sort of trying to stake your financial planning on some kind of effort to peek into the future, but just prepare for a plausible worst case scenario, right? That means what is something that could possibly happen that would be bad? Would you be okay? Would you be able to ride it out? That means, you know, maybe emergency fund, maybe unexpected housing emergency, that kind of thing.

And also when it comes to investing, make sure that you have an investment strategy that you are confident in, that you are confident in that you really understand why you're doing what you're doing so that you're not going to be tempted to pull all your money out when the market goes down or vice versa you're not going to be tempted to put all your money into something that your uncle recommended erica this was really interesting. Thank you so much for taking the time to go through all this today.

Thank you so much for having me. That's it for today. I'm Maina Karaman-Wilms. Jay Coburn helped work on this episode. Our producers are Madeline White, Cheryl Sutherland, and Rachel Levy-McLaughlin. David Crosby edits the show.

Adrienne Chung is our senior producer, and Angela Pachenza is our executive editor. Thanks so much for listening, and I'll talk to you tomorrow.