As a beginner to investing, you might feel comfortable cherry-picking a handful of blue-chip stocks you’re familiar with, adhering to the old adage of “buy what you know,” right?
It seems like a safe, straightforward strategy, especially for recognizable companies you encounter in daily life. However, this approach, particularly for beginners, can be fraught with risk, leading to a portfolio that’s alarmingly underdiversified.
Diversification is the cornerstone of reducing risk in your investment portfolio. Relying solely on a few well-known stocks leaves you vulnerable to industry-specific downturns and misses out on the growth potential across other sectors and geographies.
If you truly have no experience in investing, the smart move isn’t to put all your eggs in one or two baskets, no matter how sturdy those baskets may seem.
Instead, I recommend a more balanced approach that can offer both exposure and protection across the broader market. Following a few simple steps and investing in this global quality exchange-traded fund (ETF) can be a game-changer for your investment journey.
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Understand what makes up a “quality” stock
As a beginner in the investment world, it’s tempting to go bargain hunting, looking for stocks that seem cheap at first glance. However, it’s crucial to understand that if a stock is priced low, there’s often a valid reason for it.
The market has a way of factoring in everyone’s expectations, and a low price can indicate a consensus view that there’s not much upside to the company. Many of these stocks are cheap because, frankly, they deserve to be, as the market anticipates poor performance or growth prospects.
Echoing the wisdom of Warren Buffett, it’s generally smarter to buy wonderful companies at a fair price rather than average companies at a bargain price. This philosophy centres on investing in quality stocks, but what exactly constitutes a “quality” stock?
In my view, and simplifying Buffett’s approach for beginners, there are three key factors that can help identify a quality stock:
- High return on equity (ROE): This measures a company’s ability to efficiently generate profits from its shareholders’ equity.
- Stable year-over-year earnings growth: This shows that the company is not only profitable but also consistently growing its profits over time.
- Low financial leverage: A company with low financial leverage has not overburdened itself with debt, making it less risky, especially in economic downturns.
An ETF that does it all for you
As a beginner, diving into financial metrics and understanding what to look for in a quality stock can be quite daunting. But here’s the good news: you don’t have to navigate these complexities on your own.
An ETF like BMO MSCI All Country World High Quality Index ETF (TSX: ZGQ) is designed to do the heavy lifting for you. You can buy shares of ZGQ in your brokerage like any other stock.
This ETF is built around the concept of investing in high-quality stocks globally, using the very criteria we’ve discussed: high ROE, stable year-over-year earnings growth, and low financial leverage.
Currently, ZGQ holds over 500 stocks from around the world, each selected based on these quality factors. The fund then weighs these stocks by the product of their quality score and size, capping each stock at 5% to avoid over-concentration in any single company.
With an annual fee of 0.50%, ZGQ offers a cost-effective way to own a globally diversified portfolio of top-tier stocks. While you might not find this ETF “on sale,” its focus on quality makes it a solid investment that I personally feel confident holding through various market conditions.
