Where does your income come from after you retire?
Your first thought might be to answer that question with something like “CPP,” or “my RRSP,” or “my employer’s pension plan.”
These programs are indeed part of the mix for most Canadians. But they mask the real source of income, which, in many cases, is the stock market.
All of Canada’s major pension programs invest in stocks, along with other securities such as bonds. You can use the same strategies these programs use to invest for your retirement to generate income today (or in the near future at any rate).
In this article, I’ll explore how you can use the stock market to earn reliable payouts that—after some diligent effort—might come to exceed what you earn from your job.
Source: Getty Images
Intelligent investing: The basics
Investing is of course a massive topic, one that thousands of professionals around the world devote their entire lives to. I can’t give you an entire investment strategy in a few short paragraphs. Nevertheless, it’s possible to explore the basics in a few paragraphs.
The investment strategy that works best for most people is best described as “widely diversified.” “Diversified” means holding lots of stocks—little pieces of the entire market, even. Studies show that a highly diversified approach beats other investment strategies, provided that you do not pay high investment management fees.
A type of investment that lets you achieve both diversification and low fees is an index fund. An index fund invests in all (or at least most) of the stocks in a broad market index, like the S&P 500. Tracking such an index removes the need for high management fees, as the list of stocks that the fund invests in is available at relatively low cost, and serves as a substitute for having an active manager. Numerous studies have shown that index funds outperform active stock funds over the long term.
Many index funds are structured as exchange-traded funds (ETFs). This means they are traded on the stock market instead of held in an account at a company. This structure makes ETFs liquid and easy to sell for a known market price, a feature not shared by other types of funds.
How much income can you get by investing in index ETFs?
Going by average dividend yields, not a whole lot currently. The TSX yields about 2%, the big U.S. indexes even less than that. You won’t get rich investing at 2% returns, but remember that companies often raise their dividends over time, and that buying stocks during bear markets increases your portfolio yield.
A good starter ETF
A good ETF for a Canadian investor to get started with is iShares S&P/TSX Capped Composite Index Fund (TSX: XIC). It’s a Canadian fund built on the iShares S&P/TSX Capped Composite Index, an index of the 240 biggest publicly traded Canadian companies. XIC holds 220 of the 240 companies, providing both ample diversification and representative sampling. It also has a low management fee (0.05%) and management expense ratio (0.06%). So, XIC ticks all of the boxes that an index ETF is supposed to tick. It’s probably a pretty good means through which to get Canadian equity market exposure in your portfolio.
Foolish bottom line
If you’re like most working-age Canadians, your job is probably your main source of income. That will also probably be true for some time to come. It needn’t be the case forever, though. Through disciplined index fund investing, you can earn quarterly income that gradually comes to rival what you earn at work.
