Posts Tagged ‘bonds’
Stocks, bonds and what? People need to learn more about investing
Financial literacy or a pair of shoes?
Last year I blogged about financial literacy in Canada.
Statistics about kids and adults are a little worrying when it comes to financial literacy. From new data, Americans aren’t much different. Studies show people need to do a lot more to become financially knowledgeable.
Juggling the egg
I recently overheard this: “What’s in your portfolio?”
Blank stare, and then: “I own XYZ.” (One of the biggest stocks in the U.S.)
That’s it. XYZ. Nothing else.
But wait! XYZ’s done great! It should go up forever or even longer.
Hmmmm … The thing is:
Those are the two “it’s different this time” ideas that have humbled investors since stock markets were born. Short-term thinking … People forget that the XYZ’s of this world have been a long interchange of different companies throughout investing history.
Do you really want one egg dictating your financial future?
Investing without diversification is potential financial suicide. (Or at least financial Russian roulette.)
Momentum is a marvelous thing when it’s on your side. But your worst enemy when the tide changes.
Ask former RIM, Palm, Nortel, Enron, Lehman Brothers investors.
If this had been your only stock, how would you have felt? What would have happened to your portfolio?
Know what you know:
Find out what you don’t know
According to the Investor Education Foundation of the Financial Industry Regulatory Authority’s study in the U.S.:
- 67 per cent rated their financial knowledge as “high”
but,
- Only 53 per cent answered this question correctly:
True or false: Buying a single company’s stock usually provides a safer return than a stock mutual fund.
I doubt that most of these respondents were momentum traders trading single stocks. It’s more likely that the majority had no idea that this is one of the most important rules of wealth creation: Diversification.
- Only 6% got the above question wrong, choosing “True.”
But,
- 40% said they didn’t know the answer, and 1% declined to answer
Ouch.
Maybe it was just an anomaly.
Let’s try again:
If interest rates rise, what will typically happen to bond prices?
Rise? Fall? Stay the same?
No relationship?
- Just 28 per cent answered correctly
Yes, they will usually fall.
- 37 per cent didn’t know
- 18 per cent said bond prices would rise if interest rates rise
- 10 per cent said there’s no relationship between bond prices and interest rates
- 5 per cent said bond prices would stay the same
- 2 per cent said they preferred not to answer
Becoming a statistic can have long-term complications
Looking at these stats shows there’s a lot of financial illiteracy out there.
It’s a crime that financial literacy is not taught in high schools.
— Michael Finke, professor of personal financial planning at Texas Tech University/co-developer of the Financial Literacy Assessment Test, part of Ohio State University’s Consumer Finance Monthly survey.
(In Canada, things are changing.)
Can teachers help?
When asked about six personal financial planning concepts:
- Fewer than 20 per cent of teachers and teachers-in-training said they felt “very competent” to teach those topics
- Teachers felt least competent about saving and investing
— 2009 survey of 1,200 K-12 teachers/prospective teachers National Endowment for Financial Education
What do you do if teachers don’t feel competent to teach financial literacy skills?
Governments …
- Need to focus on helping teachers get these skills
or
- Need to bring in outside help to assist in improving financial literacy skills
Agencies are doing their part in both the U.S. and Canada to raise awareness around financial literacy. They can’t do it alone:
- Parents need to teach their kids about debt
But parents need to understand the dangers they’re trying to warn their kids about.
The consequences to our economy and economic future of financial illiteracy are immense. Championing long-lasting positive changes for kids (and adults) is important.
Those shoes were made for walking (but they could really cost you)
Study after study has shown that adults will spend more time focusing on buying a pair of shoes (or other purchase) than they will on their financial future.
Is this the legacy we want to leave our kids?
Find out more about diversification:
You don’t need to listen to Warren Buffett (if you’ve allocated your investment portfolio properly)
A simple way to arrive at the right asset allocation for your portfolio
Plan like a pension fund manager when it comes to your investment portfolio
Asset allocation: Diversification is king
Related articles
- Americans don’t understand investing basics (marketwatch.com)
- Kids need financial literacy, too, many say (dispatch.com)
- U.S. high schoolers get another F in financial literacy, new study shows (oregonlive.com)
Is it better to have invested, and lost, than never to have invested at all?
Well … 
It certainly helps you achieve your investment goals if you own investments that have a chance of getting you to your destination.
Take a look at the following charts and ask yourself two questions:
- If you had bought during the major dips, would it have benefited you?
and
- How would you have done with your money in low interest instruments according to the charts below? *
Example fund vs. 1-year GIC
Example fund vs. 5-year GIC
It’s clear that the most conservative investments wouldn’t have served you as well since the inception of this fund. What investors would do well to remember is that GICs lock your money in until maturity while mutual funds, ETFs and stocks are more liquid, generally.
Not to mention:
- If you had bought during the dips
and
- If you had rebalanced regularly
… you’d have done better than the chart shows since you would have lowered your cost or ACB and generally bought lower and sold higher.
So …
Do you have a plan, a strategy?
What is it?
Remember a few weeks ago when the news about Europe was so bad that optimism seemed naive?
I’m paraphrasing myself from a previous post. I talked about learning to harness your fear. There are always reasons you can find for Armageddon if you look hard enough.
People want stability. At times, markets and the business cycle are anything but stable. Above, you can see that during the worst stock market correction in most of our lives, an example of a balanced, dividend-based portfolio outperforming the most conservative of investments, GICs, by four times or more.
When the doom and the gloom gets really thick, many investors feel paralyzed. But that’s exactly when great investors look for opportunity.
During the doom and gloom, markets often decide to have a good bounce.
Isn’t that counter-intuitive?
Actually, it’s pretty normal. If there were no walls of worry to climb, there’d be no bull markets. In “Wait a minute. There’s some good news re the markets?” I blogged about how investors often miss the opportunity in the end-of-the-world-as-we-know-it scenarios.
I posted some stark stats in “Why you should consider new investments now”.
Since we’re supposed to be strategic about long-term investing, let’s ask ourselves a question again:
When the market takes a substantial dip, is there more chance that it’ll rise or keep falling on average?
In “Don’t Panic”, I also talked about managing fear while investing. Learning to harness your fear is important in sports. Imagine you’re taking a penalty. It isn’t easy to stand there and score in front of 70,000 people.
Why should it be any different when you invest?
What’s the market going to do?
No one knows. There are a lot of educated guesses, research, charting, but no one knows.
Accept it.
Just as, if you decide to start a business or enter into any kind of relationship, there’s no 100 per cent satisfaction guarantee.
Business, economic news, the process of investing, continues to flow. It’s a river. There are rapids. There are waterfalls.
There may even be a couple of Niagaras out there.
But if you look at history, you’ll see that there were always those who pushed and went further. For every time you encounter end-of-the-world-scenarios, you’re going to see that someone steps up, looks at the recent correction in the market and says:
Hey, there may be some value here.
Accept the psychology of the market. But get a plan.
Is the bad news over?
Here’s what I said in that previous post:
We’ve come through a tough time. We’re not out of the woods yet, but if you’ve been sticking to a sound investing plan, you’ve taken advantage of the weakness in the market.
The bad news about being an inactive investor in 2011
If you had been sitting in cash only:
- You missed a very nice rise in the bond markets
and
- A great opportunity to reallocate investments to stocks
You might have taken advantage of a great time to buy equities at lower prices and participated in the rise of the bond markets.
Or, you might have asked the more unlucky question:
What happens if the world ends?
It might be better to ask:
What happens if I think strategically about my investments?
What happens if the world doesn’t end?
Want more information?
Click here for more about bonds and fixed income investments.
Click below for more about asset allocation and reallocation strategies:
A simple way to arrive at the right asset allocation for your portfolio
Plan like a pension fund manager when it comes to your investment portfolio
Asset allocation: Diversification is king
Click here for articles about dividends/dividend-payers.
* Example fund chosen out of large bank balanced funds with a dividend bias. Fund used purely for illustrative purposes with a time period of less than ten years since the effect of the financial crisis should have been greater during this period.
Chart source: Globeinvestor.com
Part Two: You don’t need to listen to Warren Buffett* (if you’ve allocated your investment portfolio properly)
In Part One of this post, I left off saying I’d discuss why having a plan benefits you when it comes to asset allocation within your portfolio.
Markets keep on moving
Investors have to be conscious of the fact that the markets are never static. No one knows exactly what’s going to happen in the markets.
Since markets change, and taking into consideration recent events, here are three points we should consider:
- Are investors now overweight bonds?
- Do investors miss out by trying to time the markets?
- Can you achieve your investment/retirement goals by holding (supposedly) low-risk investments?
The bond blackhole
It’s highly probable that some investors are overweight bonds. If this movement to bonds is related to short-term fear rather than long-term planning, it’s a mistake.
Consider an older retiree who’s heavy in bonds. That same retiree holding a large fixed income component in his portfolio is going to suffer in a bond correction.
Still, these older retirees need the safety fixed income investments provide them. But retired investors need to weigh the potential in equities long-term over the safety in bonds or GICs and allocate accordingly.
Equities, inflation and long-term hedges
Here’s an interesting article from The Economist discussing Canada’s pension plans.
Ask yourself: Why do professional pension fund managers include equities in their investments? Are they about to abandon stocks?
Without growth an investor’s going to be in trouble when they begin withdrawing investments in retirement. Equities have done best over the very long-term against inflation, even during recent superb bond outperformance.
So, what’s happened to stocks? Why all the noise?
Of course, it’s generated by abuses leading up to the financial crisis, and investors who’ve been spooked by the big correction of 2008-2009. But here’s the thing:
Stocks have undergone a period that will go down in history as one of the largest corrections most investors have seen. Equities then had a larger than average correction last year.
Since that time, if you’d focused on the opportunity presented, you’d have had some nice returns. Stocks may correct again since they’ve had a march upwards. Companies have increased dividends focusing on what looks like better times with strong balance sheets.
Are stocks a better value than bonds?
In Part One, you can find solid reasoning on why they are.
Don’t want to be glued to your portfolio?
What’s the easiest way to take advantage of market swings that favour different investments at different times — without becoming a burden on your personal time resources?
Proper asset allocation.
Despite the volatility, stocks have done pretty well
As the chart above shows, stocks and bonds have still done pretty well over the long-term. Amidst all the volatility, stocks and bonds have performed. U.S. stocks may not have done as well for Canadian investors, but they picked up enormously in 2011.
Avoiding equities? It’s going to cost you in the long-term
The S&P/TSX 60 is made up of sixty of the largest companies in Canada. These dividend-paying stocks have done well over the ten years above despite the correction during the financial crisis.
Since equities have had a couple of major corrections in the last five years, they continue to show value especially in the face of historically low interest rates. U.S. equities are showing even more value relative to those in Canada. But they’ve also had a nice increase lately.
Believe in your plan
The stock and bond markets have shown an amazing ability to outwit retail investors. It’s hard to know what the markets will do. Don’t worry about it.
The secret is focusing your energy in a pro-active plan:
That long-term plan will help keep you focused.
Do you still believe in your plan? Are you comfortable with the amount of risk your taking?
If you believe in your plan and you are comfortable with the amount of risk you’re exposed to, make sure you apply the following to your investment portfolio:
- A well-balanced mix of suitable assets
- Evaluate your portfolio regularly
- Stick to your plan
- Rebalance your portfolio
- Diversify with respect to the assets you hold, as well as the geographies you hold them in
- Contribute regularly to your plan in order to take advantage of market volatility
Stocks have a lot going for them at the moment, but they’ve had a great run over the last few months. Will they correct?
Bonds have performed very well since the financial crisis. Will they correct?
Whether there’s a market correction or not in either asset category isn’t important. What is important is that you have a long-term plan that takes advantage of outperformance at different times in both stocks and bonds.
A good manager will make use of market volatility.
So can you.
Need more information?
Click below for more about asset allocation and reallocation strategies:
A simple way to arrive at the right asset allocation for your portfolio
Plan like a pension fund manager when it comes to your investment portfolio
Asset allocation: Diversification is king
How’s Warren Buffett’s long-term stock-picking record?
Chart source: Globe Investor
*While using proper asset allocation may reduce your need to listen to Warren Buffett about the stock markets, listen to him, anyway. Few have been as successful as Buffett in stocks.
The title of my blog post is a poke at his critics. Even fewer of them have had the same long-term track record as Buffett!
You don’t need to listen to Warren Buffett (if you’ve allocated your investment portfolio properly)
Warren Buffett came out and highlighted the risk in bonds recently. He pointed out that long-term, stocks have a lot less risk than currency-based investments like bonds.
Stocks or bonds? Maybe both
Backing Buffett, the S&P 500 has had it’s best February since 1998. The S&P/TSX 60 has hit a five-month high.
Sadly, RRSP contributions are hitting lows just as the markets have taken off.
There are many reasons RRSP participation has declined: difficult economic times, fear generated by stock market volatility and the effect of demographics are just a few.
If some investors are avoiding the stock market because of fear stemming from the financial crisis, it’s cost them this year. If this becomes a long-term trend, it will cost people in retirement.
In “Bonds: Why you should love the unloved investment”, I discussed the role bonds play in a diversified, balanced portfolio within the context of stock market corrections.
Since the financial crisis, investors have seen a bull market in bonds as people bought “safer” investments like bonds.
But bonds tend to rise when interest rates decline. If interest rates don’t continue to decline, the return on bonds will be limited.
Considering today’s already low rates, is it likely that they’ll continue to decline?
If interest rates go up, the returns will become negative, and we might see the first correction in the bond markets since before the financial crisis.
Bonds vs. the S&P/TSX 60: The return of equities
Dom Grestoni of Investors Group recently said: “Rates are going to start rising, so if you commit to a 20-year bond at 2½% and the market rate goes up half a percentage point, you’re going to part with 30% of your capital.
We’re seeing valuations that are now discounted relative to the past 20 years, and interest rates are at record lows … Would you rather lock into a 10-year government of Canada bond paying 2.1%, with no prospect of growth, or buy a high-grade dividend-oriented stock, like a bank or utility, with yields above 4% … and that dividend is going to grow year after year.
Investors were underweight bonds as stock markets went from outperforming to underperforming during the financial crisis. Many may now be overweight bonds.
Both Buffett and Grestoni are trying to alert investors to this danger.
The mania is the message
Buffett would probably be happy if you didn’t need to listen to him. Some wise investors are already well-prepared.
How can you be one of them?
What Buffett was trying to counter are the manias that investors inevitably fall for. Sadly, most investors go for whatever investment vehicle has been getting the majority of cash flows.
Too many investors arrive late in the game.
Bad news burnout
The barrage of bad news has influenced investors: events in Europe, and other withering news grabbed all the headlines. Have people noticed that news has gotten more positive regarding companies, Europe and the outlook for stocks?
There are still threats amongst the opportunities. Financial news from Europe and the U.S. is mixed though better than it was.
Bonds?
There’s nothing wrong with holding bonds in a properly diversified portfolio. In fact, many managers hold bonds in their portfolios.
As mentioned in “Bonds: Why you should love the unloved investment”, many pundits were calling for a bond correction last year, and it turned out to be a great year to hold bonds.
But the same may not hold true in the future.
In Part Two, I’m going to discuss why having a plan benefits you when it comes to asset allocation within your portfolio.
Chart source: Globe Investor
Follow @JohnRondina
Flash in the pan or long-lasting hedge? Buffett speaks out on gold, again
Will all the gold that glitters glitter less?
Warren Buffett tossed some nuggets of wisdown into the stream again.
In “Gold Riot”, I discussed gold bullion, gold stocks and Buffett’s opinion on the metal.
Despite gold’s excellent performance of the last ten years, it’s been one heck of a ride. Soaring and then plummeting, gold has shown investors that when it corrects, it corrects with a vengeance.
Buffett sees gold as an unproductive asset. He believes stocks are the more “productive” assets and will “prove to be the runaway winner” trumping bonds or gold over an “extended period of time”.
He also says stocks will be “by far the safest” of assets.
Bonds, says Buffett, need a “warning label”. He believes they’ll fall victim to inflation and taxes.
Risk is a slippery slope. While many investors don’t realize it, so-called “safe” investments like GICs or U.S. Treasuries have risks, too. At the moment, Buffett sees bonds (including other currency-based assets) as “dangerous”.
Still, portfolios need some bonds depending on the investor’s risk tolerance. Buffett’s company, Berkshire Hathaway, holds bonds for liquidity issues.
Investors who have been heavy in bonds have had a great year, but such returns may be harder to come by in the future.
Buffett says:
… owners [of gold] are not inspired by what the asset itself can produce — it will remain lifeless forever — but rather by the belief that others will desire it even more avidly in the future … bubbles blown large enough eventually pop.
To see Buffett’s interesting metaphor on gold, see my blog from last December, “Gold Riot”. Famously, Buffett compared gold to stocks and farmland.
Fondling the cube
Buffett again emphasizes his position on gold:
A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops — and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.
If you didn’t check the link above, do it now for a more complete picture of Buffett’s philosophy.
Buffett highlighted the mania in gold near it’s peak. Gold has recovered since it dropped, but Buffett’s still not a big fan.
In “Gold Riot”, I pointed out, agreeing with Buffett, that it would be wise to be cautious.
The new boss different from the old boss?
Buffett called the tech bubble early over ten years ago. Many made light of his opinion then, saying the “new economy” no longer needed to play by the old rules.
But the “new bosses” turned out to be wrong and the “old boss” turned out to be right.
Hype and speculation eventually led to a blow out. Buffett was early, but he was right.
With respect to gold, if an investor interested in gold had held off during its spike last year and waited for the correction, they would have:
- Had a great buying opportunity
and/or
- Avoided a big downturn
Gold has its place in a portfolio, but there are some great points to remember about investing in bullion or gold stocks.
As with any other investment – perhaps even more because of its volatility – hype and value are part of the equation.
Gold will play its part in the next few years, but do investors understand the risks associated with investing in gold?
See Buffett’s article in Fortune
Sprott diversifies:
Click here for more about bonds and fixed income investments
Click below for more about asset allocation and reallocation strategies:
A simple way to arrive at the right asset allocation for your portfolio
Plan like a pension fund manager when it comes to your investment portfolio
Get the balance right
Can we simplify asset allocation?
Yes, we can.
While there may be more to asset allocation than just stocks and bonds, stocks and bonds are the best starting points for most investors. Anyone can become an investor through mutual funds or ETFs.
What have most investors heard about stocks?
• Stocks usually outperform bonds over long periods of time
Ok, now, in this hypothetical, let’s imagine that stocks take longer than average for that outperformance to take place. What can we do to bolster our portfolios?
If we find ourselves in a period where equities take longer to outperform than average, we can arrive at two conclusions:
• Fixed income positions (bonds) are even more important
• Rebalancing is even more important
Why?
Because, although a 100 per cent portfolio of stocks should statistically outperform over the long-term, most investors are more human than they are instruments of logic. People are emotional. Since they’re emotional, what is theoretically true about investing may not hold true in real life.
Volatility takes its toll. Big market drops herald big investor reactions. When bad news reaches a fever pitch about stock markets, many investors start to feel ill. Investors start abandoning strategy and discipline.
After all, there’s Europe, a potential recession, inflated house prices in Canada, and a blue sky that’s sure to fall. (Never mind that equities haven’t been this cheap in quite a while.)
The only things that have really changed are the names of the crises. Not to belittle the difficulties we face economically – these are challenging times – but we’ve always faced difficulties economically. With market corrections, and, with prudent planning, difficulties become opportunities.
Seeing the opportunity in today’s markets may be better than running around screaming the sky is falling.
If your portfolio has a good allocation to fixed income products – if you have a mix you’re comfortable with – and you have a disciplined rebalancing strategy, you should benefit. There are times when stocks and bonds move up or down at the same time, but usually, stocks and bonds move in opposite directions.
If your allocation is 65 per cent equity (stocks) and 35 per cent fixed income (bonds), then when your allocation drifts, let’s say to 70 per cent equity and 30 per cent fixed income, it’s time to rebalance.
What do you need to do? Sell some stocks and buy some bonds. Sell the asset class that has outperformed, and buy the asset class that has underperformed.
Sell high. Buy low.
Everyone knows that, right? But it takes great discipline to do. You have to automate the process.
Some investors worry that they’ll impede portfolio performance by selling stocks when they seem to be doing nothing but going up. True. This happens. Your allocation may change early in a bull market. But many investors struggle seeing future benefit in the face of the madness of crowds. The “noise” affects their focus and their resolve. It can make investors buy at the wrong time or sell at the wrong time. In down markets, too many investors only see current losses or declines.
What might be the best rebalancing schedule theoretically, may not work for the average investor struggling to cope with “noise” during a market correction, especially, if it’s a severe correction like 2008-2009.
While the financial crisis may have caused some grey hair, it was one of the best times in recent memory to test out your portfolio. Recent weeks also put some pressure on investor nerves while squeezing portfolio integrity.
It’s times like 2008 – 2009 that make people happy to own bonds. Bonds performed very well as stocks declined. Stocks usually outperform bonds over the long-term, but bonds add some insurance to your portfolio.
As the market began the steepest part of its recent decline, we can see that bonds once again outperformed as investors positioned themselves for safety. The steady income from bonds and the hedge they provide against market drops often make them fund manager favourites.
Why should the average investor be any different?
Bonds providing a hedge during recent market correction
Part Two is here.
Plan like a pension fund manager when it comes to your investment portfolio
GICs, bonds or stocks? What would you have rather held for the last two years?
Employees have paid more attention to their pension plans in the last few years due to the financial crisis and volatility in markets. However, volatility made even the brave flinch during 2009. So, just what’s the situation in Canada? And what’s an employee to think these days?
Think sound planning
Careful planning is what drives investments and pension plans forward. When the market dropped in 2009, it rattled a lot of investors, and, of course, we’re all pension holders whether it is through the company we work for or the Canada Pension Plan.
Make volatility your friend
Volatility works for you in the markets if you have a plan. It’s part of investing. Ask any fund manager.
Equity and bond markets can’t go up in a straight line because there are too many interconnected parts to the economy, business and world events. News, especially in an increasingly digitized society moves at light speed, and news impacts on investments. In order to achieve the goals we set for retirement, exposure to the equity markets is necessary. Equities provide the added growth and performance few other assets do. After all, if you held a lot of cash since March 2009 or invested new cash into GICs rather than equities, you’d have gotten simply anemic returns.
Have a look at historical charts
If you pulled your money out of the markets in May 2009 and kept it out, you would have missed out on a 40 per cent return on the S&P TSX 60 Index at its recent peak. On the other hand, pension managers, as markets stabilized, began reinvesting new money into equities at bargain prices. Meanwhile, bond holdings that should be part of every balanced portfolio, accelerated through the market turmoil providing a buffer. The DEX Universe Bond Index returned about 16 per cent from the time the equity markets began correcting to now. Compare that to the average 1-Year GIC returns shown in the chart above – they’re barely recognizable during that time.
The picture I’m painting is your pension’s doing what it should be as the manager sticks to his plan.
What lesson can the average investor learn?
- Get a plan
- Stick to your plan
- Remember to reallocate investments
Remember to diversify
Proper asset reallocation on the part of managers forces them to buy assets when they are cheaper, rather than when prices are steep. The average diversified fund manager measures himself against a benchmark that is 55 per cent equity and 45 per cent fixed income. These percentages are reallocated as the portfolio weightings and market conditions change.
The average investor would do well to remember the fixed income component of their plan. A short while ago nobody had anything good to say about bonds but since commodities and the markets have started backing up recently, fixed income is showing us, once again, why it belongs in our portfolios. There’s nothing like some income and fixed income investments that generally rise when equities go down to stabilize a portfolio.
The bottom line is that performance has been excellent since 2009 and in the first quarter of 2011. How would you feel right now if your pension fund manager had been holding a portfolio of GICs exclusively during that period?
Probably, a little sick …
Contrast the 1-Year Average GIC Index return of slightly more than 1 per cent with the above returns on the iShares S&P/TSX 60 Index and the iShares DEX Universe Bond Index since May 09.
While returns are never guaranteed for any asset class, you can bet that over the long-term, stocks and bonds will beat out GICs.
*Note iShares S&P/TSX 60 Index and iShares DEX Universe Bond Index used only for illustrative purposes
Update: The Canada Pension Plan has hit a record, largely by scooping up bargains in the equity markets after the financial crisis and resulting market correction. For more details.
Update: I was gratified to see that a connection of mine, Adrian Mastracci was thinking similarly about investing like a pension fund manager! See article here.
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