Posts Tagged ‘Canada’
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.
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!
Market volatility: Why and how to make it work for you
Freaked out about the markets? You’re not alone.
This year’s market volatility has rattled investors. While nobody loves market volatility, the wealthiest members of society seem to tolerate it better than the average Canadian or American. At least, they don’t seem to cash out of their investments after large market drops, and, according to studies, many investors do.
What separates the wealthy from the average investor? What is it that causes Joe and Josephine Average to be less successful as investors than they could be?
Recent research on young people and financial literacy shows that fin lit is an area where young people need help. Kids aren’t alone. Many adults don’t understand financial markets. In “Kids and money: What kind of financial legacy are we leaving our children?”, you can find some startling information on adults and financial literacy.
Investing (and financial literacy generally) is a major factor separating the poor from the wealthy in Canada and the U.S. While this is obviously not the only factor determining household wealth, it is a large contributor.
The media’s been saturated with stories about the “1 and 99”. Awareness about the 1 per cent and the 99 per cent of society in the U.S., and about why the 1 per cent hold so much more wealth than the 99 per cent is high right now. The Occupy movement has gotten a lot of attention in the media despite criticism that the movement’s message is somewhat muddled.
Some facts about the extremely wealthy in Canada (the richest 1 per cent of Canadians who capture 32 per cent of all income growth, according to StatsCan):
- They own an enormous proportion of our society’s wealth
- They are major holders of stock, bonds and real estate
- They tend to be well-informed when it comes to investing, or they seek out experts to assist them with their financial planning strategies
- They understand market volatility much better than the average investor does (again, they seek out experts more than the average investor does)
Up down and all around
Market volatility has put terror into more than one heart. Especially that of the novice investor. The danger here is that fear will stop the average investor in his tracks.
But don’t the 1 per cent face market volatility as well?
The volatility during the last five years has been extraordinary. The market has undergone two of its most extreme periods of volatility starting in 2008 and ending in 2009 and then beginning again this year. And, yes, we’re still in the midst of it. We may be closer to the end of the current period of volatility, but that’s difficult to know given the number of variables involved.
In Part Two, I’ll discuss why market volatility is your friend, and how changing the way you look at volatility leads to superior returns.
Kids and money: What kind of financial legacy are we leaving our children?
When I graduated with a BA in English, the only thing I knew how to do financially was a budget. I loved literature, but financial literacy?
I knew land could be good. I’d learned about budgeting and land from my parents.
During my first year of work, it didn’t take long for me to learn that there were a lot of things I didn’t know a whole lot about.
The stock markets had just crashed. (It was a great time to buy.)
Every day as I rode the TTC, I read about things I couldn’t begin to understand. For a pretty smart guy, I felt stupid. That year, I read everything I could about investing and financial planning and gave myself the expertise I needed to understand the events in the newspapers.
I have never regretted that investment.
It’s been part of my active research ever since.
Financial literacy is on the move this year. The $5 million Task Force on Financial Literacy released a report with a host of recommendations. November is Financial Literacy Month in Canada. Non-profits are collaborating on monthly events.
Why do we need this focus on Financial Literacy?
• Average debt to household income has increased in Canada
And it’s not so-called good debt (where you can write-off the interest payments). Our burgeoning debt alone should prove the need for financial literacy.
The B.C. Securities Commission, in a survey of more than 3,000 17-to-20-year olds, released the following last week:
• They expect to be making $90,000 a year by 30. Three times the national average.
• Three-quarters think they’ll own homes at that age. Government data estimates 42 per cent of 25-to-29-year olds are homeowners.
• Many students graduate with “weak financial skills and little knowledge of the financial realities they will face.”
Those stats should give parents and concerned members of Canadian society great pause. During a time when credit-binging has led to some brutal consequences in the U.S., Canadians have loaded up on debt. Some people have warned of our own inflated housing prices … Low interest rates are making this housing price boom long. Too many people think housing will go up forever.
There are always exceptions, but the statistics are overwhelming. Kids are out-of-touch with financial reality.
The digital universe is changing so fast some can practically feel the wind blowing them back into their chairs. Information has more channels than most can keep up with. Plugged-in like never before, but disconnected from financial reality, kids need help understanding debt, budgets and saving.
Add to this:
• Baby boomers are aging
• Europe and the U.S. are having their issues with taxes, debt and political infighting
• Though Canada’s doing comparatively well, the crisis of 2008-2009 illustrated how global markets and economies are interconnected , and how poor the average person’s understanding of market volatility is
Of Canadians in general:
• One in three is struggling or can’t keep up with their finances
• One in four is weak in key areas of planning and budgeting
• 30 per cent are not preparing for retirement
• Millions of Canadians won’t have sufficient retirement savings and no pension plan other than the CPP/QPP and Old Age Security
• People have very low tolerance for market volatility (and without being able to process market volatility, it’s pretty hard to be an investor. Without becoming an investor, it’s hard to get ahead.)
While there are great agencies doing their part to raise awareness and make lasting and effective changes to our education system, parents need to teach their kids about debt.
The consequences to our economy and economic future of financial illiteracy are immense. Championing long-lasting positive changes in the way schools teach financial literacy is no longer optional.
It’s our future. It’s their future.
A simple way to arrive at the right asset allocation for your portfolio
What’s your piece of the pie?
Instant asset allocation
Asset allocation can be as complicated as you want to make it. But since many investors don’t have time to get overly complex about assets in their portfolios, here’s a simple look at how to allocate.
Financial planners used to say subtract your age from 100:
- The remaining percentage is what you should have in stocks
So, if you’re 30, keep 70 per cent of your portfolio in stocks. If you’re 70, keep 30 per cent in stocks.
The best asset allocation for your age
Canadians can look forward to living longer. Because we’re living longer, we have to take this into consideration when it comes to our portfolios. Some recommendations are suggesting the number used should be increased to 110 or 120 minus your age reflecting our greater longevity.
If you’re living longer, you need to make your money last longer. You’ll need the extra growth that stocks can deliver.
Many experienced investors find that adjusting the number to suit their risk tolerance after a large correction, say, like 2008-2009, a good metric. Large corrections can get you in touch with your investor psyche pretty quickly. But be cautious about selling when the mood has reached maximum pessimism. It rarely turns out well.
In “Plan like a pension fund manager when it comes to your investment portfolio”, I discussed the benchmark for the average diversified fund manager. The important thing is to choose an asset allocation you think you can be comfortable with.
For example, if you had a 50/50 portfolio split, you could expect that your stock holdings would move a lot less than a broad index like the S&P/TSX 60 in Canada, or the S&P 500 in the U.S. While you may be tempted to think it’ll move half of one of these indices, it will depend on how close the equity component of your portfolio correlates to either of these indices. If your stock allocation is geographically diversified, this will also change things.
When you compare the S&P/TSX 60 (60 of the biggest companies in Canada) with a balanced fund that is geographically diversified, we’d expect, generally, to see:
- Less volatility because of the fixed income component in the balanced fund
- Less volatility because of the geographic diversification in stocks and bonds in the balanced fund
This is exactly what happens when you graph the S&P/TSX 60 and the Claymore Balanced Growth Core Portfolio (TSX:CBN). The Claymore portfolio is based on the Sabrient Global Balanced Growth Index. Roughly an 80/20 balance between growth and income-oriented ETFs holding stocks and bonds.
The S&P/TSX 60 shows more volatility than the Claymore ETF. There are reasons for this.
The S&P/TSX 60 is made up of sixty of the biggest stocks in Canada – one country with a big presence in financials, energy and materials.
The Claymore ETF is geographically diversified. It holds stocks from all over the world. It also has a fixed income component. Its equity and fixed income allocations are further diversified. They hold different investments that perform somewhat differently depending on market/economic conditions.
What investors have to remember is that while volatility is reduced when fixed income products are added to a portfolio, it also reduces the upside of the portfolio when markets turn around. A geographically diversified portfolio with fixed income products added into the mix isn’t going to perform as aggressively as the broader stock market.
Most investors can tolerate less upside for less downside. As we’ve recently seen, it’s the drops that make people a little shaky in the knees.
Remember, should you want even less exposure to stock, there are plenty of products out there that are closer to a 60/40 split between equities and fixed income.
Asset allocation is going to affect performance and risk. You can always use systems (like the simple ones above) to come up with a benchmark for your portfolio, but in the end, your portfolio’s going to be slightly different because it won’t have exactly the same investments.
Opportunity abounds in down markets. Part of the opportunity of market volatility is figuring out your risk tolerance. If this last correction gave you palpitations, maybe you have too much stock.
But consider:
- The markets have corrected. This graph is from September 2010 to September 2011. If you sell investments now, you may be selling near the bottom.
- Having an asset allocation system in place is going to be the best benchmark for rebalancing your portfolio. If you haven’t had such a system in place, think, and act now.
There may be opportunity out there. In fact, the last few days in the markets have seen some extraordinary upward movements in equities. September is often the cruelest month in markets, but October has ended a lot of bear markets historically. Bad news travels fast and furious, yet the sounds of optimism often appear within the pessimism and noise.
*ETFs used here are for illustrative purposes
Part Two — Bonds: Why you should love the unloved investment
Count bonds. Forget about sheep.
In the two years before the financial crisis, government bonds underperformed. Stock markets were hitting all-time highs and few investors were interested in bonds. However, as the risk premium for stocks was rising and stock indices in Canada and the U.S. were hitting highs, shrewd investors were reallocating their portfolios to include more bonds.
Bonds were unloved, but they were cheap, and when stock markets came down in a hurry, bonds acted like the buffers they are: they rose while stocks were coming down in portfolios.
The case for bonds in a portfolio as a permanent asset seems pretty solid. Let’s take a look at the last six months.
Over the last six months, stocks have finally gone into a correction. Stocks have been incredibly buoyant since the bottom of the 2009 crisis and have performed very well. But corrections are a normal part of the investing landscape. Corrections are healthy since they clean out the speculative element in the market periodically. Investors, on the other hand, especially average investors, aren’t huge fans of volatility.
Looking at the chart over the last six months, we can see that government bonds turned up as the markets headed down. Bonds are doing what they do, once again: smoothing out returns by acting like insurance in your portfolio.
Equities hit home runs, but bonds keep you from crashing into the catcher’s mitt and getting called out at the plate.
Equities should outperform bonds in the next few years because bonds have made out well recently, but good diversification together with prudent asset allocation suggest the average investor should have some bonds in the asset mix. Recent news has shown us how commodities and stock markets can change direction in a hurry.
The debt situations in Europe and the U.S. illustrate the importance of having Canadian bonds in a diversified portfolio. Canadian bonds are in a good place when it comes to quality these days. Just when many were saying Canadian bond returns had peaked and there was no future investing in them, boom, sovereign debt issues exploded in the media – again. Both recent history and the last few days are excellent reminders of why bonds have a place in the average investor’s portfolio.
Canadian government bonds may not work in a get-rich-quick scheme, yet when it comes to your portfolio, it pays to think. Think of bonds as insurance. Think of bonds before you go to sleep. In times of volatility, count bonds and forget about the sheep.
Part One is here.
Update: Foreign investors are also loving the unloved investment in Canada.