Posts Tagged ‘diversification’
One sector is the loneliest number when it comes to investing
My last post, One stock is the loneliest number when it comes to investing, made the case for why you shouldn’t own one stock as an investor. Diversification is an important part of your investment planning.
Similarly, today’s activity in the gold market, and really, the last few years, has demonstrated why single sectors present significant dangers to investors who overweight them.
Gold is having a massive down day. It’s dropped nearly 10 per cent as of this writing — in one day — the most since the early 1980s.
The writing was on the wall a long time ago. In Gold riot, I discussed why gold had much risk built into it for investors, especially when few were talking about this risk.
Here’s a quote from Warren Buffett as posted on my blog from a few years ago:
Buffet on gold:
“(Gold) gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”
Ah, the Ziggy Stardust gold analysis …
In Fortune, Buffett recently said:
“You could take all the gold that’s ever been mined, and it would fill a cube 67 feet in each direction. For what that’s worth at current gold prices, you could buy all — not some — all of the farmland in the United States,” Buffett said. “Plus, you could buy 10 Exxon Mobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?”
A very, very interesting illustration …
Anyone who paid attention to the wisdom above, to the valuations that Buffett drew attention to, would have known that there was huge risk in gold.
Forget all the reasons you’ve heard over the last few years for why gold was a great buy. History has proven that reasoning wrong.
As in many things, now that the stratospheric valuation in gold has been beaten down badly, gold is cheaper (down almost 18 per cent year-over-year). What the future holds is unknown. But what hasn’t changed is the following:
- Single sectors expose you to great risk if you haven’t built a well-diversified portfolio
- “Hot money” moves fast and takes few prisoners when it leaves a sector
Gold may be much cheaper now than it was a few years ago, but gold is only a compelling buy if the future shows it to have been cheap. Meanwhile, are there other companies out there that are actively engaged in producing goods or services that will have a better chance of creating value in the future?
By way of comparison, from gold’s peak a few years ago, the returns on dividend-payers in the U.S., Canada and globally look spectacular. The “fear trade” (buying gold) has been a poor investment.
Markets will correct. It’s inevitable. You can do your part protecting yourself by making sure you have a diversified portfolio.
Do you?
Click here for more about bonds/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
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Related articles
- One stock is the loneliest number when it comes to investing (johnrondina.wordpress.com)
- Hedge Fund Billionaires John Paulson And David Einhorn Lost $640M In Gold Market Collapse
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One stock is the loneliest number when it comes to investing
The U.S. markets have had a great run this year. They may be entering a phase of correction as I write.
Some stocks affect markets more than others.
Falling back to Earth
Remember Apple — everybody’s darling? Have a look at a post from back in April, 2012.
What goes up spectacularly, can come down spectacularly
Over one year, Apple fell nearly 40 per cent from its peak. While Apple may have done very well long-term, if you held Apple over the last year, you’re investment dropped 40 per cent from its high. It acted as a drag on the S&P 500 and the Nasdaq just as it lifted both during its run. That’s 40 per cent of your investment or very nearly the amount the broad markets came down during the financial crisis, an amount that caused many investors to rethink their risk tolerance.
One, is indeed, the loneliest number
You should never hold just one stock, no matter how well it’s done. Sure, you can do very well, but what some forget is that your risk goes into the stratosphere with your investment.
Apple as case history
Apple’s downturn presents a strong argument for diversification.
Steve Job’s heirs were being advised to sell Apple and diversify even before Apple hit an all-time high. But that story didn’t capture much attention.
One is the riskiest number
The reality is, that in investing, one is the riskiest number. There’s a reason most investment professionals own anywhere from 30 to 300 stocks or more in a broadly based portfolio. Broad indices may even go as high as 500 stocks (S&P 500) or 1,000 or more (Russel 1000).
Grow slow**
And this is why diversification is so important. While it’s true everyone’s a winner while they’re winning, it’s also true that spectacular runs in individual stocks can come to an end.
Apple’s future? Unknown. But principles of diversification are well-known, tested over time, and retested. There are aberrations, but even better, investors sleep at night when they know their risk tolerance.
As Apple stalled, the broad market accelerated
We may be overdue for a correction. U.S.-based indices like The Dow Jones Industrial Average (DJIA) hit a record while the broad S&P 500 fell from its nominal high recently. Both indices have performed very well.
Both indices were bargains after ten years of relative underperformance, especially compared to the Canadian market and a soaring Canadian dollar. After the financial crisis, and the ensuing market correction, few wanted U.S. stocks (or any equities). But they were extremely cheap.
Is big better?
As money came out of Apple, the broad markets took off. We’re not just talking big … Apple had reached monolithic proportions. Articles like this are often a warning to investors. A warning that often goes unheard.
Can’t you just see Tim Cook breaststroking through cashmoney? I can.
— The Atlantic
Was Apple absorbing a lot of investment capital? Considering the huge cash position Apple held (over $100 billion U.S.) was that capital being used well or was it being used as a buffer against the inevitable slide in Apple stock?
Investors looked out at investment opportunity, increasing competition for the iPhone and decided to take profits and put their money in more companies in different businesses. After all, while some may argue the opposite, does any country create lasting success through the overwhelming dominance of one company in its markets?
The history of antitrust law would say no. You be the judge.
You’re risk tolerance may be severely tested only once every ten years, but when it is, what you thought you knew about yourself can change as fast as the passage of that ray of light that just went by but left the sun eight minutes ago.
Click here for more about bonds/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.
Click here for a collection of articles about investing.
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* Based on an average basket of Canadian dividend-payers
** Recent activity in gold adds fuel to a philosophy of owning dividend-payers during tough times, the dangers of volatility for investors who haven’t diversified and the perils of overweighting one speculative sector or stock, no matter how “safe” the crowd thinks it is
Is it better to have invested, and lost, than never to have invested at all?
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? *
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
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.
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.
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
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Wait a minute. There’s some good news re the markets?
It’s all bad news, right?
Nope. Surprise, surprise. And it’s on the upside.
Pour this latest data into your glass and see if it looks half-full.
Panic and pessimism may usher in a market rise (It’s happened before. It’ll happen again.)
Contrarians love all the bad news. To them, it means we’re closer to good news as they wait for the point of maximum pessimism. But maybe we’ve already hit that point?
- Inventory levels in the U.S. are low.
- Stocks look cheap. Compare U.S. equities to U.S. bond yields. Dividends look great and promise more than bonds currently.
- In the U.S., the fall in housing prices and low financing costs have created the most affordable housing climate in decades.
When could “mean” be green?
All things revert to a mean, don’t they? Usually, when someone says it’s different this time, it’s exactly the same as last time.
- Bonds have beat the pants off stocks over the past 10 years. The last time equities were performing like this was the 1970s. Since this is true, bonds have become overvalued relative to stocks.
- It’d be an understatement to mention that investors are increasingly risk averse. Panic is prevalent — especially in the news. In the face of this: Corporations continue to show financial strength and profitability. U.S. dividend payments continue to rise paying investors to wait.
- The market went through the roof last week at an agreement to agree to agree in Europe. Looks like a ton of pent-up demand. The will for the markets to go higher is there. But investors who weren’t already in the markets had little chance to get in. Things just moved way too fast. Sitting on the sidelines may leave the average investor sitting on the sidelines.
What will be the impetus for markets to rise?
If governments stimulate again, we could see a big push in equity markets. There’s value in the markets. Stick to your plan.
Filter out the noise. Focus on the facts. Find the candles burning in the doom and gloom.
How many times have you heard someone say: I wish I’d bought shares in XYZ Corp.? Isn’t it funny that when companies are at big discounts, only the few and the brave want to go shopping?
When it comes to the markets, it’s often looked darkest before the dawn. But the facts above may be the lantern to help light your way.
Updates:
Prem Watsa of Fairfax Financial sees value in the market in the guise of RIM and doubles stake
Frank Mersch of Front Street Capital says stock market’s showing value and is cheap
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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 — Get the balance right
Can we simplify asset allocation?
Yes, we can.
Watch out for rebalancing fever
It’s possible to get rebalancing fever. Be careful. Like all manias, there are dangers. If you start rebalancing your portfolio every time there’s a slight move, you may find you have no more time for anything else – not to mention creating potential tax liabilities.
In “Let’s think about assets” I also discussed rebalancing. A five per cent portfolio drift is a good measure of when you need to act. The time frame for a five per cent change in your stock or bond allocation depends on markets and economic conditions, investor sentiment and the ever-changing universe of moving parts and multiple players in a global economy. It’s a fluid investing universe.
Automatic for the people
The key with asset allocation is to make it automatic. The sun will rise. The sun will set. Investors rebalance their portfolios.
Eliminating emotion from your rebalancing philosophy makes it more effective. When you rid yourself of the “noise”, you can gain focus, discipline and the ability to implement.
Check your portfolio at least once a year. If you do, you should be able to catch when your portfolio needs rebalancing. When your allocation has strayed enough, rebalance. During times of great volatility, like this past August, have a peek to see if your allocation has moved enough.
Do your emotions get the best of you? Stick to looking at the percentages of your different allocations rather than the dollar values of investments. Market corrections and severe volatility have a way of making investors, especially novice investors, weak in the knees.
Discipline
There is one overarching rule to rebalancing:
• Stick with your plan
Once you have decided on a plan of action, abandoning your strategy makes it useless. So why do so many investors flee their plans when the going gets tough? Because they’re allowing emotion to eat into their strategy. Often, the cause is assessing yourself as a more aggressive investor than you really are.
Everyone is superhuman when there’s no kryptonite around.
What’s an investor to do?
Use market corrections to re-evaluate your risk tolerance. Corrections are opportunities. Not only do they show who you really are as an investor, but they reveal inevitable bargains.
Remember, assessing yourself openly and honestly as an investor is very important. After all, this is a conversation with yourself (and your advisor, if you use one).
In the end, every investor has to take a certain amount of responsibility for their investment decisions. We should expect good counsel, transparency and best practices, but we are the best evaluators of ourselves – especially during market volatility. The financial crisis and the resulting market drop clearly demonstrated that many investors couldn’t take the heat. That’s okay.
Know thyself. Then move forward from there.
When it all comes down to it, remember, if you’ve been sitting in GICs for the last few years, you have missed out. (See “Bonds: Why you should love the unloved investment”)
Invest in You Inc.
The thing some investors miss when they rebalance their portfolios is that rebalancing really is taking stock of you. When the media becomes shrill and volatility is very high, this is a strong signal to look in the investment mirror and ask:
• Who am I?
• What’s going on?
• Where are the opportunities?
All we are is all we are
No one ever knows exactly what the markets are going to do. Rarely are great opportunities uncovered by knee-jerk reactions to our most basic fears. We are who we are. But we can all step back from ourselves, think, and reflect:
Fear is a great motivator, but so is stepping outside of fear and looking out at opportunity. Opportunity is like a good neighbour. Often, the potential for good fortune knocks at the door in an unusual form. It’s up to us to recognize it.
Meanwhile, there may be shrill voices on the street and much gnashing of teeth.
Part One is here.
Find out more: Asset Allocation can be easy as A, B, C