Posts Tagged ‘invest’
Investing: ‘What ifs’ and ‘maybes’ lose out to long-term planning
Back in August 2011, I posted Don’t Panic. 
I took a look at investor psychology in the face of negative sentiment on the markets. In It was the best of times (for dividend investors), I outlined how well dividend-payers did over the last few years. The markets have done very well for the dividend-centric.
So what’s an investor to do, now?
Interesting U.S. market stats
Bob Pisani, of CNBC, points out some interesting information regrading U.S. markets:
Most notable among the trends was a near-record pace of fund flows last week into equity funds.
Stock mutuals saw $19 billion come in, the highest since 2008 and the fourth-biggest in the 12-year history of tracking the data, according to Bank of America Merrill Lynch.
The latest American Association of Individual Investors survey registered a 46.4 percent bullish reading during the same period, well above historical averages, while those expecting the market to be lower in six months fell to 26.9 percent.
Finally, the CBOE Volatility Index, or VIX, a popular measure of market fear, is at a subdued sub-14. A declining VIX usually means rising stock prices.
(Read More: Why VIX’s Recent Plunge May Be Bad for Stocks)
About the only areas showing caution were safe-haven money market funds, which saw assets grow to $2.72 trillion on an influx from institutions, and commodities, which had outflows of $570 million.
The most popular reason among traders for all the optimism is basic relief that the U.S. made it through the “fiscal cliff” scare relatively unscathed.
If that’s the case, the looming debt-ceiling battle and a likely lackluster earnings period could offer perilous counterweights.
So, what’s an investor to do?
The reality is, if you know who you are as an investor, and more importantly, where you want to be, none of this should rattle you. But it should make you think. Trading the media is something some do, and some do it very successfully, but most don’t. And that’s why investors must plan.
When planning for a year, plant corn. When planning for a decade, plant trees. When planning for life, train and educate people.
— Chinese proverb
Warren Buffett plans. Why not you? After all, planning is a form of self-reflection and self-education.
The metric of the past and planning for the future
It may be wise for investors to reassess their investing plans, to decide if their plan is capable of meeting their goals and then have the courage to sail on the course they’ve charted. If past is prologue, then the last couple of years have rewarded the longer-term planners for wading through the ‘what ifs’ and ‘maybes’ and sticking to the fundamentals.
The market hasn’t had a 10 per cent correction in a while in the U.S. While we all watch, we have to wonder at the market’s resilience while remembering why we hold assets that act as ‘insurance’ against revaluations. Any correction should be incorporated into your plan and taken advantage of. But a 2 or 3 per cent drop from an all-time high is hardly a correction. Having some cash on hand when markets have hit recent highs is rarely a bad idea.
The market hasn’t seen a traditional correction in almost three years. Majority sentiment would have seemed against this phenomenon three years ago. We will have a correction at some point. No one can be sure of the degree of the next correction. But does this alter your planning?
Planning empowers you in the face of ‘peril’
It’s best if you incorporate the possibility of a correction into your plan. Because, at some point, the stock markets will correct.
In a world gone into overdrive, where the short-term seems like the long-term to some, authentic long-term planning may be the most valuable commodity.
The markets are like anything else with respect to planning. And the markets are one of the best barometers of human psychology. ‘Perilous counterweights’ need to be part of your planning.
We’ve all heard that in the long-term risk gets reduced by time-in-the-market. In the meantime, knowing your tolerance for risk is crucial. What we can learn from the period from August 2011 to now is that risk happens in so-called ‘safe’ investments, too.
The broad markets have outperformed cash. At some point, markets will correct. Maybe that process has started. Markets correct. This is part of what makes a bull market healthy. And corrections are the reason why we should use proper asset allocation in our portfolios.
One thing is sure. It was better to be in-the-market than it was to be in cash in the time period we looked at above.
No one owns the patent on the future. No one ever knows the exact nature of the next correction. It’ll be interesting to see what the next six months holds …
A plan we can live with is part of what keeps people happy as investors over the long-term. So that we can sleep and dream of sheep.
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Help! I can’t understand if I’ve made any money with my dividend-paying investments!
Having difficulty understanding if you’ve made money with a dividend-paying investment?
So many investors look at their statement when it arrives and think:
I haven’t made any money! (Cue gnashing of teeth.)
But is it true?
Let’s say you hold investments that are of a dividend-paying nature. How do they operate?
Well, whether you’re investment is a mutual fund, an ETF or a stock, if it pays dividends, and you don’t really understand how dividends work, you’ll be confused.
Paid to wait
First, it’s important to separate your original investment from your dividend payments (distributions).
Dividend payments might be:
- Monthly
- Quarterly
or,
- Yearly
Most dividends come in quarterly payments.
In this example, I’m going to use Royal Bank, a widely-held Canadian bank stock. It doesn’t matter what dividend-payer you use. It’s also the same with an ETF, a stock or a mutual fund. It’s only the terminology that changes (e.g. shareholder or unitholder).
Royal Bank pays a dividend of .63 cents quarterly. If you hold 100 shares of Royal Bank, you’ll receive a payment of approximately .63 cents four times per year per share.
Why “approximately”? Because depending on the health of the company, it may raise or lower the dividend. For example, Royal Bank raised it’s dividend payments this year. It’s first two dividend payments were .60 cents, and the last two were .63 cents.
To make things easy, let’s assume Royal Bank had made four dividend payments of .63 cents:
4 x .63 = 2.52
In my example, the dividend payment would be $2.52 per year. If the stock were valued at $62.00, that yearly dividend payment would be equal to 4.06 per cent (or one year’s dividend payments). Our example is very close to Royal Bank’s dividend yield (currently 3.94 per cent).
Let’s imagine the Royal Bank illustration above was a mutual fund. If the fund paid a dividend of $2.52, the dividend payment amount would be subtracted from the unit price each quarter.
Each time the dividend was paid (.63 cents), the unit price of the fund would be subtracted by the dividend payment.
Why?
But wait! Wasn’t there a dividend payment?
Because your Adjusted Cost Base (ACB) changes when dividends are paid out. If the unit price of the fund did nothing, for example, ended the year at the same price it began it, your investment would look like it hadn’t made any money. Superficially, at least.
But it would have, because, when you receive the dividend, you get more shares / units. Your 100 original shares will increase in number.
Didn’t that fund pay $2.52 for the year? And wasn’t that payment supposed to be 4.06 per cent? And so, didn’t you, as an investor, make over 4 per cent on your investment?
Yes.
And every time the dividend was paid out, didn’t you get additional shares in your investment?
Yes.
But the four dividend payments, when made, count as dividend income if they’re held outside of a registered account. The dividend is reinvested into the fund. So, when your payment of .63 cents per share is made, for accounting purposes, it’s considered new money and a new investment.
In a future post, I’ll give you an example of what this looks like, and a key error less-experienced investors make in understanding their investments.
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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
A question every investor should ask: What happens if the world doesn’t end?
Learn to harness your fear
Remember a few months ago when the economic news was so bad that optimism seemed naive?
Well …
Markets the world over made solid gains in January.
Have a look at this recent article. Negative investor sentiment is occurring at the same time as the best January in the markets since 1987.
The markets often climb significant walls of worry. Sometimes, it pays to focus on bad investor sentiment and use it as a contrarian indicator.
In “Wait a minute. There’s some good news re the markets?” I blogged about how investors often miss the good news flying below the radar.
Many people have been burned by the excesses of credit mania, culminating in the market implosion of the financial crisis.
Humans in all walks of life sometimes give in to greed. Exuberance and fear are flip sides of a coin forged at the beginning of time.
I posted some stark stats in “Why you should consider new investments now”.
Why post negative stats? Because, while end-of-the-world scenarios might sell bytes of information in the short-term, they don’t do much for the average investor who’s trying to be strategic about long-term investing.
The starkness of information can be helpful.
Ask yourself a simple question:
When the market takes a substantial dip, generally, is there more chance that it’ll rise or keep falling on average?
Bad news gets the big, black ink (or bytes)
There are always going to be onslaughts of bad news. Good news rarely gets the big, black ink of the headlines until the story’s over. In between, you need to manage your fear.
You need to think strategically.
In “Don’t Panic”, I went into greater detail about managing fear while investing. Learning to harness your fear as an investor will go a long way toward helping you create an intelligent plan of action when it comes to investing and financial planning.
Again, in “The grand parade of future dividends “, I discussed how corporations were increasing dividends (good news for investors) and ended with the question:
“What happens if the world doesn’t end?”
While Canada is experiencing higher unemployment, the U.S., recently written-off as a basket case, just posted strong employment numbers.
What people keep forgetting, is that business, economic news, and the process of investing is fluid. Some get so used to bad news that they forget good news exists.
Until January, there wasn’t a big focus on the positive. But whispers of good news were there if you read between the lines (or read more than just the headlines).
Now, was it really a good idea to sit on the sidelines as an investor during all that bad news? And is the bad news over?
Well, here’s the thing:
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’ve been sitting in cash only:
- You’ve missed a very nice rise in the bond markets
and
- A great opportunity to reallocate investments to stocks
Risk applies to low-paying GICs just as much as it does to equities or real estate.
In this case, low-paying GICs weren’t much of a safe haven when compared to the Altamira Income Fund, or even the broad Globe Fixed Income Peer Index.
Sitting in GICs can cost you.
So, when you consider the past year would’ve been:
- A great time to buy equities at lower prices
and
- That bond funds significantly outperformed the GIC index *
… it pays to ask this question again:
What happens if the world doesn’t end?
The case for bonds against ...
... GICs. (Over five years)
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
* Many criticize bond funds for their higher fees as compared to ETFs, but for many average investors they are the easiest way to get a diversified bond portfolio since not every investor has a trading account.
* You should also note that since bonds have significantly outperformed, they may not perform as well over the next few years. A balanced portfolio is the best way to ensure consistent outperformance while minimizing risk.
Note: Fund/funds used here are only for illustrative purposes.
Chart source: Globe Investor
Part Three — Market volatility: Why and how to make it work for you
In Part Two, I left off discussing benchmarks on investment returns.
Easy as ACB revisited
I stressed that such benchmarks only reveal how your investment would have done if you invested all of your funds at the beginning of the period. These benchmarks assume you were inactive during the time period you’re measuring, and you did zero rebalancing during 2008-2009 or other significant market corrections — exactly the periods of time when you should be (or should have been) more active.
While investors should have been rebalancing during 2009, research shows average investors freeze up during these times, or worse, sell.
The worst case scenario is that they sell heavily.
Let’s say you had a large cash position in your portfolio near the bottom in 2008-2009. New cash, profits you’d taken, whatever …
Now, let’s say you used that cash and bought equities around that time, which turned out to be the bottom or near the bottom of the correction. Your return would be considerably different. And this is why rebalancing is so important to the success of your investments, portfolio and retirement plan.
If you’d been following a sound rebalancing strategy, you would have bought during the downturn in 2008-2009 because your asset allocation would have drifted away from your plan.
Let’s use a simple illustration:
• You bought 50 shares (or units of a mutual fund ) at an average cost of $7
• Then you bought 10 shares at $5 (you were brave and when the market dropped 50 per cent in panic selling, you saw opportunity)
• You then continued to deploy your cash while the market was cheap and bought 10 shares at $6 (because of your rebalancing strategy, which you follow automatically. You bought while prices were cheap because your asset allocation had changed.)
• The market rose dramatically after this period and your asset allocation reached your target. You stopped buying.
So, your adjusted cost is:
50 @ 7= 350
10 @ 5 = 50
10 @ 6 = 60
Your total cost was $460. The price now is $7.
7 x 70 = $490
You now have profit of $30, called a capital gain.
In reality, your transactions will be more complicated, and there will be dividend payments in there somewhere. But the simplicity of this example shows us how following asset allocation strategies with your investments will help you lower your Average Cost Base (ACB).
Your equity component would have been, percentage-wise, less than it had been. Your allocation plan would have kicked in, and you would have bought the underperforming equity investments.
Even if you did this more gradually, before, during, and after the correction, it would have lowered your average cost.
One way for Joe and Josephine Average to get a leg up is to take advantage of what’s available to them. Tax-preferred or (deferred) investments and plans, and sound portfolio strategies included.
But research shows they don’t. Volatility spooks them, and sadly, this will cost the average investor over the long-term.
When I was a kid …
An older colleague I used to work with said the following, loosely paraphrased, about his lack of savings and investments in his youth: “When I was a kid, I was convinced I wouldn’t make it to forty.”
Heavy pause.
“I was wrong …”
I had asked him why he didn’t have an RRSP because I wanted to understand how he thought. He later added that he had lost a ton of money in real estate (Canadians seem to have forgotten the real estate crash that happened in 1989-1990 – Americans have had a harsh reminder).
Looking at real estate in this context reinforces my point of view on buying assets when they’re low. While it took residential real estate a long time to recover from ’89-’90, today’s real estate prices (supported by an extended period of low interest rates) prove that buying assets when they’re cheap is rewarding.
Yet nobody wanted residential real estate in ’89-’90, and many developers lost their livelihoods during that time.
Raising awareness, being startegic
Raising awareness about the investing habits of Joe and Josephine Average will help them over the long-term. They need to better educate themselves about market volatility and be more strategic in their approach to it.
While this is easier said than done, it is one of the reasons the Warren Buffetts do better than the Joe and Josephines when it comes to investing and financial planning.
Market volatility, understood properly, is your friend. Reminding yourself of this completely reframes the way you look at the market, your investments and corrections.
Maybe your friend goes a little berserk once in a while. Maybe he’s a little impatient or a little irrational at times, but he’s still your friend.
You know you can count on him when you’re down. Looking at market events this way, despite difficult times, puts you in control.
Just make sure the relationship is a long, diversified one.
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.
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
Follow @JohnRondina
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.
Diversification reduces volatility
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
Why you should consider new investments now
Thinking about contributing to an RRSP, a TFSA, an RESP or other investment account? Now may be one of the best times since 2009 to fund any of these accounts, especially if you have over ten years for your investment to bear fruit.
Why?
Because, at the time of writing:
- In Canada, the S&P/TSX Composite is down 20 per cent over six months
- In the U.S., the S&P 500 is down about 17 per cent
- Any good news out of Europe causes some nice upward movement on Canadian and U.S. equity prices, suggesting there may be some upward momentum if Europe gets its act together regarding a solution to the debt crisis
- As the two most common areas for Canadian investors to put their money to work, Canada and the U.S. present compelling values for stock investors compared to six months ago
- The S&P/TSX Composite is down about 10 per cent over one year
- The S&P 500 is down about 5 per cent over one year
- The iShares DEX Universe Bond Index is up over 7 per cent since its low within the last year
While nobody wants negative returns (unless you’re looking to buy at cheaper prices!), this current equity correction doesn’t look as bad over one year, and looking at returns over that time frame provides some perspective. Over one year, the declines don’t look as dramatic, and that takes some of the fear out of equities.
Fixed income has outperformed. Looking at this outperformance in a rebalancing context, shows stock is currently cheaper.
No one is sure what the future holds, but what is sure is that stocks are a better deal than they were, and bonds aren’t as attractive.
Do yourself a favour: If you’re nervous about markets do some gradual, strategic buying. If you don’t have a plan regarding your asset allocation, get one.
Fear of losing may keep you from winning. Fear is a motivator, so if fear is keeping you from being a strategic investor, consider that fear should also keep you focused on your plan.
Investors have to accept that they will never know exactly what the market is going to do — and then plan accordingly.
Take comfort in the fact that someone like Warren Buffett recently invested $4 billion in the stock market.
Markets will either go up, down (or sideways) in the short-term. If you stay with a balanced portfolio, you have limited downside risk. But if you stay completely out of the market, expecting the four horsemen of the apocalypse, you may be disappointed if the horsemen don’t arrive.
A good long look at a stock chart after the 2009 market bottom (and such a chart can be found in one of the above links), might help you steel yourself, too. Markets had quite an increase until the latest correction began.
The planning you do now will serve you well when the market next moves into a bull phase and increases.
Related:
In times of volatility, you might want to focus on conservative dividend-paying investments
Part Two — Bonds: Why you should love the unloved investment
Count bonds. Forget about sheep.
5-year chart comparing Canadian government bonds and the S&P/TSX 60
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.
6-month chart comparing Canadian government bonds and the S&P TSX 60
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.
JohnBlog 