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Is it better to have invested, and lost, than never to have invested at all?

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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:

Get the balance right

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

Let’s think about assets

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

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Part Three — Market volatility: Why and how to make it work for you

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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.

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Part Two: Cash, corrections, the end and feeling fine

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It`s the end of the world as we know it -- or is it?

In my last post, I discussed cash on corporate balance sheets, whether all that cash on balance sheets is the best use of corporate funds, and what companies will do with that cash (hopefully, sooner than later).
 
Onward …
 

Squabble, squabble, squabble: What happened to collaboration?

We’ve watched U.S. and European politicians do little. Squabbling doesn’t really count as a productive activity these days. Playing politics looks pretty selfish. Procrastinating looks plain stupid. The crisis in Europe is a serious issue that requires a serious response. Most probably, one that involves world-wide collaboration.

The markets are going to force politicians to get their acts together. This isn’t the time to think regionally. The global economy is here, like it or not. It’s time to act for the greater good rather than protecting one’s own backside.

We live in a global world. Interconnected, with dependencies that aren’t always transparent on the surface of things, a large event in any one country or region has far-reaching consequences. Yet too many politicians are shouting, “Mine!” Toddlers in daycare show more skill in sharing and thinking about their larger community.

iShare

Warren Buffett’s belief that increasing taxes on high income-earners is the way to go has become popular with many people. There seems to be a growing feeling of community amongst some individuals. A feeling that it’s time to share the wealth, and that tax cuts for the wealthy have gone too far.

Agree or disagree with Buffett’s belief on taxes, he`s a man that’s been, to understate the obvious, fairly successful at what he does. No wonder he has something like superhero status amongst Berkshire Hathaway’s shareholders and the followers of what’s become the “cult of Warren”. Not to mention that he’s one of the biggest philanthropists in history. He also advocates that the wealthy should follow his example. He counts Bill Gates amongst his admirers and a fellow in philanthropic efforts.

Project Band-Aid: (It’s [not] just a flesh wound)

Solutions in Europe have been largely plastic. But Band-Aid’s are short-term. Germany is coming under increasing pressure to be a leader in Europe rather than dwelling on its own self-interests. Take a look at the share prices of German banks or the MCSI Germany Index down 28 per cent year-to-date.

The market’s telling us you can’t have your cake and eat it, too. You can’t create markets, sell to them and leave them, according to investors. Not without paying for the engagement ring, at least. And the price tag is more than three months’ salary.

What investors would really like to see is a unified Euro bond. Perhaps leadership in Germany (and Europe broadly) needs to think more about the greater good (including Germany) rather than more national self-interests.

After all, why create a broader community in Europe if when crises appear leadership is going to become nationalistic? Marriages are for better or worse. If any one nation in Europe thinks it’s going to skate away from the Europen crisis, it’s sadly mistaken. The fact is the interconnectedness of financial instituitons, financial transactions and myriad moving parts is not going to ignore Germany. It’s punishing its stock market along with those of other European countries. And inaction and lack of adequate response will make this situation worse.

President Obama’s under pressure as well. American politicians have looked just as ridiculous as their European counterparts. The inability to collaborate, to forge solutions and move forward is getting a lot of press. Markets gave the Operation Twist strategy a big thumbs-down within moments, and today’s activity in the markets reinforces that.

So, wait a minute … Where’s opportunity?

Here:

  • Corporate profits are near record levels
  • Corporations are in better shape than some governments
  • Corporate bonds look better than some nations’ bonds
  • Global housing bubbles have burst already (largely)

In Canada, we are fortunate to have a strong bond market, but in the U.S. and Europe, there are more than a few questions regarding bonds. However, during the last few days’ extreme market volatility, investors still threw their money into the U.S. dollar and Treasuries – liquidity foremost in their minds.

Bonds and dividend yields

Bonds have done exactly what they were supposed to do in this correction. They have provided income and have risen dramatically as investors ran for cover. With bonds yielding very low rates of return (despite functioning as insurance in portfolios) in both the U.S. and Canada, the situation seems better and better for strong dividend-paying stocks long-term. Recently, we saw the S&P dividend yield rise above the 10-year Treasury.  In Canada, dividend yields have also risen dramatically. Your dividend yield is paying you to wait. Not bad.

The economic situation may be deteriorating; still, it’s hard to imagine that GICs are going to be worthwhile as an investment for anything other than short-term concerns in the current environment of low interest rates.

Hopefully, many investors have been following a strategic protocol of rebalancing their portfolios.  If they have, they don’t need to worry as much about the volatility in today’s markets. They may have to wait for better returns, but at the same time, they’ll get paid to wait knowing they own solid companies with a history of dividend payments.

Holding dividend-paying equities is really important because it’s the end of the world as we know it. But it’s been the end of the world as we knew it so many times before. Past is prologue. Perspective is very persuasive.

In the end, dividends provide what more speculative investments can’t:

  • A solid income stream

While the pain created by the Financial Crisis, and the current crisis in Europe is serious, investors who’ve followed prudent rebalancing strategies will be able to:

  • Count bond and dividend payments as they sleep

And that’s probably the best measure of whether your portfolio accurately measures your ability to tolerate risk … being able to sleep at night.

It’s the end of the world as we know it (like so many times before), but from an investor`s perspective, a solid income stream might help us feel fine.

Related:

As if on cue, Warren Buffett announced today that Berkshire Hathaway would buy back its own shares.

Warren Buffett bought $4 billion worth of stock in the third quarter as markets slid, investors worried and pessimism gathered steam.

Cash, corrections, the end and feeling fine

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 It’s all about the cash (and being able to sleep at night) when it comes to the stock market correction: Finding optimism in the insomnia of the moment

Didn’t the Twist go out a long time ago?

Somebody should tell the U.S. government that half-measures hardly ever satisfy anyone. Doing the Twist may be the middle ground, but now is the time for leadership and focusing on one’s convictions.

Is the glass still half-full?

Cash on Corporate Balance Sheets

In “Too much cash on corporate balance sheets: So, does this mean we can expect higher payouts?”, I wrote about the Everest of cash sitting on balance sheets. Today, Thursday, September 22, as I write, markets are moving down aggressively suggesting the Fed’s doing the Twist wasn’t what the markets wanted. There’s still one overwhelming fact that we shouldn’t overlook:

• Corporations are sitting on mountains of cash

What are they going to do?

Since they’re not in the business of becoming money market funds, (though some companies are starting to look like balanced funds by the mounds of cash they’re hording [more on this in a moment], these corporations need to do something with all this cash. After all, just like investors sitting on GICs, corporations sitting on cash aren’t going to get much of a return on it.

Now, let’s Think Apple, for example.

Seems the apple’s full of cash. But Apple’s not a balanced fund. It’s a company. Not everyone’s enamoured of Apple’s strategy.

While a lot of this cash hording relates directly to our current economic times, it still raises the ire of many people. High unemployment, especially amongst students, doesn’t make people rejoice when they hear you’re sitting on $76 billion.

With that amount of cash on the balance sheet, it seems management at Apple’s got the Mayan calendar out and are waiting for the end of the world. If that’s their forward-looking scenario, an iPhone or iPad won’t be much use …

“Hi … Mom, dad, I just thought I’d say bye … The end is coming …”

Perhaps investors in Apple have more confidence in Apple’s future than Apple management does?

But let’s revisit what’s most important to remember:

• Corporations have to do something with all this cash
• And some are

Microsoft recently raised its dividend: One of many companies to do this. It’s about sharing the wealth.

The fact that Apple hasn’t issued a dividend seems like a strategic mistake. It will be interesting to see how long investors will tolerate so much cash on Apple’s books.

Since opportunity appears in times of crisis, it’d be foolish to forget that all this cash has to go somewhere eventually.

Where?

  • Dividends
  • Mergers, acquisitions
  • Buying back shares
  • Towards hiring the most important resource, people, as the economy improves

Part Two is here.

Part Two — Get the balance right

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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

Get the balance right

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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.

Part Two — Bonds: Why you should love the unloved investment

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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.

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