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:

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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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:

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

* 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

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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.

Follow @JohnRondina

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

In Part One, I discussed some differences between the 1 per cent and 99.

How do the 1 per cent differ from the 99 when it comes to market volatility? Is there something the average investor can learn?

I’m not trying to defend the 1 per cent. What I am trying to do is point out that the market is public and that market volatility leaves no one untouched. No stone unturned.

I’m not here to talk about tax inequality or to defend either side. People like Warren Buffett have done that. There have been arguments for and arguments against Buffett.

What I’d like to focus on is:

While the 1 per cent have better intelligence and more powerful networks when it comes to investing, there are strategies the 99 can use to get ahead. Strategies Warren Buffett and the 1 per cent have been using for a long time.

If you’re a long-term investor, you can own a lot of the same assets. Granted, you may not get these assets at the same transaction costs due to scale, but you can own assets that should enrich you over time.

Have the wealthiest people sold all of their assets? Doubtful.

Do they sell them after market declines?

Well, let’s look at this rationally.

• You need to find a buyer in order to sell your shares (the sheer scale of owning billions in assets means it’s harder to find a buyer when you sell)¹

• Liquidating such assets might cause some significant tax implications²

• Because of professional counsel, the 1 per cent are exposed to more and better research than average investors, leading to fewer knee-jerk reactions in the face of market events

There would be barriers to the 1 per cent selling their assets.

Taxes …

You can see at least three articles above discussing whether taxes on investments and the 1 per cent are too low. There is definitely a movement afoot to examine these issues.

Let’s set the 1 per cent aside for a minute.

Remember, Joe Average gets a break on taxation for certain investments, too. So does his partner, Josephine. They may not get as big a break, but they do get a break.

They get a deduction for contributing to an RRSP. They get tax-free earnings in a TFSA. If they’re invested in dividend-paying equities outside of an RRSP or TFSA, they get tax-preferred income from those dividends.

Advice

Because the wealthy have the means to get good counsel when it comes to their investments and financial planning strategies, we can assume that those professionals counsel their clients:

• To avoid panic selling

• To rebalance regularly and systematically

• To take advantage of market volatility through rebalancing strategies

Joe and Joe and Market Volatility

Now, what about Josephine and Joe Average? Are they taking advantage of the better prices presented through market volatility?

After the 2008-2009 correction, did the average investor take advantage of some of the cheapest prices we’ve seen in a generation? Is the average investor taking advantage of cheaper prices now?

Research says no. (Like to explore this idea further? I blogged about it in “Don’t Panic”.)

People concentrate on returns over a given period of time. But such assessments assume that you invested your money all at one time at the beginning of the period. How many investors do that?

Easy as ACB

Your Adjusted Cost Base (ACB), basically, how much you paid as you bought an investment, is a much more realistic measurement of how you’re doing.

If the broad market’s down 20 per cent, and you’re ACB is showing that your investment in a broad-based mutual fund or ETF has broken even, e.g. the investment’s price is 10 and your ACB is 10, you’ve done great.

Why? Because you’ve outperformed the market over the same period.

How did you accomplish this? By using excellent rebalancing strategies.

Of course, if you’ve had a more conservative position, you have to realize that when the market turns around, the broad index may start outperforming with respect to your investment. Your rebalancing plan will help with this, and sticking to that plan will help even more.

Figuring out who you are as an investor is important.

In Part Three, I’ll continue, focusing more on long-term strategy with a simple illustration of why that focus will make you a better investor.

Notes:

¹The 1 per cent tend to buy shares of companies more than they buy mutual funds. Diversification isn’t as big a deal for them. They have the means to buy enough shares and still be adequately diversified. This isn’t true of the average investor. Some market experts say you should have at least a million dollars to invest to be adequately diversified when holding stocks. Others disagree. It’s true that the fewer companies you hold, the less diversified you are, and the more risk you’re taking on. Employees that held most of their investments in Enron or Nortel found this out the hard way when the stocks collapsed^3.

²Taxation is another reason why the 1 per cent sell their holdings, e.g., experts have suggested Steve Jobs’ heirs sell their shares in Apple to avoid over $800 million in tax liabilities.

³More evidence for diversification comes by way of Bill Gates example. While he has significant wealth in Microsoft shares, he holds a lot of Berkshire Hathaway in order to further diversify his holdings. Forbes claims that more than half of Gates wealth is held outside Microsoft stock.

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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.

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Kids and money: What kind of financial legacy are we leaving our children?

When I graduated with a BA in English, the only thing I knew how to do financially was a budget. I loved literature, but financial literacy?

I knew land could be good. I’d learned about budgeting and land from my parents.

During my first year of work, it didn’t take long for me to learn that there were a lot of things I didn’t know a whole lot about.

The stock markets had just crashed. (It was a great time to buy.)

Every day as I rode the TTC, I read about things I couldn’t begin to understand. For a pretty smart guy, I felt stupid. That year, I read everything I could about investing and financial planning and gave myself the expertise I needed to understand the events in the newspapers.

I have never regretted that investment.

It’s been part of my active research ever since.

Financial literacy is on the move this year. The $5 million Task Force on Financial Literacy released a report with a host of recommendations. November is Financial Literacy Month in Canada. Non-profits are collaborating on monthly events.

Why do we need this focus on Financial Literacy?

• Average debt to household income has increased in Canada

And it’s not so-called good debt (where you can write-off the interest payments). Our burgeoning debt alone should prove the need for financial literacy.

The B.C. Securities Commission, in a survey of more than 3,000 17-to-20-year olds, released the following last week:

• They expect to be making $90,000 a year by 30. Three times the national average.

• Three-quarters think they’ll own homes at that age. Government data estimates 42 per cent of 25-to-29-year olds are homeowners.

• Many students graduate with “weak financial skills and little knowledge of the financial realities they will face.”

Those stats should give parents and concerned members of Canadian society great pause. During a time when credit-binging has led to some brutal consequences in the U.S., Canadians have loaded up on debt. Some people have warned of our own inflated housing prices … Low interest rates are making this housing price boom long. Too many people think housing will go up forever.

There are always exceptions, but the statistics are overwhelming. Kids are out-of-touch with financial reality.

The digital universe is changing so fast some can practically feel the wind blowing them back into their chairs. Information has more channels than most can keep up with. Plugged-in like never before, but disconnected from financial reality, kids need help understanding debt, budgets and saving.

Add to this:

• Baby boomers are aging

• Europe and the U.S. are having their issues with taxes, debt and political infighting

• Though Canada’s doing comparatively well, the crisis of 2008-2009 illustrated how global markets and economies are interconnected , and how poor the average person’s understanding of market volatility is

Of Canadians in general:

• One in three is struggling or can’t keep up with their finances

• One in four is weak in key areas of planning and budgeting

• 30 per cent are not preparing for retirement

• Millions of Canadians won’t have sufficient retirement savings and no pension plan other than the CPP/QPP and Old Age Security

• People have very low tolerance for market volatility (and without being able to process market volatility, it’s pretty hard to be an investor. Without becoming an investor, it’s hard to get ahead.)

While there are great agencies doing their part to raise awareness and make lasting and effective changes to our education system, parents need to teach their kids about debt.

The consequences to our economy and economic future of financial illiteracy are immense. Championing long-lasting positive changes in the way schools teach financial literacy is no longer optional.

It’s our future. It’s their future.

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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:

Feeling some panic?

What’s a TFSA?

In times of volatility, you might want to focus on conservative dividend-paying investments

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

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.

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Cash, corrections, the end and feeling fine

 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.

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Get the balance right

Can we simplify asset allocation?

Yes, we can.

While there may be more to asset allocation than just stocks and bonds, stocks and bonds are the best starting points for most investors. Anyone can become an investor through mutual funds or ETFs.

What have most investors heard about stocks?

• Stocks usually outperform bonds over long periods of time

Ok, now, in this hypothetical, let’s imagine that stocks take longer than average for that outperformance to take place. What can we do to bolster our portfolios?

If we find ourselves in a period where equities take longer to outperform than average, we can arrive at two conclusions:

• Fixed income positions (bonds) are even more important

• Rebalancing is even more important

Why?

Because, although a 100 per cent portfolio of stocks should statistically outperform over the long-term, most investors are more human than they are instruments of logic. People are emotional.  Since they’re emotional, what is theoretically true about investing may not hold true in real life.

Volatility takes its toll. Big market drops herald big investor reactions. When bad news reaches a fever pitch about stock markets, many investors start to feel ill. Investors start abandoning strategy and discipline.

After all, there’s Europe, a potential recession, inflated house prices in Canada, and a blue sky that’s sure to fall. (Never mind that equities haven’t been this cheap in quite a while.)

The only things that have really changed are the names of the crises. Not to belittle the difficulties we face economically – these are challenging times – but we’ve always faced difficulties economically. With market corrections, and, with prudent planning, difficulties become opportunities.

Seeing the opportunity in today’s markets may be better than running around screaming the sky is falling.

If your portfolio has a good allocation to fixed income products – if you have a mix you’re comfortable with – and you have a disciplined rebalancing strategy, you should benefit. There are times when stocks and bonds move up or down at the same time, but usually, stocks and bonds move in opposite directions.

If your allocation is 65 per cent equity (stocks) and 35 per cent fixed income (bonds), then when your allocation drifts, let’s say to 70 per cent equity and 30 per cent fixed income, it’s time to rebalance.

What do you need to do? Sell some stocks and buy some bonds. Sell the asset class that has outperformed, and buy the asset class that has underperformed.

Sell high. Buy low.

Everyone knows that, right? But it takes great discipline to do. You have to automate the process.

Some investors worry that they’ll impede portfolio performance by selling stocks when they seem to be doing nothing but going up. True. This happens. Your allocation may change early in a bull market. But many investors struggle seeing future benefit in the face of the madness of crowds. The “noise” affects their focus and their resolve. It can make investors buy at the wrong time or sell at the wrong time. In down markets, too many investors only see current losses or declines.

What might be the best rebalancing schedule theoretically, may not work for the average investor struggling to cope with “noise” during a market correction, especially, if it’s a severe correction like 2008-2009.

While the financial crisis may have caused some grey hair, it was one of the best times in recent memory to test out your portfolio. Recent weeks also put some pressure on investor nerves while squeezing portfolio integrity.

It’s times like 2008 – 2009 that make people happy to own bonds. Bonds performed very well as stocks declined.  Stocks usually outperform bonds over the long-term, but bonds add some insurance to your portfolio.

As the market began the steepest part of its recent decline, we can see that bonds once again outperformed as investors positioned themselves for safety. The steady income from bonds and the hedge they provide against market drops often make them fund manager favourites.

Why should the average investor be any different?

Bonds providing a hedge during recent market correction

Part Two is here.

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