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ALWAYS CONSULT YOUR INVESTMENT PROFESSIONAL BEFORE MAKING ANY INVESTMENT DECISION

June 7, 2018 | Bring It On

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

Allison is 32, self-employed (runs a family plumbing supply company), single, drives a used Boxster (“my one folly”), owns a tiny bung and thinks she’s fearless.

“I have a big tolerance for risk,” she says. “Besides, I’m young, never gonna have kids, own my job and day-to-day things don’t rattle me. So let’s roll the dice.”

She wants a portfolio that is all-stock, all the time – based entirely on her personality, her cowgirl attitude and the innate belief she’s bullet-proof because of a long time horizon as an investor. “So long as I don’t panic,” she says, mockingly, “and turn into a girly girl, then it’s all good.”

But it’s not. Ally confuses investing with gambling. Her portfolio is a couple of hundred thou – not enough money to achieve diversification buying individual stocks (that takes a few dozen positions, despite what you might think), and if any one of the eight or ten equities she now holds takes a hit, she loses big. Also, A has yet to go through any kind of serious or protracted market correction (we actually haven’t had a decent one since 2011). So she has no idea if her bravado will hold up, or the inner wimp come through.

Let’s make some assumptions that Allison is like everyone else I’ve ever met, and has the same two goals: (a) don’t lose money and (b) score a reasonable rate of return.

The second principle of investing is that despite age, appetite for risk, family status, wealth or goals, we all live in the same world. The challenges and opportunities are universal. You’re not going to change any of the factors which will move economies or markets over the next few years. So invest for to ensure both (a) and (b). In that regard, all-equities doesn’t cut it.

We all have to deal with Trump, the most unpredictable and quixotic prez ever. We all live in a time of rekindling inflation and steadily creeping interest rates. Our society is laced as never before with personal debt and government deficits. There’s an international trade war brewing. Corporate profits are massive by historic measure, global growth is robust and US tax cuts are making titans rich. But it’s also a world where the wealth divide is driving politics, leading to populism, tribalism, nationalism, jingoism and xenophobia. Technology is running rampant, but things like AI, the Internet of Things and autonomous vehicles will forever alter the nature of work. More voter upheaval. Meanwhile many financial markets are near record highs while central banks actively plot to suck back the stimulus that fed them.

In short, the good and the bad surround us. The world’s finally growing again after almost a decade of loss. But it comes atop a mountain of fresh debt and political threats to the monetary policy that enabled it. Thinking you can pick a few stocks, outperform the market, avoid corrections and be the smartest gal in the room is fatal. Sooner or later, after all, individual stocks have a 70% chance of catastrophic loss. You don’t want that happening the year before you retire.

The first defence is to be diversified. Don’t pick six equities, but instead buy one ETF which holds all of the market. For example, the exchange-traded fund XSP gives exposure to the 500 biggest companies in the US – and so, it’s a proxy for the entire American economy. And the fund ZLB provides low-vol exposure to the whole Canadian market, which means about 25% is exposed to our money-spewing banks. Use ETFs to build broad exposure to other needed asset classes, like preferred shares and real estate investment trusts (commercial property).

Being diversified also means avoiding the trap of home country bias. Canada is a cool place, but maple should not make up most of your portfolio. Nor should the US – where Trumpenomics has helped propel equities into nosebleed territory. It’s a big world, in which China is on the path to be the largest economy and Europe has emerged from deflation into growth. So, be diversified and be global.

But also be balanced. The correct mixture of bonds (government, corporate, high-yield and provincial) can reduce volatility substantially. When stocks fall, money doesn’t evaporate. Instead, it moves – usually into safer places, and often into bonds. However, bonds decline as rates rise so mitigate that by going short, plus adding the kind of preferred shares that grow along with the cost of money but still pay a steady (low-taxed) dividend. In the world in which both Allison and retirees live, they equally need balance – with a traditional 60/40 (growth/safe stuff) being the norm.

Investing should be boring. If you want scary unpredictable, vote NDP.

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June 7th, 2018

Posted In: The Greater Fool

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