Rethink the way you invest

A long-term outlook and knowing your goals are key to sustainable wealth creation.

One of my partners, Edward Goodfellow, is a part-time finance instructor at Royal Roads University. He created a presentation he uses to teach students and market to potential new clients. With his permission, I have reduced it from a 24-page document to key elements investors can use to evaluate and review the structure and approach of their financial plan, with the goal of achieving long-term wealth creation.

1. Understand markets. Know all five asset classes, not just the stock and bond markets — or find an adviser who does. Each class has its own risk and return parameters and a properly diversified portfolio stands a better chance of earning higher returns with lower risk. Let the different markets work for you. More importantly, invest; don’t speculate. Investing builds wealth over time. Speculating can create wealth but can also lead to wealth destruction.

Understand the concept of diversification. We consistently see portfolios with a large number of different holdings in one asset class. On the surface, they look like a diversified portfolio, but with careful analysis we find concentrated exposure to specific sectors or geographic areas. We see no point in a client holding four international funds if their specific holdings are highly correlated. That’s “diworsification,” not diversification.

2. Keep costs low. High turnover leads to excessive costs and sometimes excessive losses. Over the past several years, many investors have turned to online trading, but due to a lack of disciplined asset class diversification, they are increasing their risk profile. Even the introduction of exchange traded funds (ETFs) and their low-cost structures have not reduced investors’ propensity to increasing turnover by making more and more short-term trades.

{advertisement} 3. Know yourself. Don’t confuse entertainment with investment advice. Twenty-five years ago, people used investment advisers because we had the best access to information that affected financial markets. Today, people use investment advisers because they are fed up with information overload. Television alone offers at least three channels dedicated to financial market action, while the Internet provides investors with hundreds of differing views, newsletters, and “advice.”

The challenge is in sifting through all of these views and opinions and simplifying them down to observations that can be incorporated into asset allocation strategies. For example, how does one plan and react to interest-rate forecasts in light of inflationary pricing pressures, rising fiscal deficits, and economic austerity measures. Should one invest in short-term, long-term, or floating rate debt, and in which currency or sovereignty? With the threat of sovereign debt downgrades or defaults on the horizon, should investors mitigate their exposure entirely or redirect their funds to corporate debt?

4. Work your plan. No asset allocation plan, market timing, improper time horizons, and chasing performance are common mistakes investors make when doing it themselves. Keep a long-term perspective, stay the course, and manage your emotions and biases. Being too greedy is just as dangerous as being too timid. Bad past experiences can colour your judgment and inhibit your return potentials.

Greed led many investors to disastrous losses when the Hunt brothers tried to corner the market in silver in 1979-1980. Through their actions and the action of speculators, silver jumped from $6 per ounce to an all-time record high of $48.70 by January 1980. The Commodity Exchange engineered Silver Rule 7, which increased the amount of margin needed to buy and hold silver. Within days, the price of silver collapsed by 50 per cent; by 1981 it had fallen to an average price of $8.42, wiping out the profits and fortunes of speculators around the world. Gold struck a record high of $850 around the same time, but its prices tumbled during the corresponding period. Some investors to this day avoid precious metals as an asset class.

Mutual funds went through a period of rampant speculation in the 1960s, when they were known as “go-go funds,” but fell out of favour when the market turned in 1969. While few funds manage to outperform their benchmark indices, they play a valuable role for small investors looking for asset class diversification.

Once you have mastered the key investment themes, the question of execution and management becomes the next hurdle. Can you do this yourself? With time, practice, and education, the answer is “yes.” But do you want to do this yourself? Only you and your significant other can make that decision.

Markets are continuously evolving, and it is a full-time job investigating and evaluating new investment products. If you don’t have the knowledge base, it’s easy and dangerous to fall for flavour-of-the-month strategies that promise amazing returns but invariably produce poor outcomes.

Recently, I was shocked by the results of a question posed by a certain TV show. About 10 people were asked whether the Bank of Canada should raise interest rates to reduce rising inflation. Most said “yes” because they wanted the Canadian dollar to fall relative to the U.S. dollar, and they believed that raising interest rates would accomplish that goal. I was of the view that raising short-term interest rates would lead to a rise in the value of the loonie relative to the U.S. dollar. Anyone planning a strategy based on the opinions of that television interview could potentially end up losing money.

For investors who use an investment or financial adviser, important points need to be considered. First, make sure the investment firm belongs to a provincial or federal investment organization like IIROC, MFDA, or the Insurance Council of B.C. They review the activities of their member firms to ensure they are following good business practices.

Next, make sure the firm is a member of the Canadian Investor Protection Fund, the Canada Deposit Insurance Corp., or Assuris. You don’t want to end up as another statistic.

Finally, what are your needs? Do you need help with a basic financial plan that requires careful deliberation around allocating limited financial resources into various pools, such as RRSP, RESP, TFSA, investment portfolios, or life and sickness insurance? Or perhaps you are a successful business owner and need an adviser to help structure your investments for retirement and succession planning. Some people need specialists in one area, while others require the services of a generalist who has a strong working knowledge of more than one area. When shopping for an adviser, talk to more than just one.

Steve Bokor, CFA, is a licensed portfolio manager with PI Financial Corp, a member of CIPF.