Thoughts on more investing claims

Disclaimer: this blog is my personal opinion only. Information presented are accurate to the best of my knowledge. This blog does not provide any personal financial advice, or solication to buy/sell securities or financial services. I do not take any responsibility for any actions you take as a result of reading this blog.

Originally I was planning to write about personal bond investing, however I decided to postpone that for now. I read this blog called Greater Fool (http://www.greaterfool.ca/) daily. I first started reading when searching around for Vancouver Real Estate bubble. While I agree with the author, Garth Turner, assessments of Canadian’s RE market and some of his thoughts on economy and government policies, I find myself getting quite worked up over some of his financial/investing advices he gives out to his readers. A lot of his claims about stock market and investing are not suitable for the average person and some of them are just frankly dangerous in my view & experience. Yet these claims are given out almost as financial laws/truism. A lot of his readers look up to him as an expert and follows his advice for their real estate and personal finance decisions. I feel a lot of them are likely to be very disappointed!

Due to the number of claims/statements Garth makes this will be the start of a series of posts. This is a good thing as there are a lot of important topics that I can cover and hopefully clear up some misconceptions. For this post I will just list some of the common claims related to financial investing by Garth in his commentary or responses to reader/commenter questions.

1. Inflation will be a concern.
2. Interest rate will be going up.
3. One should have a percentage of assets in gold as a hedge against inflation.
4. One should stay liquid.
5. GIC is not an answer going forward and one should not be keeping money in GIC, a guaranteed loss after inflation and taxes.
6. It’s easy to build a diversified portfolio earn 6% return in the current environment using preferred shares, medium/long term bank/corporate bonds, sector funds and individual stocks.
7. Buy and hold is not going to work, active trading is required.
8. Just buying the index will not work, you need to be nimble and buy specific stocks.
9. Owning bank preferred shares, or bonds can easily get a 6% pre-tax return and they are safe as none of the Canadian banks will fail, and Canadian banks have never suspends dividends on preferred shares.
10. Owning medium/long market bonds from big corporations are perfectly fine, even for short term, as they are 100% liquid and safe. Even short time frame of less than 5 years.
11. One should buy preferred shares due to the high dividend yield and tax advantages, even in a rising interest rate environment.
12. Keep bonds inside RSP, high growth stocks in TSFA, and dividends stocks & preferred share in non-registered accounts.
13. Do it yourself investing is almost guaranteed to fail, one should find a good financial advisor to handle the investments.
14. 6% return is a minimum one should get in this market without much risk and any advisor who says it can’t be done should be fired.
15. The real risk is not losing money but outliving your money.

Well that’s a very long list and covers a lot of important areas. For this post I will simply state my view on each point. Later posts will go into details for those points that I don’t agree with.

1. Agree – I think inflation might be a big concern going forward, especially if governments and central banks decide to print, print, print.
2. Agree – Too much debt chasing too little money.
3. Agree – but not for the same reason. Gold is actually not a good inflation hedge based on performance from 1980s to 2000. However gold is in a bull market and is real money! Understand difference between real money versus fiat currency versus debt-based monetary system and you will know why owning gold is a good idea. Also understand the difference between money, currency, and wealth.
4. Agree – when there is too much debt and everyone is borrowing, staying liquid is a good idea. However one has to understand what it means to be liquid.
5. Disagree – While GIC rates are low and heavily taxes, GIC can be a very valuable and useful tool. In fact, over the decade, GICs have beaten the S&P500 and likely TSX300 Indices total return (dividends included). Not bad for something that’s guaranteed a loss after inflation and taxes. I will write more about GIC in a future post as for most people, more often than not, they will do better by having a big chunk of their money in GIC.
6. Disagree – with long term bonds rates and dividend yields less than 6%, getting a 6% total return after-tax with a balanced portfolio and limited risk is very hard in the current environment. Now if interest rate for long term government bond goes back up to 8% then 6% portfolio return is possible.
7. Partial Agree – Buy & Hold will likely not work going forward, but timing the market correct is extremely tough, more luck than skill.
8. Partial Agree – Stock investing takes a lot of time and effort to research the companies to buy and at what prices. Expecting high return simply from buying individual stock or sector funds without realizing the time, efforts, and risk involved is recipe for large losses.
9. Disagree - Buying bank preferred shared is not without risks. Currently available preferred shares on the market are unlikely to be paying 6% yield. As well, if the preferred are without risk then why aren’t the rich buying them all up? Why did the banks issue them paying such a high rate for something with no risk? How did Citibank and Bank of America’s preferred shares issued in 2007 and 2008 do? A lot of "impossible" things happened during the credit crisis in 2008.
10. Disagree - Corporate bonds are not liquid and for individual investors, selling them can be impossible sometimes. They are marketable but that’s not the same as being liquid! Bond has a lot of risks that most people do not realize and it’s not easy for the average investors to buy and sell corporate bonds like stocks.
11. Partial Agree – Purchasing income producing investment in a rising interest rate environment only works if you re-invest dividends, keeps purchasing, and don’t plan on selling. Income producing securities move inversely with interest rates.
12. Partial Agree – Bonds should be kept in RSP accounts. However keeping high growth stocks in TSFA maybe not the best option for various reasons. Portfolio tax planning is not as simple as where to put different types of investments, even though these are good general guidelines.
13. Partial Agree – Most people do not know enough, have enough discipline, or have enough time to manage their own portfolio. However the average investors will not be able to access competent, never mind good financial advisors. Those are only available to high net worth clients, those with $5M or more. The average person with less than $500K to invest is not going to be able to hire a good financial advisor; there just aren’t enough of those around. The ones who are good aren’t going to bother with small time clients when they can get clients with $5M, $10M, or more to invest.
14. Disagree – If your advisor tells you that, keep him/her because he’s telling you the truth! That’s a very rare trait as most advisors will not tell clients any possible bad news or things their clients don’t want to hear.
15. Partial Agree – Outliving your money is a problem but nothing guarantees that more than risking and losing a lot of it! Risk does not guarantee reward!

Debunking Some Stock Investing “Axioms” – Part 2

Disclaimer: this blog is my personal opinion only. Information presented are accurate to the best of my knowledge. This blog does not provide any personal financial advice, or solication to buy/sell securities or financial services. I do not take any responsibility for any actions you take as a result of reading this blog.

The 4 almost universally accepted investing “axioms” from last post:
1. Stocks have returned 10% per year on average.
2. US/CAD stocks have never lost money over any 10 year period, so invest for long term and ignore the short term fluctuations. It’s time in the market not timing the market.
3. You must invest in stocks for growth so you will have enough money for retirement.
4. Stocks return is always higher than bond returns over the long term and investing long term will smooth out the volatility in equity.

Last time we examines point 1 and 2, let’s examine the remaining point 3 and 4.

Point 3 - You must invest in stocks for growth so you will have enough money for retirement. Well I wonder if this has anything to do with the fact that the MER on equity funds are anywhere from 0.5% (general market funds) to 1.5% or even 2% (specialty sector funds/foreign equity funds) higher than the MER on bond funds. The question you really need to ask yourself is how much do I really need to save for retirement and how much can I save? If you only need say $2M for retirement that’s 40 years down the road and you can save a large portion of your money every month, then do you really need to invest in equities hoping to get 10% per year? If you only need a 5% returns then why take the risk with equity when bonds and GIC can provider sufficient return? Why chase higher return with the risk of losing money when you can achieve your goal with certainty.

Point 4 - Stocks return is always higher than bond returns over the long term and investing long term will smooth out the volatility in equity. This point has been taken as pretty much the gospel/axiom/absolute truth in investing. Stock always returns more than bonds over the medium to long term. However that’s actually not true. Based on the Andex charts, the returns for S&P500 Total Return Index, US Long term bonds, TSX Total Return Index and Canadian Long term bonds are shown in the table below ending in year 2009:

Source – Andex Charts – Ending in 2009


Source - http://www.assetplay.net/financial-tools/rolling-returns.html



As you can see, while the 1980s and 1990s were characterized by large, unprecedented equity market return, the bond funds didn’t that badly relatively speaking. In 2000s, the bonds vastly outperformed the stock market. Taking the market crash of 08 into account, bonds has outperformed stocks over the last 10, 20, 30 years! Even the lowly T-Bills have outperformed the S&P 500 Total Return Index for 2000-2009. So much for the claim that stocks always outperform bonds over the long term!

Debunking Some Stock Investing Axioms – Part 1

Disclaimer: this blog is my personal opinion only. Information presented are accurate to the best of my knowledge. This blog does not provide any personal financial advice, or solication to buy/sell securities or financial services. I do not take any responsibility for any actions you take as a result of reading this blog.

Ok, since I do get ask a lot of finance related questions and I do like to read these stuff, I thought it would be a good idea to try to do a blog on topics in this area. This way I can hopefully educate some people about finance, clear up misconceptions of which there are many in this field, explain some of the common things you hear and what they actually mean, and answer a few questions along the way as well.

I do tend to output massive amount of information and write a lot of stuff, so I will try to do my best to keep each post short (less than 1000 words, except for this first one) and interesting. Hopefully I will improve my write style as I go along. You are welcome to post feedback and suggestions to me either on the blog or via email.

Now one thing to be clear, whatever I write is my own personal opinion. Nothing here is intended as professional advice, or solicitation for buy or selling securities, or as personal financial advice of any kind. Nor do I guarantee that my understanding and explanations are always correct, though I try my best. Lastly, don’t expect to get rich reading this blog! This is not a stock picking newsletter. I take no responsibility as a result of anything you do after reading this blog.

Ok, got all the preamble and disclaimer out of the way, let’s move on to the first blog post!

We have probably all read/heard the 4 points below, usually in marketing materials and from TV commentators. They are almost to be accepted as investing axioms:

1. Stocks have returned 10% per year on average.
2. US or CAD stocks have never lost money over any 10 year period, so invest for long term and ignore the short term fluctuations. It’s time in the market not timing the market.
3. You must invest in stocks for growth so you will have enough money for retirement.
4. Stocks return is always higher than bond returns over the long term and investing long term will smooth out the volatility in equity.

So let’s examine point 1 and 2 in turn in this post while point 3 and 4 will be analyzed in the next post.

Point 1 – Stock have returned 10% per year on average. This really depends on your starting point and the stock market index chosen. Usually it is the S&P500 Total Return Index that’s chosen for US stock market and TSX 300 Total Return Index for Canadian stock market. The starting point chosen for this claim is either right after WW2 or 1980 when the stock market level was really low. Following WW2, the western economies have been in a general growth trend with the baby boomer generation driving and increasing the size of the economy. Along the way we had large bouts of inflations and a couple recessions. In general however the economy has grown from population increase due to baby boomers generation, generation X, Y & Z, and scientific progress. The other common starting point of 1980 just happens to be the start of a great 20 year stock market bull run that ended around 1999/2000 with the bursting of the technology bubble.

However if you picked 1999/2000 as your starting point then the stats would look very different. Instead of 10% per year you would be look at about a -1% return in US$ for the S&P500 Total Return Index (source: Andex chart 2009 US Edition), and about 4% return in CAD$ for TSX 300 Total Return Index (source: Andex chart 2009 CAD Edition). Quite different from the 10% per year return that people were expecting and probably counting on from the stock market! If you were a Canadian investor who invested in S&P 500, your return in Canadian $ would be even worst at about -4% per year (source: Andex chart 2009 US Edition)!

As the mutual fund/investing industry is fond of saying: past performance is no guarantee for future performance. This warning applies extremely well to this situation, just because stock markets has returned 10% per year on average for the last 40 years doesn’t mean it will continue to do so! As the years 2000 to 2009 has now shown, the stock market return has fallen far short of what’s advertised.

Point 2 – Stock market has never lost money over a 10 year period so invest for the long term and ignore the short term fluctuations.

Well this is really nice for the mutual fund companies because they want you to keep your $$ with them so they can charge one of the highest MER in the world year after year. But as has just been shown, if you had invested in the S&P for the last decade, you lost money! So much for the guarantee that investing long term means you wouldn’t lose money in the market.

For an even worse example, take a look at the Japanese stock market. If you invested in Japanese equities back in late 80s/early 90s, you probably have lost money for 2 decades straight! That’s right; Japan’s Lost Decade is now officially running 20 years and shows no sign of stopping! Everyone who bought into the Nikkei when it was at its high of 40000 lost a lot of money! Even buying when the index is at 30000, or even 20000 would still probably cost you money!

The current US and Canadian stock market valuation of greater than 20 P/E ratios is generally associated with market tops, not market bottoms! There has been several research shown that when P/E are as high as 20, the return for the next decade is generally very low, between 0% to 5% (will do a more detailed post on this later).

So in summary for this post, don’t believe the marketing slogan! As well don’t assume the past well be repeated in the future. The only constant in the market is the cycle of fear to greed and back to fear that drives the market down to unbelievable lows and great values and then swing back up into unbelievable highs via greed and the back to another low as greed gives way to fear and the cycle repeats again.