Almost 75 years after it was written, Fred Schwed’s Where are the Customers’ Yachts? remains one of the most entertaining books ever written about the investment industry. Here’s one of its best remembered lines: “There are certain things that cannot be adequately explained to a virgin either by words or pictures. Nor can any description I might offer here even approximate what it feels like to lose a real chunk of money that you used to own.”
As Schwed recognized all those years ago, no one can really gauge their risk tolerance by filling out a questionnaire, or by pondering standard deviations. It’s easy to say that you have a long time horizon and you won’t panic in a downturn. But the fact is, no one really knows how they will react until they have actually lived through a devastating bear market.
And if you only started investing in the last few years, you haven’t been tested yet.
According to a Bloomberg article published earlier this month, the S&P 500 has now gone more than 1,000 days without a correction of 10%. The last time investors enjoyed a run like this was a 1,127-day period that ran from July 1984 to August 1987, the article reports. If you’re under 40 years old, it’s fair to say you don’t remember that one.
The situation is similar in Canada: the last time there was a 10% correction was mid-2011. The Horizons S&P/TSX 60 ETF (HXT), a proxy for the total return of Canadian large cap stocks, has not seen a 10% decline since August of that year—almost 1,100 days ago.
It don’t mean a thing if you ain’t seen those swings
Not only have we managed to avoid a significant drawdown for close to three years, the volatility of the markets has also been well below average. Have a look at the standard deviation of Canadian, US and international stocks in recent years:
| Annualized Standard Deviation of Major Stock Markets (%) | ||||
| Index | 3 years | 5 years | 10 years | 20 years |
| S&P/TSX Composite | 10.15 | 10.65 | 13.84 | 15.20 |
| Russell 3000 | 8.62 | 8.89 | 11.48 | 12.87 |
| MSCI EAFE + Emerging Markets | 11.26 | 11.24 | 13.42 | 13.58 |
Source: Dimensional Returns 2.0. Figures are in Canadian dollars. Period ending June 30, 2014. |
||||
As you can see, the volatility of returns in Canada and the US has been about 50% lower in the last three and five years than it was during the past two decades. For even more perspective, the Credit Suisse Global Investment Returns Yearbook 2014 reports that the return of US stocks had an annualized standard deviation of about 20% from 1928 through 2013. Since mid-2009, it has been less than 9% (when measured in Canadian dollars). That’s a leisurely float down a river without many rapids and not a single waterfall.
A time for calm reflection
So what is the lesson for investors? I think there are a couple. First, if you’re young and just getting started, don’t make the mistake of thinking your long-term journey will always look like the last five years. These days I hear from a lot of new investors who say they’re comfortable with volatility, and they’re confident they can handle a 100% equity portfolio. But they haven’t really experienced volatility, and except for a short-lived downturn in 2011, they haven’t suffered a significant loss. A word of advice: your risk tolerance probably isn’t as high as you think.
Second, periods of low volatility provide a good opportunity to firm up your long-term investment strategy. The best time to make changes to your portfolio is when you’re feeling calm and rational. So if you’ve been procrastinating about dumping your high-cost active funds, investing that idle cash, or adjusting your asset allocation to keep it in line with your goals, then now might be a good time to do that. Because when this winning streak finally ends—and it will, though no one knows when—any changes you make are likely to be based on fear and emotion. And we all know how that works out, don’t we?
Great article! I have been thinking of this often lately. After recently reading “The Investor’s Manifesto” which discusses this topic as well (and quotes Schwed too), I decided I probably should make my allocation a bit more conservative to see how I handle a bear market.
Unfortunately I’ll have to trigger some capital gains to do so, but I think in the long run it should be worthwhile.
Even more interesting than backwards-looking measures of volatility — for what it’s worth, VIX, the S&P 500 volatility index, is near one of its all-time (20 year) lows. This is interesting, as it implies a market view of continued relatively low volatility (at least in the US markets) over the next 30 days. Of course, that means an expectation of likely low volatility on the upside as well …
Needless to add, current expectations of low future volatility could change at any time and in a hurry, so a low VIX measure doesn’t alter the need for a suitable investment plan and long-term asset allocation.
Hasn’t anyone figured out the fact fact that the short form “Risk Tolerance” questionnaire you fill out is used more for the protection of the institution rather then the investor. Since we live in a country where the “suitability standard” is what we base our investment choices on, if a client is put in poorly performing investments it’s a fallback document absolving the broker of blame. I think after the 10 question document is filled out there are probably 20 more questions and some cost explanations, that should be asked before putting an individual in any kind of investment
At least young investors should have a better capacity for risk and so should hope for a correction to buy cheaper assets, but I’m finding more and more retired friends increasing their exposure to equities chasing yield by buying very expensive dividend stocks. They are so focused on required rate of return they are blinded by the fact that companies do reduce and even suspend dividends! Distribution phase investors are in a bind with current poor riskless assets! What are they to do but reduce their standard of living? Surely changing one’s asset allocation is a perilous choice?
Thanks for this post. I think these kinds of periodic “gentle warnings” are useful. No question, the last 5yrs in general, and especially the last 3, have been a truly easy ride. It’s good to keep perspective and not get too comfortable.
@CCP: Just a detail I don’t understand. after describing the supposedly most recent longest (1127 days) recent period without a 10% correction that ended in 1987, the article later refers to another more recent period that seems longer. “The longest stretch without a 10% pullback dates back to the go-go 1990s, when the S&P 500 went 2,553 days in a seven-year span that began in October 1990 and ended in October 1997.”
What’s the difference?
(I still accept the general cautionary point of your article of course).
@Oldie: I noticed that too and I’m not sure how to reconcile the two claims, since I don’t have access to the data they used.
@Oldie: total guess, but maybe one is just price, and the other is total return with dividends?
“if you’ve been procrastinating about dumping your high-cost active funds”.. Quick question about this. It took me almost two years to slowly get almost all my investments (RRSP, TFSA, and non-registered) aligned with CCP and I’m really happy with the overall philosophy, ease of it, and information you’ve provided. However, I still have two actively managed funds I haven’t switched in–$16K in TD Canadian Bond Fund TDB162 (1.1% MER) and $3K in TD Real Return Bond Fund TDB646 (1.5% MER). I’d been planning on flipping them in come January (after December dividends are paid out). To balance my portfolio they’ll have to go into equities. (I was extremely bond heavy around 2008 and this is the tail end still showing.) Rebalancing will make my portfolio perfectly in line across accounts with proper asset allocations of 40% index bonds, 60% index equities.
While I know it’s impossible to predict the direction of equities or how/if interest rates changes will effect bonds in the near future, my simple question is: Are there any real advantages to moving them now rather than in January/December after the annual dividend is paid out? (Excluding the possibility of missing an equity run?) This anomaly accounts for about 10% of my portfolio, I do want it gone, but not sure whether there’s an advantage to doing it immediately or not. The bonds are in the RRSP so I won’t have to pay capital gains tax or trading commissions. I also know that having equities in the RRSP isn’t the optimal asset allocation, but I plan to work on that further later. Opinions?
Another good article! Thanks, Dan!
@Edward: There’s no advantage to waiting to the end of the year to receive dividends or interest. This is a common misunderstanding.
All dividends and interest collect in the fund as they are paid by the stocks or bonds, and the net asset value (unit price) is adjusted accordingly. At the end of the year the fund distributes these in cash or in the form of new units, but the unit price will then fall by the same amount. So there is no advantage or disadvantage to trying to time it, especially in an RRSP, where you wouldn’t pay tax on the distribution anyway.
Page 11 of this document does a good job of explaining this:
https://www.phn.com/portals/0/pdfs/FormsandDocuments/030-2013-rbc-1834-S-tax-invet-mutal-fund-final.pdf
Does that mean we should be holding cash?? :) Just starting to panic at the mention of 1987.
My first foray into investing was in the summer of ’87. The investment “advisor” (i.e. the salesman) show how things had gone so well in the last 5 years and convinced me the right thing to do was to leaverage an investment into a 9% up-front mutual fund. Buy 2/3’s on the security of the first 1/3. Yeah, nothing like losing 80% of your nest egg when you are 24 years old to make you cringe whenever anyone mentions leaveraged investments. I guess for the 4 grand I lost, it was probably worth the lesson early in life.
Great, thanks again!!
Good reminder. I’m sort of in this boat and it’s been smooth sailing so far!
I would be OK if I lost all the gains over the past couple years (my entire investing history) but I’d be disappointed to lose the actual contributions. And it’s all in equities so that’s a distinct possibility.
However, only my TFSA is actually invested so… it’s not very much money total. If I lost all of it, I’d be disappointed, but I’d still leave it in there. I hope I’d have the fortitude to actually invest in a corrected market but we’ll see. My capacity for doing nothing is limitless…
Meb Faber’s blog is timely on this topic.
He has a chart from Patrick O’Shaughnessy showing some scenarios that would be hard to live with if they occurred again.
Can you stand to lose money over a 10, 20, 50 or even 112 year period? Do you have the stomach for that?
One lesson from the chart is that you need to diversify across the world with your equities. But even then, you could have a losing streak of 20 years.
http://mebfaber.com/2014/07/29/112-year-holding-period-not-enough/
http://patrickoshag.tumblr.com/post/93207823244/the-dangers-of-portfolio-patriotism
if i invest 10,000 today evenly split 50/50 and next year the percentage of bonds is 45% and equites 55% why do you guys say if i don’t rebalance i have more risk now? how can i have more risk investment when i invested my money 50/50 and never added or subtracted any money?
@Jake: I’ll turn the question around and ask you to imagine you invested $10,000 and the portfolio doubled to $20,000. Would you say you had the same amount of money because you never added or subtracted from the portfolio? The only relevant value is what the investments are worth today, not what you paid for them.
i would have invested the same amount, i don’t consider anything more than the 10,000 as my money. so if that the 20,000 dropped down to 10,000 i didn’t gain or lose any of my actual money which is why i don’t understand how someone’s becomes less or more risky just because parts of their investment gained more or less than other. if for example above the 50% bonds did 0 return and the 50% equites tripled i would think my risk is still the same. until i sell something i don’t consider it my money as I never had that in actual cash, just some value on paper in someones fund.
i just don’t understand how risk increases or decreases with the value of an investment if you never added any more of your own money (cash) ?
@Jake: You should definitely read Dan’s article “Train Your Investing Brain”. It permanently changed lots of ways I see money and investing. (See the section on “Mental Accounting”.) I reread it myself fairly often just to reinforce its message.
http://www.moneysense.ca/invest/train-your-investing-brain
@Edward: Thanks for recommending the link to my article. I do think it would be helpful.
@Jake: Assume you bought $1 million worth of Company X stock. You know have $1 million exposed to market risk and company risk. Now assume the company’s stock goes to zero. Do you still think your risk exposure is the same? That’s a silly exaggeration, but it might help make the point. If you have $10,000 in the stock market and it grows to $15,000, you clearly have more money at risk.
Here is my story about learning about my risk tolerance. Everyone talks a good game about how much money they’ve made investing so instead, I’ll talk about how much I’ve lost. Hopefully some can learn from my follies. :)
In the 1990’s, I invested in GICs, mutual funds. After a while I realized that mutual funds weren’t working for me so I started to try to invest in individual stocks. Over time I saw that while stocks were volatile, I did make money with some of them when I just held on to them. Because of this, biannually, I started investing a portion of my salary (my savings) into stocks. At some point, my stock portfolio shrank to one holding that had done very well for me.
The volatility of a one stock portfolio was high but when it was a small portfolio it didn’t bother me. As the dollar value of the portfolio grew, my tolerance grew with it. At one point I remember seeing $20,000 (or more) dollar swings per week which for me is substantial. But I grew into accepting it and stopped thinking too much about the day to day stock price or total value and just asked do I still like the investment.
Then the dot.com bubble hit and over a few days I lost about 50% of my stock value (even though it was not a dot.com stock), which in dollar terms was well into 6-digits which was a huge loss for me. My honest reaction was 1) shock (what just happened) 2) humbled … I knew this could happen and it did 3) composed … I asked myself one important question what was my investment plan and does it still make sense?
Before doing anything and selling at a loss, I revisited my investment plan/strategy. My strategy at that time was to invest in a place to live (my house), safety (GICs) and speculation. Two of the three were going well and one had blown up, which I accepted as not being unexpected.
On review, I actually liked my investment plan and accepted it for what it was. However, where I had gone wrong, is that when I had a high flyer like I had, I never took anything off the table and rebalanced. What I learned is if you don’t rebalance your risk, the market will do it for you and you won’t like it.
The rest of the story is interesting but suffice to say I became a much better investor because of it and I am glad the events happened as they did. Nothing teaches you a lesson more than losing one third of your wealth in a few days. I’ve heard similar stories from all good, older investors. I fear the investor who doesn’t have a story like this.
Going forward, I never once again lost sight of knowing my risks and having an investment plan that controls those risks and sticking to it. I think that’s the most important lesson.
more money at risk on paper but that’s not all of my money. if i bought 10000 of stock with own cash, it went to 20000 value on paper then company bankrupt i would have lost 10000, not 20000, i never had 20000 cash in my hand, just the 10000 when i bought.
@Brian G: Thanks for sharing your story. I have heard many similar ones: a big loss that genuinely hurts really can go a long way to making you a better investor. That’s one more reason you should start investing when you’re young. It’s a lot easier to lose half your portfolio when it’s $20,000 and you’re 23 years old. :)
@Jake: Imagine if the insurance industry used your logic. You buy a house for $100,000 and 20 years later its market value is $500,000. When it burns to the ground they give you $100,000 because that’s all you paid for it and the increase in value “wasn’t your money, it was just a paper gain.” Then you buy a $40,000 car and 10 years later you get sideswiped by a dump truck and the car is totaled. Do you think they’ll pay you $40,000 to replace it? Because, hey, that’s what you paid for it.
@Jake: It appears that you currently have a point of view that from the CP (i.e. rational) viewpoint seems irrational. Hope you don’t mind explanations that appear argumentative to your point of view, but as long as you are posting to this site, one must assume you are searching for collective wisdom, and don’t understand why everyone else gets it and you don’t, and so you will be offered explanations from me and other helpful (we hope) strangers.
“more money at risk on paper but that’s not all of my money. if i bought 10000 of stock with own cash, it went to 20000 value on paper then company bankrupt i would have lost 10000, not 20000, i never had 20000 cash in my hand, just the 10000 when i bought.”
Please temporarily suspend your current belief (or beliefs — there are probably multiple emotional distractors going on here) and consider my arguments one at a time, and please excuse me apparently stating the obvious — we have to start with common ground, and I am not intentionally belabouring the point.
How about assuming that every day is a new day. In this sense, yesterday or last week is irrelevant. Only today and today’s situation counts.
Now, despite only putting in $10,000 of your own money last week, this week, today, your stock is worth $20,000.
“but that’s not all of my money”
On the contrary, it IS all of your own money — just the same as if you had worked overtime for an unaccustomed period and got an anomalous pay check, or if your Aunt Matilda gave you the extra $10,000, or the government refunded overpaid tax, or you finally got a legal settlement of $10,000 from 10 years ago when someone trashed your car, or if you had found $10,000 cash that you had stashed under the carpet and forgotten about. You are possibly bothered by the uncertainty of its outcome before. That uncertainty is over now, today. It has been replaced by $10,000 extra certain dollars, although of equivalent future uncertainty.
It is legally your money, and whether or not you felt you earned it or were truly worthy of it — that is irrelevant. If you cashed in your stocks today, you would legally receive $20,000 in cash. (You would likely be liable for some tax, but let’s ignore that detail for now). Therefore whether you actually have a pile of 20,000 loonies on your kitchen table or whether you leave it invested in the original stock, that lump of concept represents $20,000 of your net worth (whether or not you want to deal with it), which could continue to work to earn money if left in that stock, or possibly vanish suddenly overnight; or be re-distributed more prudently to protect your new investment.
The big question is, whatever your total asset allocation was when you initially were happy with where the $10,000 was invested last week, you now have $20,000 in this allocation slot: Are you happy with $20,000 in this location?
Pretend you had $20,000 in cash, (the amount you would have if you had cashed it in as in the last paragraph) and had never invested in the first place (which, if we accept that last week is irrelevant, is essentially the same situation). Are you so happy with the current allocation ($20k where you had, in a different era, assigned $10k) that if you had $20,000 and no stock you would go out today and purchase the full $20,000 worth AT THE CURRENT PRICE? Because leaving the situation at today’s status quo (doing “nothing”) is the equivalent of the latter transaction. All arguments for rebalancing regularly must take into account this rational equivalency process.
If you have a paper gain and it’s not really your money, then you won’t mind selling and writing me a cheque…? ;)
@Jake, I used to think like you… but now I think like Oldie. :)
To be a good investor (passive or active) you do have to eliminate history (e.g. how did I get here) from your thinking and instead be thinking that every day you make a new investment decision that will have consequences. That decision can take the form of action (change something) or inaction (stay the course) but there is no avoiding making an investment decision every day. Even if you hold on to all cash, that is an investment decision that will mean you will lose purchasing power every day.
*** I cannot emphasize this enough: every day, everybody makes an investment decision. ***
This is why having an investment plan is so important to being a successful investor and staying on track. I am a huge believer than anyone who doesn’t have an investment plan is doomed to failure because without a plan you will exhibit many of the classic behavioural finance biases and you won’t manage risk.
Of course, if you are a passive investor, your investment plan can be quite simple and most days your investment plan will guide you to deliberately stay the course but on a rare occasion you will rebalance to ensure you keep your risk exposure on track.
If you are an active investor, every day you should be asking yourself, “if I had X dollars to invest today, where would I invest it?” Then tell yourself, “I have X dollars to invest today.” :) Your active investment plan should help with these decisions too. It shouldn’t be ad-hoc. Ad-hoc, is again doomed to failure or at best blind luck.
FYI, I am not making a judgement call for or against active investing, I am just saying either way you need a robust plan.
Finally, in your simple scenario don’t be fooled about your loss. You also lost out on inflation and the opportunity cost of investing in a lower risk portfolio which would have almost no chance of going to zero. For example, let’s assume it took you 7 years to double your money before you lost it all. Had you invested in a CP portfolio you would have likely made at least 7% per year. After 7 years, which would you rather have; $0 or at least $16,000? You can’t get back time… opportunity cost is as real as it gets.
@BrianG: Well said — you said it in different words than mine, but perhaps more succinctly. I like the first paragraph, especially that first sentence; gotta write that down somewhere — perhaps best on the wall in big red felt pen! .
Awesome discussion!
I think I understand what @Jake is trying to say, but maybe just saying it wrong? Perhaps he is saying if he invested $10,000 and it grew to $20,000, then he lost $10,000, he wouldn’t be happy about it but it would make the loss easier to take as his original capital was still in place.
If this is the case, @Jake should do everything he can to minimize the possibility of losing half of his portfolio by reducing his risk. @Brian G sums it up nicely in his post.
Great article, thanks CCP. This could not have come at a better time for me. I’m 25 and have held e-Series funds in my TFSA for about a year now. When I began investing, I told myself that my time horizon is long and that I would be comfortable having some extra risk in my portfolio. I am currently allocating 75% to equities. As you mentioned in the post, over this time period someone like me has seen great returns. However, as my life situation changes, I realize I may be better served holding a more conservative portfolio. I plan on marrying within the next year or two, and I have considered going back to school at some point, so my TFSA savings may not be the long-term nest-egg that I thought it would be a year ago.
I am close to maxing my TFSA, and I am planning on opening an RRSP soon. Do you think it would be a good strategy to hold a more conservative portfolio in my TFSA, which I may need to dip into in the next few years, and hold a more aggressive asset mix in my RRSP which I hope not to touch until retirement?
Thanks for this great blog. I’ve learned a lot about responsible saving and investing from it.
There is no difference between digital currency earned at work (i.e., money which was initially transferred from your bank account into an investment) and digital currency earned through its gains. They are both earned by you in their own way. Separating them in your head is like staring at a swimming pool and thinking, “Some of that water I pumped in, some of it came from the rain. As long as my water stays OK and only the rain water evaporates, I’m fine with it.” The water is the water. The current water level is the current water level. It’s all the same and doesn’t care where it initially came from. You should occasionally care about the level of the water, whether it all dries up or whether it overflows abundantly, not the initial source of an H2O molecule or how much you originally put in the pool. …I also believe this is called stretching an analogy.
I’m trying to digest all the comments
thankyou for all of them
@Edward: Actually I really like your analogy. Jake may not realise that I used to think exactly like him. My carefully thought out rationale that I laid out was in defence of this really strong emotional way of looking at it, which often tries to sneak back into my brain, and I need any other clear analogy that may be available to keep me on the straight and narrow.
@Edward: that is indeed a good analogy. I find people are even more susceptible to this kind of mental accounting with real estate. People will buy a house, live in it (or rent it out) for *years*, and when contemplating selling the most important consideration for many will be how much of a gain or a loss it would be from where they bought. “Can’t sell now for a loss! I’ll have to rent it out for a couple years and wait for the market to turn around.”
But of course, it doesn’t _matter_ what you bought it for. All that matters is what your situation is now, and whether it makes more sense to own the house, or other things that you could buy for the money, after taxes and fees – be they investments, a different house, whatever. The house is worth what it’s worth today. Yesterday or last year doesn’t matter.
@Nathan: That’s probably how I would think about personal real estate, if I were to think about it right now, which I don’t. It’s funny, the CP education and training we are getting helps to make us think more rationally in this specific field of portfolio investing. But we don’t necessarily make the connection to persisting irrational thinking in other outside fields, until it is specifically pointed out to us!
I would simply ask Jake how long he would be happy with loosing it all (but 10K)? There must be a timeline in his head where he would finally consider all of his investment amount (dividends, capital gains, interest etc.) his own. For example would he still feel the same way he does now in 20 years or even 5 years? Surely if his original investment amount grew from 10K to 300K in 15 years he would then not feel the way he does now (could anyone possibly)? The reason we all invest is to earn money on the money we were able to accumulate and save. To disregard the earnings or not to consider them part of one’s own money defeats the very purpose for which we invest our money in the first place. I can see someone using this flawed logic possibly as a way to help deal with the prospect of loosing earned money but not as a rational investment argument. Investment income is as legitimate as any other form of income.
@CPP – is a schedule of historical annual returns for CPP model portfolios available?
I am aware of the very informative summary schedule previously published (thanks) …
https://canadiancouchpotato.com/wp-content/uploads/2014/01/CCP_Model_Portfolio_Performance_1994-2013.pdf
the CPP approach offers commendable diversification that should, through low correlation, moderate returns. but it would be curious to review the distribution of annual portfolio returns (whether in simple %/yr, or std deviations or otherwise). even better if any analysis also showed the performance of each asset class on a historical annual basis.
@Ross: I could compile and report all of this information, but I’m really unenthusiastic about doing so. The returns would just be hypothetical and I always worry that people put far too much emphasis on backtested returns. If you’re interested in looking at year-by-year asset class returns, you may want to download this useful spreadsheet from Libra Investment Management:
http://libra-investments.com/Total-returns.xls
You may also want to experiment with this tool:
http://www.ndir.com/cgi-bin/downside_adv.cgi
This post is an honest reflection of my situation, and my view of risk and investments. If you choose to comment to me directly, please be kind.
I am 36 and am in a solid financial situation. My wife and I paid off our mortgage last year, we have no debt and we consciously live well below our means.
We have always taken full advantage of personal RRSP/401K contributions and both left all money invested during the downturn of 2007-2009 and also put additional money in at that time. 3 years ago, after watching the market (S&P500 and TSX) climb rapidly off the lows in 2009, I started monitoring my investments closely hoping to see them increasing along with general equities. What I noticed was that while my investments definitely decreased along with other equities, my gains during the rise wasn’t nearly what I expected. I was quite disappointed and decided I’d made an investment mistake and needed to make a change. Someone recommended an Edward Jone’s advisor, and after meeting with them, I decided to make the switch from our employer accounts and moved all available money to this advisor to manage. The advisor had us invest 50% in 2 high-yield stocks and the balance in various actively managed funds.
I was excited that I’d taken a big step in managing my own money and I anticipated seeing big rewards in the new investment choices. Unfortunately, as the market fluctuated in 2011 and 2012, I again started to notice that my losses matched the market losses but my gains always lagged. I didn’t mind losing when the market declined, but it frustrated me that I didn’t seem to participate fully in the market’s advance.
As I looked into the reasons for it, I discovered it had to do with the high cost of MER’s (all around 3%) and the fact that I was in actively managed mutual funds that research pointed out were destined to trail general index funds.
Late in 2012, while discussing my situation with a great friend, he suggested I turn to CCP. Since then, I’ve read most of the articles, studied all the portfolios, and done significant research on investing and specifically “passive investing with regular rebalancing”.
In early 2013, I decided that investing with Edward Jones was a second investing mistake, and so I sold my 2 stocks and all of my DSC funds from Edward Jones. I opened several self-directed savings accounts with TD and transferred all RRSP, RSP and LIRA funds to the TD accounts.
Once all of our investment money was safely deposited in-cash to our TD accounts, I made what I now realize was my third investment error (and maybe my biggest yet…?), I stayed in cash during the tremendous gains the market saw in 2013 due to constant fear of buying in at a top. The longer I waited, the more I saw the market climb, the more I regretted the decision and the more I was convinced I shouldn’t buy “now”.
So, with all I’ve read and learned, here is what I now believe:
1. I should choose my risk tolerance and with it a target allocation (equities vs bonds vs real estate).
2. Low-cost ETF’s that track broad indexes are the best vehicle to invest my money in, rather than trying to pick “winners and losers”.
3. Rebalancing a portfolio quarterly or annually is important to maintan the allocation and acceptable level of risk
Here’s where my primary struggle lies:
1. I have only followed market movements since 2001. In that time, there were 2 occasions where I saw the market declining and general sentiment toward equities was negative. During both of those timeframes (2001 and 2008), I wished I had significant amounts of cash so I could buy equities while they seemed very cheap. I specifially remember October of 2008 when I felt strongly that a big investment in equities would definitely pay off in the long run. Of course, that wasn’t the market low any investment would have dropped further, but today those prices seem like a steal. I was not in a financial situation in either of those periods so as to have the ability to invest substantial money (beyond monthly max RRSP contributions). When we have another event like that in the future, I want very much to have the ability to buy equities while they’re selling at a big discount.
2. I don’t agree with the idea of a complete “random walk” when it comes to equities over long periods of time. In the short term, yes, but in the long term, no. I don’t believe anyone has the ability to tiem the markets, but I do believe it is possible to evaluate general equity value (through P/E levels – trailing or fwd). Equities simply look expensive to me at the moment. Corporate earnings are very strong, the economy shows signs of continuing to grow, but we’re also in a bizarre time where there is tremendous FED intervention and no one knows how that will play out. Ultimately, I am convinced there will be another opportunity to buy equities “on-sale” within the next decade.
3. Given points 1 and 2, I feel that cash should be one of the asset allocations, and that one should find a simple formula to adjust a target portfolio with an adjustable percentage in Equities, Bonds and Cash. I see the inherent pitfall that letting emotions cannot be used to determine this adjustable percentage, and I haven’t yet found a simple solution.
@A.Ban: I can relate. It’s generally thought of as prudent in much of the personal finance world to have some cash on hand. I keep 4 months worth of expenses in my “emergency fund” (a high interest savings account) and enough in my chequing account so that I don’t have to pay monthly fees. Together they form a substantial chunk of change–7% of my overall net worth.
That said, it sounds to me like you are suffering a little bit from “paralysis by analysis”. There’s a lot of information out there and it’s definitely a scary time to get into the markets. But it always is–it never seems calm. There will also always be things one could have done better. Wednesday (see my comment from July 29th) I just transferred about $16K from bonds to equity indexes and just two days later equities have dropped 3%. While most CCPs this year would be rebalancing equities to bonds, I did the opposite to get rid of a high MER fund. (A move I’d been procrastinating because I didn’t want to feel like I was tinkering too much.) Does the bad timing of that switch make me feel like a loser? Maybe a little bit at the moment. But I’m fine with that. Dollar cost averaging should pan out in the long run. And one thing I’ve learned is that it doesn’t seem to take equity indexes long to return up to previous levels. All I can do it let forth a Homer Simpson, “Doh!”, and trust that I’ve done the right thing.
@A.Ban, every day every investor is faced with the SAME challenge “I have X dollars to invest today, where should I invest it”. How we each got to this point is irrelevant, the point is we each have X dollars to invest TODAY and we each need to make a decision TODAY of how to invest our X dollars.
To guide your decision making I suggest that you construct a personalized investment plan/strategy that maps out how you will make those decisions. The plan should include: how long do you plan to invest, how you will control risks, how you will control expenses, how will new money be invested (e.g. small amounts and large lump sums), what events will trigger changes in the portfolio and lastly what are the investment vehicles you will use.
I can’t make your plan. You have to make it or hire someone like Dan to help you make it but you need one.
Here’s my personal observation… please don’t take this badly, it’s meant to help… here goes:
– You are churning. This is bad and needs to stop. There is even a chance that if you stuck with your original strategy you may have been better off. You really need to find a strategy you are comfortable with and then stick with it for a long time. E.g. 10 to 20 years.
– You think you can predict the market. I will predict that almost certainly you cannot. With your track record, I wouldn’t hire you to manage my money and neither should you. :) You are suffering from overconfidence in your abilities. I think Dan has a post on this somewhere. Don’t worry, we’re all guilty of this from time to time.
@A.Ban: I don’t think anyone here wishes to be unkind. However your situation and opinions may need tuning, or at very least challenging, and that would necessarily require presentation of points of view that differ from yours. If there is a consistency to these other points of view, that should tell you something. There definitely is not a prearranged conspiracy or anything to act against you.
The fact that at you and your wife have paid off your mortgage at such a young age, have no debt, and live well within your means in this age of easy borrowing and popular over-spending is a credit to your self control and rationality — it already places you in an enviable minority, and hopefully everyone in this forum agrees that this is the fundamental essential basis for future wealth that we can all agree upon.
Your statement of “what I now believe:” in points 1. 2. and 3. is fundamentally sound, and is in fact as far as I can see a pretty succinct wrap up of the whole Couch Potato philosophy.
The thoughts expressed in your “primary struggles” however, are a mixture of rationality (“I don’t believe anybody has the ability to time the markets…”) and emotionality (“…but I do believe it’s possible to evaluate general equity values…etc.”). Perhaps you can review your thoughts carefully, and see how some ideas you have, particularly regarding the concept of being able to know when certain stocks or sectors are “overvalued” or “undervalued” are at odds with your stated acceptance that it is futile to try to pick “winners” and to avoid “losers”.
I won’t go on further to specifically address discrepancies in your stated espousal of the rational CP philosophy and your emotionally driven rejection of CP investing when it gets down to actually doing it now — that would be less productive than to advise you to keep on reading and following the discussions here in this excellent site until you feel comfortable acting.
But just remember that most of the people here, (maybe all of them :) ) certainly myself included, started in your position, and it was no easy task to move from investing with our emotions to rational investing in spite of our emotions. We all made mistakes along the way, sometimes painful ones. That’s why we are here.
@A.Ban: PS. Your last sentence shows you are essentially grappling with the core of the problem. No doubt you will finally accept the mathematical elegance of the simple solution. Simple, but not easy.
Hi Dan
Regular reader, and have now over a period of two years implemented a CCP balanced approach, and I feel I have a decent grasp on my risk tolerance. One of the part that I am still trying to integrate with my balance is that a significant part of my fixed income portfolio (and 20% of total) is in the form of an inflation protected deferred defined benefit pension credit (note inflation protection is both in deferral and payment portion, and main reason why I decided to leave it as part of portfolio).
Obviously this is only marked to market once I get my annual statement, and even then the value in 6 months out. This makes my variability appear artificially lower during the year. But not including it, makes my portfolio appear too weighted on equity.
Furthermore should I be concerned that I am now including things like mortality changes into my gains/loss?
Any recommendation?
@Francois: I’m not sure I understand all of your concerns (e.g. mortality changes?) but the larger question of how to think of a pension as part of your overall asset mix is one I address here:
https://canadiancouchpotato.com/2014/04/14/ask-the-spud-is-my-pension-like-a-bond/
@dan
Thanks, I guess in my mind not including value was forcing me to overload in long term interest sensitive assets, which I actually felt too risky.
As for Mortality. My most recent statement saw a increase in the PV value of the pension, due to a change in the Mortality assumption used to value the Pension credit. This adds an additional element of variability, that I don’t think I have elsewhere in my portfolio. Obviously if I am not counting to PV of the pension in my assets this is not a concern
I’m no bear, or bull. I have been convinced of low cost indexing route since shortly after I began investing in the late 90s. But now, I find myself in a weird situation.
In May I sold all of my investments and placed everything into high interest savings (about 500k over our RRSPs, RESPs, and TFSAs). They were mostly in index ETFs with about 8.0% equity/20% bond. My reasoning was that I MIGHT end up moving and entering a retirement-like lifestyle where I would need to find a bit lower risk allocation that would generate some income. Also, I was due for a re-balance so figured I’d just go ahead and do that after the summer if I decided to stay put and keep working.
Well, summer is over. Now I find that I should reinvest in the index ETFs (since I am not going to move soon), but in the meantime I missed 9% returns over the past 2.5 months? I am now extremely reluctant to dump into the markets since I “feel” like there can’t be much more upside before a correction. Feelings typically don’t play a role in investing for me, but this summer was pretty crazy with the gains. In short, I am too scared to invest now. I also recognize I am trying to time the market in that i would like nothing more than a 25% correction in the next month or two.
The obvious “solution” might be to DCA my way back in…but even then I am not sure how much, how frequent…and will be stuck with e-series (which isn’t so horrible) since there would be many trades (there are 8 accounts involved that cannot be combined).
I’m at the point where my risk tolerance isn’t what it used to be. I have 500k to invest but feel everything went too high too fast. Any advice?
@RW: I would have said from a rational viewpoint that your risk tolerance is what it is and you should divvy your assets accordingly.. But having felt similar emotions under similar circumstances, to be fair, I have to dig deeper and think a bit. It appears your (mine too) risk tolerance changes according to the circumstances, in this case perception of the economic climate, i.e. tainted by an element of market timing. Therefore, one has to sit down and think really hard what percentage shift is dictated by one’s hopes/fears of market timing, and what “basic” percentage is truly matched to your risk tolerance. That latter number, hopefully, is the one that would not change no matter what the markets had done lately, or are likely to do in the future.
@RW: “I am now extremely reluctant to dump into the markets since I ‘feel’ like there can’t be much more upside before a correction.” You can find this same feeling stated in comments a 6 months ago, a year ago, a year and a half ago, and two years ago. “I’m scared to go in because the market seems to be so up lately.”
You can find the exact same sentiment in bear market comments from 2007-09. “I’m scared to go in because things have been so down lately.”
Sadly, nobody can ‘feel’ the markets. You either go in or you don’t. And you hold some faith that if you do, historically the indexes will rise and a portfolio which includes rebalancing will do well over the long-term. Suffering “paralysis by analysis” isn’t a good a investment strategy, in my opinion.
@Oldie states it well–personal risk tolerance seems to change under different economic climates. It’s probably best to ignore your instincts and go with an actual written plan.
@RW – really nicely put reply…
It’s for exactly those doubt’s that I prefer investing in long term blue chip companies that provide dividends and did not cut them during the 2007-2008 crisis. I have heard all the arguments about the value of dividend vs. growth stocks, the whole “those dividend people” thing. When you focus more on making your goal of a monthly payout of $1000.00 for example and you reach it, these correction fears are easier to live with.
Who cares if your Telus stock went down or your Dream office Reit loses 25% like mine did after it steadily was going up. As long as you can cover your monthly expenses or purchase more shares at a lower price. Down the road you will be rewarded. It may not be the “ideal” way to invest but it’s far from the worst. The increasing dividends make you feel good even if your share or unit values go down.
@RW, it looks like you’ve got a lot of opinions. Here’s mine… :)
My “advice” (if you can call it that) is to create a new investment plan that you can live with no matter what happens in the market. Only you know what that is but here’s a few hints. You’ve said that you’re “risk tolerance isn’t what it used to be”. This would suggest to me that your target asset allocation of 80% equity/20% fixed income isn’t correct for you any more.
You also seem worried that you are entering the market at a bad time. Would you have felt this way if you had stayed fully invested since May or would you be holding steady? It’s hard to internalize but like I’ve stated on here before: everyday, every investor makes a decision as to how to invest that day. For example, an investor that has stayed fully invested since May and decides to stay in the market on August 22, 2014 is making the exact same decision as an investor that is switching from cash to being fully invested on August 22, 2014. They are both taking their wealth and investing it on August 22, 2014. There really is no difference but it seems like there is!
If you are speculating for only a few months then it may or may not be the case that the market has got too hot but nobody knows for sure either way. That’s why it’s called speculation. If however, you expect to be invested for a proper amount of time (e.g. 10 years or more for equities) then whatever happened in the last 3 months is likely inconsequential and that’s called investing.
DCA in if that makes you sleep at night (which is a valid reason.) Only you know what is right for you. Create a plan that you can live with not knowing if the markets will go up 50% or drop 50% in the next year and each subsequent year… because those are the realities of equities. :)
I’m planning on taking an 8 month leave of absence from work beginning in January of 2015. To finance it I plan to use much of my TFSA, to help me meet an estimated budget of about $65k. As I’ve only recently begin educating myself on investing, I’ve had all that money sitting in a 1.25% savings account rather than invested. My research has brought me to index funds and the CCP specifically and I’m just about to move my whole $31k TFSA into the CCP recommended TD e-series funds, but I’m wondering if that maybe too risky since I do plan on using at least $20k of that, perhaps more depending on my how my saving proceeds over the next 14 months.
I also have another $25k saved for this so far which I am also unsure what to do with since my TFSA is maxed. Is it worth investing this savings some how as well, or is it better to just to keep it in my 1.25% saving account?