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Posts Tagged ‘Investing’

As a financial planner I am often bemused by the thousands of financial self help books.  Like most self-help books, they simplify complex problems and provide an easy sounding and tempting solution which never quite works.  If any one of the books actually were able to help most people to save more and invest wisely then I hardly think that there will be so many books crowding the financial planning  section of the book store. But while they don’t actually provide the cure that they promise, most are harmless. So as I was recently flipping through “The Total Money Makeover: A Proven Plan” by Dave Ramsey, a few things caught my eye which I really felt I had to comment on. In the section “what this book is not” the author responds to previous challenges to his approach. In fact, if you search for  “Dave Ramsey bad advice” on Google you’ll get over 100,000 hits, so what I have to say may be treading some old ground. In a subsection entitled “This book is NOT going to mislead you on investment returns” he says:

“People seem to think that making a 12% return on your money in a long-term investment is impossible. And that if I state that there is a 12% return available then I have lied to you or misled you. I recommend good growth stock type mutual funds in this book as a long-term investment and dare to state that you should make 12% on your money over time.”

He then goes on to explain how the S&P 500 has averaged 11.67% in the last 80 years and how this indicates that you should therefore be able to get the same returns. Now, you can search for  funds that have averaged 10 year returns over 12% on Morningstar (I found 19).

Morningstar search result where mutual fund's 10 year average return is > 12%

But none of the above funds had the tenure that Ramsey had indicated in the book where he’s citing data from the 1930’s. Ramsey did give return data but slyly did not tell you what funds he’s invested in, rather referring to you to speak to one of the “approved” advisors (I would assume that they pay a fee to be approved by Mr Ramsey who must share his secrets with them).

So a little more digging led me to this list which does seem to be the funds that Mr. Ramsey is talking about in his book.

Hey if there are magical funds out there that are giving you S&P returns over the long term then sign me up (keep in mind this means they have to be beating the returns of the S&P since there are fees involved).  But why aren’t any of the funds that’s recommended by him on my morning star list?

So I dig a little deeper.

I looked at American Funds Invmt Co of America fund. The fund was created on March 31, 1934 just as the country was coming out of The Depression.  Up to Dec 31, 2011 it had an average return of approximately 11.79% annually. Even accounting for inflation which was 3.37% over that time, the returns are still above 8% annually.  So Mr. Ramsey seems to be telling the truth.

But again I ask, why isn’t on my morning star list? It didn’t make it on to my little search list because it’s return for the last 10 years is only 4.42% although it has been out performing S&P by 0.42%.

And that’s the problem that Mr. Ramsey’s critics and myself included have with his assumption of 12% return.  Just because a fund has returned on average 12%,  doesn’t mean that your return will be 12%.  When you invest matters a lot.  If you were smart and got into these funds 3 years ago at the depth of the current downturn, your return on this fund would be over 20% annually.  However if you started to invest 5 years ago (at the top of the market) your return would only be 1% annually.

Mr. Ramsey will of course say that for you to gain the average return, you need to invest in the long term.  As you can see, the 10 year results aren’t 12% but what if we look at 20 years?  The answer is 5.99%.  Only when you go back 30 years – a very long investment horizon for most people – do your numbers start to look better at 11.88%.  The question is will you able to hold the investment for 30 years and ride through all of the 50+% corrections? What if that correction came as you are just about to retire?  These are the questions that many who are nearing retirement are grappling with.

So what’s the solution?

Well I don’t really have one.  I’m no better at driving forward on an unmarked road while looking in the rearview mirror than you.  But I have a general approach that you can try to help you to get to your goals:

  • Work out what kind of returns you need to retire – be reasonable in your assumptions about your life style and government program’s availability. Likely the return won’t need to be 12%.
  • Create a portfolio that can give you a good shot at that return.  If you only need 5% to retire, then a more conservative portfolio will work.  If you need 6-7% a 60/40 portfolio will work.
  • Make your portfolio more conservative over time so that corrections have less impact on you as you near your goals, but keep your return assumptions the same.
  • Track where your investment funds should be annually/every 5 years and see if your portfolio (including money you may still be adding to to it) is meeting your objective.
  • If it isn’t, then you need to put away a bit more to guarantee the returns.
This way by the time you retire, hopefully you will guarantee you have the amount of funds you will need through both investment returns and putting enough away.
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In January 2011 I wrote about a little experiment on stock market.  Well it has been one year and so here’s the result of the experiment.  In Dec 2010, I selected 5 stocks on the Toronto Stock Exchange (S&P/TSX) using nothing but darts to see how the performance of the stocks would stack up against the index in one year’s time. I made no changes to the stocks during the year even as the stock market experienced a “correction.”  So here’s the data from Dec 21, 2011.

Security Shares Opening Price Opening Cost Ending Price Ending Value Return
Encana Corp 35 28.7800 1007.3000 18.8900 661.1500 -34.36%
Fairfax Fiancial Holdings Ltd Subordinate Voting Shares 2 407.9400 815.8800 437.0100 874.0200 7.13%
Minefinders Corp Ltd 95 10.6900 1015.5500 10.8300 1028.8500 1.31%
Royal Bank of Canada 19 51.6900 982.1100 51.9800 987.6200 0.56%
Silver Standard Resources Inc 46 24.7400 1138.0400 14.1000 648.6000 -43.01%
Dividend 87.1500
Total 4958.8800 4287.3900 -13.54%
total before Dividend 4958.8800 4200.2400 -15.30%
TSX Index 13443 11955 -11.07%
TD Dividend Growth -0.30%

So the dart test did not beat the index in my test.  Including dividends, my annual return is -13.54% while the TSX returned  -11.07%.  Considering I didn’t include the trading costs of $99.95 to buy the shares my overall return on the investment is more like -15.30% , 4.23% less than the index.

The main contributor of my negative return were my heavy weighting in Encana during a year where oversupply for natural gas depressed all stocks related to the industry and the fact that Silver Standard lost 23% of its share price in one day after announcing reduction in reserve (how much silver is available to mine) and increases in production costs.

I have also included one of my favorite Canadian mutual funds in the table to illustrate how a different weighting (heavy in financials) would have impacted your returns. In 2011, while still negative this fund did significantly better than both my darts or the index.

So what conclusion can you draw from this experiment?  As anyone knows one year’s data isn’t worth much in the grand scheme of things.  Had the darts outperformed the index in 2011, I would have to reach the same conclusion.  I think what’s illustrative in this little demonstration is that by overweighing in specific stocks, you can skew the results significantly.  However, as you add stocks in your drive to diversify you will also drive your returns to match the index which means that if you are aiming to beat the index you won’t succeed (remember that there are always fees  even with ETFs).

So what to do?

“Don’t play the stock market” has always been my conclusion.  You don’t have enough time to be looking at the stocks, doing the research that’s required to “beat the market.”  If something like that exists then why are there so many advisors and analysts around?

Go back to your financial plan and see what return you need to grant you the goals you have set for yourself.  Create a portfolio that matches your risk profile and monitor it.  If need be, add more money into the pot, because savings are the best way to reach your goals.

Now if there is only a mutual fund out there that can give me 12% return….

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I have been pretty skeptical of the abilities of stock pickers for decades now.  I remember when I was still in business school, the Toronto Star used to run this stock picking exercise where they pick 5 stocks by darts on Jan 1 and also have a bunch of portfolio analysts make their own picks. At the end of the year they would review the results.  Over the few years they ran this experiment the darts seemed to always do pretty well. They weren’t always number one but they were always in the top five.  Unfortunately, the paper no longer does this experiment. I think it’s because no analyst wants to lose to a bunch of randomly tossed darts :).

I have finance degree. But nothing I have learned in business school’s finance courses gave me any better feelings about the abilities of technical analysis to pick the right stocks.

This year, after talking about this dart experiment for many years, I have decided to put some real money behind my belief and run my own dart experiment.  I have done this once before as part of a virtual stock game with some friends, and it went incredibly well (but that’s a whole different post).

So tonight I picked the five stocks, well, the darts did actually.  I printed the TSX charts by sectors onto one sheet of paper, but due to a lack of access to dart boards (they seem to have disappeared from pubs) I improvised by dropping a pen onto the sheet of paper on the floor.  The board was turned,  by my husband, my eyes were closed, after each drop to enhance randomness.

So what did the ‘darts’ choose? My stocks are:

  • Fairfax Financial Co
  • EnCana Corp
  • Minefinders Corp
  • Silver Standard Reso
  • Royal Bank of Canada

Tomorrow I will purchase $1000 each (minus fees) of stocks and see how my little dart portfolio do by the end of the year.

It should be interesting.  Nothing like putting real money down.

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