|The five lessons of the correction
Thursday, July 16, 2010
We can all learn from our mistakes. We also learn from adversity.
This is true of the 2008 financial crisis and consequent recession.
Sometimes we have to learn them the hard way. At other times,
we are lucky enough to heed the voice of experience. I was fortunate
indeed, then, to hear some pointed words of wisdom from a market
veteran at a recent seminar in Vancouver, sponsored by Mackenzie
Financial. The keynote speaker was Nick Murray, a 40-year veteran
of the financial advisory profession. Here’s what I learned.
Lesson # 1 –You will never, ever be able to
anticipate what the economy will do in the next year or two.
Lesson # 2 –You will never be able to anticipate
what markets will do over the next 30 months, and there is no
shame in this. Nobody else can anticipate it either.
Lesson # 3 –The more dramatic the events in
the economy or markets (good or bad), the less likely you will
be able to anticipate them. Think 911 or the credit crisis.
Lesson # 4a – There is no statistical evidence
for the persistence of performance. Future mathematical performance
Lesson # 4b – At critical turning points in
a person’s lifetime, no one has been saved by selection. That
means, for example, you weren’t saved because you held, say,
AGF Canadian Stock fund instead of, say, Ivy Canadian. The differences
in each category weren’t great enough to make a large difference
Lesson # 5 –The world didn’t end, because
it doesn’t end. This means a correction is just that, and they
are a normal occurrence in a health stock market.
Yes, it sounds like common sense – and it is. But in investing,
common sense is rarely the order of the day. If we can learn,
and apply, these lessons, we will be far better off the next
time things go bad. Many advisors (including me) sometimes get
caught up in following too much economic data and fund performance/volatility
information. I think what Mr. Murray is telling us is to get
beyond the noise of the markets and media, decide on your asset
allocation (percent of assets in fixed-income, equity, cash,
and other categories), buy some investment funds, and stick
with the plan.
I personally believe in having a few sectors that don’t normally
correlate with the stock market too closely. Precious metals
and real estate are a few examples.
Interestingly, Mr. Murray also showed that the best fund in
the U.S. made about 18% over the last decade, yet the average
unitholder lost 11%. How is this possible? Simple: It boils
down to clients and their advisors chasing returns, which is
a surefire method to losing money. Essentially, they get in
after a 60% gain and bail out after a 30% loss, when they should
be doing the opposite.
Clients sometimes switch advisors because they made 9% and
a friend made 25%.They switch and promptly lose 30%. Anything
that can make 30% can also lose 30% (or more). Buy on the lows.
I agree with Mr. Murray that we can’t predict anything, but
I do have a contrarian preference, and I believe my clients
will be better off in the long run if they buy more during corrections.
When markets are near record highs, ease up on the equity and
buy more fixed income with less downside risk. Downside risk
is at the highest near market highs, or after a good run of
a few years.
Any advisor who tells you he or she can make you 8% to 10%
per year is misguided, misinformed, or outright lying. You can
purchase funds that are more volatile and invest 100% in equities,
which might give you the “opportunity” to earn 8% to 10% in
the long term. But if you purchase a balanced portfolio or diversify
with funds weighted more heavily to fixed income, achieving
performance of 8% to 10% is very unlikely, if not impossible.
Your advisor’s role is to guide you through the years of market
ups and downs and help you achieve your financial goals. Most
people have very similar goals: buy a home, pay off the mortgage,
retire early, and comfortably, put some money aside to help
educate your children, pay less income tax, and perhaps buy
a second home or cottage. There are, of course many others,
but those cover many clients’ basic goals. If you don’t meet
with your advisor once a year (or more), if you stop your contributions
when markets correct, or worse yet sell investments consistently
while in a correction, it will be more difficult if not impossible
to meet your goals.
If you do meet your advisor annually, buy more when markets
correct, stick with the plan (although it’s your right to question
strategies), invest 10% of your salary for savings/retirement,
have sufficient life/disability insurance, and get more conservative
as you approach retirement, you should be in good shape.
Your advisor should show you how markets have corrected in
the past and how they have come back every time to hit record
highs (usually sooner than later). That provides you with some
perspective. That is why we need to stay the course when things
look bleak. Stocks are a different animal. When you have a big
loser (like the infamous Nortel Networks Corp.) and the stock
has dropped 50% but the company’s prospects look even worse,
it makes sense to get out. Individual stocks have more risk,
which is why I stay away from them. I did buy some once in my
RRSP, but found it took too much time to stay abreast of the
market in addition to work, family, and other activities.
My advice is to commit these lessons to memory, discuss them
with your advisor, and apply them to your financial planning
and investing strategies. Next time the markets “correct” (and
they will!), you’ll emerge well ahead of the game.
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all may be associated with mutual fund investments. Please read the
simplified prospectus before investing. Mutual funds are not
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no assurances that the fund will be able to maintain its net asset
value per security at a constant amount or that the full amount of
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change frequently and past performance may not be repeated.
Personal Opinions & Recommendations Disclaimer
The foregoing is for general information purposes only and is the
opinion of the writer. This information is not intended to provide
specific personalized advice including, without limitation,
investment, financial, legal, accounting or tax advice. However,
please call the author to discuss your particular circumstances.