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Contrarian tips

Tuesday April 10, 2012

A contrarian is someone who takes up a position opposed to the majority, no matter how unpopular. This has often proven to be a highly effective investment strategy. More typically, though, fund investors tend to buy in after a great year for a fund category, not after a bad one. And that’s too bad, because a category that loses the most one year is often the best performer a year or two later. See Brian Bridger’s recent article for a case in point.

How can this strategy work for you?

To employ a contrarian style of investing is not normally a strategy in and of itself. It often works best in conjunction with another strategy. For example, you wouldn’t typically sit on all your capital waiting for a disastrous event to drive markets down in the hopes of buying when everyone else is selling. There is way too much risk with that strategy. The market could in fact continue rising for three or four years while you wait for your “disaster.”

Instead, you create a plan to have some base exposure to the market at all times and stick with it over the long term.

Core and explore

Consider a strategy using dollar cost averaging to build a solid, balanced portfolio using various equities, corporate bonds, government bonds, real return bonds (and other investment instruments) to form the majority of your portfolio (the “core”).

You might then “explore” by allocating 10% to 20% of your portfolio to asset classes that don’t usually correlate highly with the stock market (for example, real estate, precious metals, and natural resources). Some investors also use labour-sponsored funds and limited partnerships to create some diversity within their portfolios and receive some generous tax credits at the same time.

Owing to the volatile nature of the sectors I mentioned, many advisors recommend taking profits if your investment in a particular “Explore” asset – say, precious metals – grows by more than 30% to 50% in a year.

When your portfolio has grown to a decent size, start to hold back perhaps 10% in cash and use that when the next correction comes. We don’t know when it’s coming, but we know for certain that it is coming. Be ready for it.

To profit from this strategy you have to buy equities in the downturn, not bonds or other fixed income vehicles. This 10% injected into the market after a slide of 25% or more will give you a nice bump in returns, usually within a year, sometimes in as soon as two or three months.

When this strategy doesn’t work

I was taught to “buy low” and “buy often” during corrections in my early training. While this frequently works, it doesn’t always work. In the great tech meltdown at the turn of the century, Science & Technology funds crashed – and they never fully recovered.

The lesson here is to be wary of narrow sector funds, because the risk rises significantly compared with funds focused on blue-chip companies. Use your financial advisor to keep abreast of the big picture and to avoid falling into momentum traps.

Why the strategy isn’t well utilized

Simple. It is very, very difficult to buy when almost all the news is bad and everybody else is selling. Fear and pessimism are strong emotional drivers, and often trump logic and reason.

And this is where your financial advisor can steer you in the right direction, suggesting you buy during a correction, even though you won’t feel good about it at the time. On the flip side, your advisor should counsel caution when markets are approaching or hitting new record highs. Again, you won’t feel good about it, but you’ll be cushioned from the inevitable reversal.



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Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the simplified prospectus before investing. Mutual funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be 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 your investment in the fund will be returned to you. Fund values 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.