"Ask yourself the question 'Am I adding another fund to diversify my stock market investment, or am I adding another index fund to outperform it?'."


- Bill Schultheis, author of The New Coffee House Investor, on adding additional mutual funds to your portfolio.  Your goal when indexing is to approximate the stock market average while diversifying enough to minimize the volatility, not to try and beat it.

The Behavior of Indexes Post-2000

It seems like everybody that isn't on Wall Street is an advocate of index funds.  Reasons often include the low MERs, the average performance that beats the active investors, and the consistent rise in the indexes over time. Even I  have invested in the indexes because of this advice, and I don't plan to change that fact any time soon.

But as I am reading this book, "The New Coffeehouse Investor" by Bill Schultheis, which was originally written in the 1990s, I am beginning to wonder if indexes have had enough time to show their true nature.

Now I am obviously very new at this, so my thoughts could be way off base, but the conjecture is interesting none the less.

The S&P 500 was first published in 1957.  Up until the turn of the 21st century, there wasn't a single 10 year period where investors would lose money.  The chart on Morningstar.com for the S&P clearly shows this for the years prior to 2000:

However, if we add in the years post-2000, we see a very different picture:

Unlike the first chart, there are several places that face a drop in value after 10 years post-2000.  Of course, with the 2008 recession this is understandable, but there were also significant recessions before the year 2000, yet the impact they had on the chart seems negligible. Why is it so much more volatile now?  Is the index old enough to make judgments of its typical performance?  It almost seems like its behavior has changed after the year 2000.

This change in behavior is especially important for asset allocation, as if the indexes have become more volatile then perhaps some people who are more averse to risk won't want to fill their portfolios with them.

Perhaps there is a rational explanation, or maybe these seemingly radical up and downs will just end up being little blips in future performance charts of the S&P 500.  Either way, I am very interested in why this has changed, and what the implications are.

I'm not sure if it is as significant as I am making it seem, but it is definitely something to think about.

Review: Rob Carrick's Guide to what's Good Bad and Downright Awful in Canadian Investments Today

I have a very long to-read list.  It seems like every time I finish a book, I find five others that I know I have to read eventually.  So when I found this book online it was probably the 20th in my list, accompanied by some very big titles that have been unanimously well received.  But I'm just a sucker for Canadian investing.  So much so, that when I was browsing my local Chapters and found that the only copy they carried had a coffee stain on the cover, I drove to the closest one that had it in stock and picked it up.

I'm actually very glad I did.

The book is less of a textbook and more of a reference to investing.  It is laid out in a list formation, which is actually fantastic, and guides you through mutual funds, the stock market, bonds, and pretty much every other topic you've probably seen in this kind of book. The real difference is that in most books, I find that you learn some great strategies but in the end you aren't really sure what specifically to invest in. For example, I have learned about the advantages of having small and medium-cap funds in your portfolio, and yet I have no idea which specific funds are available to me, much less which will nicely round out my investments. 

In Rob Carrick's Guide, the lists are so specific that everything you read about is relevant to your own investments.  Here are some examples:

• "Five big, fat mutual fund industry rip-offs"
• "Five good socially responsible funds"
• "Five essential ETFs
• "Three low-cost ways to buy stocks"
• "Three online resources that do-it-yourself investors should certainly use"
• "Ten traits of a good adviser"

...and so many more.  Now don't get the wrong impression by the word 'list'.  Although that is how the sections are organized,  each one of these lists contains vital information written concisely enough that you are not bogged down by technical jargon, but still come away with advice that you can put to use right away.  The format makes it extremely easy to jump back to a section and quickly pick out the information you are looking for, without having to dive into long-winded paragraphs.  Let's break it down.

Pros

• The lists are fantastic; great advice for whatever topic you are thinking about, whenever you need it.
• The no-nonsense tone.  If something is bad, Rob Carrick will call it bad and tell you why.  If something is great, you will no doubt understand why he feels that way.  It's written in a very accessible way; there is definitely personality in these pages
• Lists, lists, lists!  Again, the index will take you wherever you want to go.
• The breadth of knowledge and experience of Carrick reinforces everything he says.  I haven't invested in any specific sectors, but he has and you can read all about them and why you might consider it.

Cons

• I can literally think of no cons.

Conclusion

Like the title suggests, this book is a guide.  If pure interest is your primary reason for reading the book, you will definitely pick up some great information.  However, I think the real value comes from the fact that no matter what I decide to do with my investment portfolio, I know there is a section about it in this book that will take me right where I want to go.  Want to venture into the stock market? the top brokerages, dividend stocks, and some great advice are all in here.  How about adding some corporate bonds to your portfolio? Here are three easy ways to do so.  Want to try do-it-yourself investing? There are two great lists about discount brokerages and the best resources online to benefit from.  I could go on.  

No matter what type of investment you are interested in, there is something to learn hidden in this guide.  I can already tell that I will be reading over these pages in the future as my portfolio evolves, and the value in that is worth way more than  the cost of any book.

Tip: Rebalancing your Portfolio

One of the most important parts of your investment portfolio is the crafting of an appropriate asset allocation plan that suits your particular situation based on your age, risk aversion, time horizon, and so on. This plan will create a structure for your portfolio and guide how you divide your contributions between investments. However, the weighting of your assets will change over time, which can be seen through the following example.

If you are properly diversified but are interested in a particular sector, you might have a portfolio like this:

• Diversified Stocks 40%
• Sector Specific Stock 20%
• Bonds 30%
• Cash 10%

The diversified stocks may further be divided into small-cap, medium-cap, and large-cap, or they may be made up of a few index funds invested in several markets, but for this example we'll keep it general.

Now, let's say you are heavily invested in the technology sector, which has just surged in stock price. This increase in value has altered your portfolio to look like this:

• Diversified Stocks 35%
• Sector Specific Stock 35%
• Bonds 25%
• Cash 5%

This might seem like a good thing; a large part of your portfolio has increased in value! However, if you compare this to the original asset allocation plan, it is quite different. To make up for this discrepancy, it is wise to sell some of the sector specific stock until the proper percentages are restored.

The same works when the weighting of an asset decreases in your portfolio. In this case, you will want to buy more of it to make up the lost value and keep your allocation as close to the plan as possible. As a rule of thumb,  it is recommended that if any instrument goes above or below it's allocation by 5% it should be rebalanced by either buying or selling.

In general, your asset allocation was created to suit your individual needs, based mainly on the time horizon for your investment and your risk aversion. If you cannot handle the ups and downs of the stock market, it is not wise to allow their weight increase relative to your other investments. Additionally, if a large part of your portfolio has become stocks and you are nearing retirement age, your investments may be much more volatile than you would like at such an age where time is not on your side.

The benefits may be more obvious if you consider the .com bubble at the turn of the century. At the time, many peoples portfolio were filled with technology stocks that were constantly growing in value and making up the bulk of their total investment. When the bubble burst, the ones who did not rebalance their portfolio saw a drastic decrease in their portfolio value, while those who did minimized the damages.

In the end, rebalancing will allow you to have a plan that you can stick to, but also avoid risking your investment when there is an impending bear market.  It is therefore a vital practice for those who have decided on a buy-and-hold strategy.

The "So-Called" Experts Part V: My Frustrations with Investment Advisors

In an ideal world, your investment advisor would treat your portfolios performance as top priority, giving you every advantage that they can, and take a small cut for themselves for their efforts.  However, as is so often the case, the world is not perfect and often the latter is true, but the former too frequently lies in a somewhat grey area.

The problem with advisors and something like a mutual fund is that the higher the MER, the more the manager gets paid.  Of course if the MER is too high, you can skip right along and pick another mutual fund to invest in because you are a savvy investor.  But I would argue that most people aren't.  Those who are uncomfortable with making decisions will trust their advisor to choose for them. They are professionals aren't they?  It is this group of people that is most susceptible to buying into sales pitches such as "great past performance" to make up for the higher MERs, and it's their advisor that tricked them into it.

I have read about this in a few books that I've picked up, and heard about it through others online, but actually experienced it for the first time when I was trying to set up my e-Series account.  The advisor at TD was persisting on a TD Dividend Growth mutual fund with an MER of just under 2%.  Despite my resistance, she continued to point out it's great return average of 6%.  At this point I well understood the benefits of index funds over actively managed funds, so I politely declined.  I still found it frustrating that they have this great e-Series fund account with MERs below 0.5%, and yet they never recommend them to anybody.

I'm not the only one who had this problem with TD.  If you take a quick look online for the experiences people have had, it ranges from pure ignorance of the advisors about the existence of an e-Series account, to extreme arrogance from the managers about how it is a terrible investment and you are a fool for not investing in their actively managed mutual funds.

It's unfortunate, but as I mentioned in a previous post anybody can call themselves an investment advisor or analyst, so the person you are working with may not be as devoted to your portfolios long term growth as someone that holds a Certified Financial Planner designation might be.

This obviously does not apply to every advisor.  I'm sure many of them take their job very seriously and get great satisfaction out of doing the best job for their clients, but it is definitely something to look out for.  I would recommend picking up a few books and going into your advisors office with some understanding of what you are investing in so that you can have a discussion with them, rather than blindly taking their advice.  

Who knows, you might end up realizing you are capable of managing your investments alone.

Vanguard Launches in Canada!

Known for their extremely low mutual fund fees, John Bogle’s legacy is now launching in Canada! This will definitely create some great new opportunities for investors, and hopefully even drive down Canada’s relatively high MERs.  So excited!


You can read the press release here