Investing for dangerous times; don’t sweat the volatility, think long-term
Trader Christopher Lotito (centre) works on the floor of the New York Stock Exchange April 24, a day which saw a Twitter report affect the market as investors started dumping stocks, eventually unloading $134 billion worth. — Photos by The Associated Press
Perhaps nothing demonstrates the volatility of markets better than this week’s sudden plunge in New York and the lesser dip in Toronto based on a false rumour about the U.S. president.
In literally seconds, a bogus tweet from The Associated Press’ official Twitter account about explosions at the White House triggered a massive sell-off of equities, sinking the Dow Jones industrial average by 150 points — 30 in the Toronto market. It also cut crude oil prices and even trimmed the Canadian dollar.
Markets just as quickly recovered on the truth that the tweet was a hoax and U.S. President Barack Obama was unharmed but, as analysts noted, the damage to some investments had already been done.
For the vast majority of ordinary Canadians, the event was a mere curiosity.
More important is the volatility that occurs during shifts in the business cycle, like the years-long drop in stock values that accompanied the 2008 financial crisis, or the 330-plus point dip in the Toronto exchange on April 15 as investors abandoned commodities, only to return three days later.
What’s an ordinary investor to do?
In the current low-interest-rate environment, bank accounts offer only a slightly better return than stuffing cash in a mattress.
The problem with burying your head in the pillow as well as your money, say investment counsellors, is that you are guaranteeing your savings will not grow and, in fact, will lose value over time as inflation slowly chips away at the principal.
“The one thing you know for sure is if you don’t have your money invested in the market, it can’t go down, but it also can’t go up,” says Barry Gordon, president and CEO of First Asset Capital Corp. in Toronto.
“But if you have long-term objectives, you should find an equity strategy that allows you to sleep at night.”
Portfolio manager Adrian Mastracci of KCM Wealth Management in Vancouver says his advice to clients is to set long-term markers and not sweat the short term.
“Think and invest like a pension plan,” he says.
The pension plan approach — establish a game plan for attaining a certain result — has a proven track record of consistent, if not spectacular, results.
In the current environment, investors should expect long-term returns of between four and six per cent. To ask for greater is courting trouble, said Mastracci.
Common mistakes that investors make in search of quick and big profits are to try to catch a particular bandwagon, whether it’s a run-up in gold or commodities or a “flavour of the day” company.
The problem, he says, is that most investors aren’t clever or knowledgeable enough to consistently pick winners. Neither are most investment counsellors, he ruefully adds.
Another mistake is that investors become too emotionally invested in their choices, causing them to ride the bandwagon too long, or to hang on beyond common sense when the run ends and begins to reverse.
Think of those investors who hung onto Nortel Networks stocks because they reasoned it couldn’t go much lower — only to find it would become worthless.
“People get attached to their stock, to their bonds, to their company,” he said. “I say forget getting attached. They don’t care about you, you shouldn’t care about them.”
One strategy Mastracci follows is to rarely go all in on a buy or sell. If a particular equity falls by 20 per cent, it might be time to unload a portion of your holding. If it falls another 20 per cent, sell another chunk. And so on.
The same strategy is recommended for upswings. If an investment increases by 20 per cent, sell a portion to lock in profits. As it increases further, sell some more.
“You don’t get all the upside, but you don’t get all the downside either and it’s the downside that you remember the most,” he says.
Not surprisingly, Mastracci advocates a balanced approach to investing, with a mix of equities across the spectrum of sectors, real estate and fixed-income assets, such as bonds and cash. Like pension plans, he says, individual investors should avoid high-risk, high-reward assets, or at the very least, limit gambles to no more than five per cent of the total portfolio.
In the risk-filled, post-recession period, many have turned to the relative safety of government bonds, particularly triple-A rated Government of Canada issues. The trouble with that is that the return for those are modest.
Gordon says a better play for the faint of heart might be provincial government bonds, almost as secure as federal debt but currently offering significantly higher return — about 95 basis points more yield on maturity. That’s a good trade-off, he says. Provincials also provide better capital appreciation than federal securities because of their perceived higher risks.
He also shares some of the same philosophy as Mastracci in favouring a longer-term approach to investing, saying he believes in “low volatility, high-dividend paying” equities and doesn’t believe in being over exposed to any particular sectors.
That may sound like common sense in uncertain economic times, but Mastracci says if he were asked the question prior the financial crisis, when the market seemed to have no ceiling, his answer would have been much different.
“I’m not smart enough to tell you which of the sectors is going to deliver what you want,” he says. “I accept that fact even if most investors want to be right 100 per cent. I think if you can be right six or seven times out of 10, you are doing well.”