November 23, 2010

I find purchasing things on-line to be really time saving.  When purchasing from major on-line sites, like Amazon and Costco you will rarely have a problem.  When buying from an unknown company, beware!  I purchased from a site that was previously unknown to me and because I glanced over the Terms and Conditions, I didn’t realize I agreed to a monthly purchase rather than the trial I thought I was buying.  The CIBC credit people were aware of the practices of the company and were able to reverse the incorrect monthly charge because I never received the product.  I discovered a great site you can search for complaints about on-line business practices:

So, before your next purchase from an on-line site you don’t know – do a search to find out what others are saying about that company.  The internet is powerful!

 Richard WR Yasinski CFP

Perspectives – How do I protect my portfolio?

In the aftermath of the 2008-09 financial crisis and Great Recession despite the fact that many portfolio’s have almost reached their pre-crash peaks the taste of the significant decline in market price of our portfolio’s we experienced has not sweetened. 

One of the questions I get is, “How do I protect my portfolio from having that happen again?”  An important question and I’ll rephrase the question with what might be the real concern:

“ How do I make certain I won’t run out of money in retirement?”

The closer we get to needing to draw an income from our portfolio’s the more concern we seem to have with making sure all the money is there when we need it.  Since the average investor that retires at 62 has a better than 50% chance to living to age 90, we’ll need the income from our portfolio’s for a long time.  Here are a few things to keep in mind when thinking about your investments, markets and financial security in retirement.

            1 – The world will not implode because it does not implode.

The comment, “This time its different.” has always been proven wrong.  Although the details of each economic catastrophe differ, the result is always the same – the world and the economy recovers.   The current “this time is different” scenario is the global currency crisis.  The fear is we are printing money which will create run away inflation and global economic collapse.   I don’t know how this will be fixed – I just know that it will be fixed, because it’s always been fixed.

In the last 100 years we’ve gone through dozen’s of world crisis.  When you study these in detail (and I urge you to google them) you get a feel for what people were thinking while going through the experience.  You can’t help but hear many saying, “This time it’s different ”  and it was, for a time.

Each of these was a crisis that was expected to end the economy or world as we knew it:

1914 – First World War

1939 – Second World War and the fear of nazi domination

1950 – Korean War

1957 – Sputnick launched and the fear of Russia winning the space race

1962 – Steel price rollback and US government interference in big business

1961 – The Bay of Pigs crisis and the threat of nuclear war

1970 – Liquidity crisis when money started getting expensive to borrow

1973 – Arab Oil embargo when the flow of oil stopped, prices increased and the market crashed

1980 – Hunt silver crisis – two brothers controlled 1/3rd of the world silver supply on margin

1981 – 18% interest rates and 12% inflation

1987 – Financial Panic

1990 – Gulf Crisis

1998 – Asian financial crisis, Russian ruble crisis and Long Term Capital crisis

2000 – Y2K and the computer crisis

2001 – The twin tower crisis

2001 – the technology bubble

2003 – The Iraq war

2008 – the global financial crisis

XXX – the next global crisis de jour

Do, you get the picture?  We will continue to experience crisis and we will always recover.  Yes, I’m an optomist, it’s the only reality.

             2 – Investing doesn’t end when retirement begins.

Since I plan for 30 year retirements for my clients, we need an investment strategy that will continue to provide income for a long time.  This means a growth investment strategy needs to be part of the plan.  Growth means investing in equities and understanding market cycles.

           3     – The real risk we face is loss of purchasing power. 

The real risk we face is in 20 years when groceries, utilities and entertainment will be 2-3 times what they cost now, will our investments earn us enough to maintain our standard of living?  With long term inflation at 3% and most predicting we’ll have higher inflation in future, we need investments that increase, based on long term averages, by the rate of inflation or more.  With most types of fixed income investment (bonds and GIC’s for example) future rates of returns are 3-4% – barely enough to cover expected inflation and taxes.   The long term return of equities has been greater than cash and bonds and inflation through out all the above crisis.

           4 – The value of the underlying business and the day to day price of its stock are two separate things.

When the market price of bank stocks fell almost 50% in 2008, does anyone believe their true value declined by 50%?  If you define their value as the future return of dividends and growth – they became an unbelievable bargain!  In fact, dividend paying bank stocks pay quarterly dividends of a specific amount of $/share – not based on their market value.  The dividends they paid continued throughout that period in the same dollar amounts, despite the market price decline.

Understanding this one point, may make all the difference in how you view your portfolio.

            5 – Any investment made that promises maintaining the market value of a portfolio will come at the risk of the long term rate of return.

There are many investment products and strategies available today that claim they will protect principle and even market gains.  They all come at a price of long term return.  Those that claim there is no additional cost and avoid market declines – have not been proven in the long term.  The following are a few of the strategies currently being used for minimizing volatility and their pro’s and cons:

Principle protected or linked notes – these products will track certain investments or indexes and provide the minimum return of your capital by giving up some of the gain.  If you are really nervous, they provide some exposure to equity markets without the volatility below your net invested.  However, you have to lock in for a specified term and because of how some are structured, you may only get your money back even though the underlying investment recovered during your term.  Since they include all manner of special clauses, they need to be clearly understood and are complicated

Guaranteed minimum withdrawal investments – Offered by insurance companies, they provide a minimum return of about 5%, regardless what the markets do while you hold them.  The costs associated with the products eat into the positive return and they come with many restrictions on withdrawals.  The details of these investments regarding withdrawals are complex and difficult to understand.

Market timing – It keeps coming up as a way to protect the “market price or gains of a portfolio.” One of the current versions of this investment strategy is to use exchange traded funds and move in and out of equities quickly based on the market outlook.  These programs are offered by very qualified and experienced managers – but they just haven’t worked over the long term.  Trying to sell high and buy low requires two mostly right decisions – when to sell and when to buy.   The risk of not getting both decisions right will be lower returns.  Although programs continue to be offered that prove success when “backed tested”, no program has stood the test of time and has outperformed just staying invested.  The current returns (to June 2010) over 20 years for staying invested in the Canadian equity market as represented by the S&P TSX index is 8.4% (from Morningstar charts) and this is measured below the peak returns of 2008.  Many investment managers have done better over that period and all experienced similar volatility to the TSX.  There is no proven market timing program that has consistently been offered during this period.

Gold and gold stocks – with the short term uncertainty of global currency, gold has risen in value.  Its value over the last decade or so is uncorrelated to stocks.  If you look at gold over 20 + years or more, its value fluctuates widely and, other than the last few years, has tracked inflation.  Gold pays no dividends and its value is dependent on market sentiment.  Most investment managers have purchased some gold for diversification and as insurance but they also plan to sell that gold quickly when appropriate.  So gold is in most portfolio’s in small quantities – taking a big bet on gold is assuming the world will implode. (See point 1)

               6 – The price of any return above inflation is volatility.  The higher the desired return, the higher the volatility.

One of the best performing market segments over 20 years is Emerging markets.  This area also has one of the highest levels of volatility.  Ibbotson, a company producing allocation charts tracking markets over 75 plus years shows that higher exposure to stocks both increases returns and volatility.   In other words, the price of higher returns is higher volatility – first law of investing.

             7 – Diversification is king

Properly diversifying your investments with asset classes or income sources that are uncorrelated will help you ride through market cycles.  However, diversification does not eliminate volatility – just mitigates it.

             8 –  A proper and comprehensive financial plan is your guide.

We don’t invest for the sake of making money but to fund the lifestyle we want to lead and live with dignity and independence in retirement.  A comprehensive plan gives purpose to our portfolio.

             9 – You’ll need a trusted advisor because this isn’t easy.

So find a good one and listen to them.  Enough said.  

The fear of loss is more painful than the love of gain.  It takes a courageous individual to accept the reality of market cycles and remain invested.  Courage comes from knowledge and acceptance and maybe even having some support. 

To get back to the original question – The best strategy for maintaining the value (but not the price because that’s temporary) and make certain you won’t run out of money in retirement is this:

1 – Have a financial plan and update it regularly so you know how you are doing and where you need to be.

2 – Have a reasonable understanding (or appreciation) of markets, investments and previous crisis.  It’s only different for awhile, then it’s the same.

3 – Diversify investments and sources of income.

4 – Work with a trusted advisor.

    Richard WR Yasinski CFP