A Few Points to Help Make you a Better Investor
For those of you who have read my blog articles from the beginning, you understand that there is no product selling on this site, only articles written to help make you a better investor. Today is going to be a bit of free-association, as you will, basically me writing thoughts that will hopefully help you on your investment journey.
What’s Really Important?
At the end of the day, it really isn’t about the fees you pay, or one single specific investment, a magic bullet that makes you rich. I don’t really even think that most investors really have the desire to get filthy rich from investing. I truly believe that investors want to use their money, to help them live a really great life, one which is rich with freedom and experiences. They want to help those close to them, such as family, as well as support causes they are passionate about. And they really want to accomplish this with as little stress and confusion as possible. This means taking away all the complexity and making things simple.
Level 1 vs Level 2 Thinking When Investing
Many investors see various investment products as entities, unto themselves, or parts that are independent from one another. Take stocks for instance. Many times an investor will look with favour upon the stocks that have performed well recently, and look to sell those which may be lower in value than when they originally purchased them. That is an example of what we would term level 1 thinking. In order to become an uncommonly successful investor, one needs to have the discipline to realize that the market does not care what price they purchased the security at, this individual viewpoint is essentially meaningless. Level 2 thinking would completely remove personal performance of each individual security from the equation, instead analyzing each security on it’s investment merits today. The Level 2 way might call for selling a stock that has risen, and purchasing a stock that is down, because the one that is down has more merit to the portfolio as a whole.
Individual vs Institutional Investors
Study after study shows that individual investor returns lag institutions, such as super-endowments, by an extremely wide margin. I am convinced that the main reason behind this is the way portfolio construction is approached. Individual investors tend to get caught up in peripheral items like yield without context, past performance as an absolute number without context, fees without context, and other level 1 criteria. On the other hand, institutional investors will study criteria such as how much value is added vs risk taken (the Sharpe Ratio), correlation of asset classes, and volatility. The analytical, unemotional approach, and not the reactive approach, ensures for a much stronger portfolio and a smoother ride. One of the unfortunate things is that investors are being sold products that the salesperson claims are similar to “pension-style” investments when in reality they are much different. Many individual investors have not even begun to compare public vs private securities, alternative investments, and hedge fund attributes. These are all actively being deployed by the most successful institutional investors, on the other hand, which can also account for performance differences.
Who Exactly are you Comparing to?
The financial industry has the average investor caught up in performance relative to benchmarks. They also have us stuck in the mentality of a traditional “balanced” approach, almost cookie-cutter, which is good for everyone. If we step back and think about it this is quite irrelevant and could be very detrimental to an individual’s financial well-being.
The very first question that needs to be answered is “Do I have enough to last my lifetime and keep me and my family living good?” This is different for everyone. Some can easily survive and be happy on 30K/yr, in today’s dollars, for the rest of their life. Some require 300K. We each make different incomes and have different time horizons. If one person, today, has more than enough to be content and happy, and keep pace with inflation for the rest of his life, with 100% guaranteed investments, why on earth would they want to take on the risk that could ruin this situation? With amounts that are more than enough maybe. Others require more growth, to make up for income deficiencies down the road, so a more balanced approach is introduced. Thus springs the mentality of looking at securities and financial products simply as tools to complete a job. Some investors need the equivalent of a house built. Others need a car. In order to accomplish each we cannot use the same tools. The closer we can come to viewing bank deposits, GICs, insurance products, stocks, bonds, hedge funds, private alternative products, commodities, etc without prejudice, the more likely we can access the proper tools to complete our individual job.
Concentration Can Kill
It is incredibly tempting, sometimes, to load up on an investment opportunity you find compelling. During my 22-yr career in financial services, I can state with confidence that concentration of assets into a single investment is the number one destroyer of wealth, by far. The following story will illustrate this as an unfortunate example:
In 2000-01, which was essentially the height of the technology bubble, I had a client who retired from Bell Canada (BCE). As a result of years of accumulation of Bell shares, this gentleman ran into quite a windfall, receiving 5000 shares of a company called Nortel Networks, which spun off from the parent company. Because the stock was on a tear, during our meetings, I could tell that this individual was in love with Nortel. We spoke one time, when the stock was trading around $100, and I made it clear to him how much he had in that single stock: $500,000 dollars! This was over half the family’s net worth, so as prudently as I could, I advised him to sell most of the stock. He looked at me as if I had three heads and just insulted his mother. Had I not read the various research reports with price targets of $200, even $400/share? Did I not know that the John Roth was Canadian Business’ CEO of the Year? It was like John Roth was the second coming, and my client had just won the lottery, and how dare I spoil the party! And on top of that, did I realize how much in capital gains tax he would have to pay. He left my office with no intention of selling for a long time. Well, we all know how this story ended, with NT topping out at $124.50, going back to $100, 70, 60, 45, right to 30, and eventually around a buck. In short order, my client lost half his net worth, and his tax problem was solved as well. Concentration can be quite evil. If you have a portfolio with too much of anything, no matter how great you think it is today, realize that anything can and just might happen. Check your greed and rebalance.
Just a bit of investment wisdom gained from a couple decades of experience. If you feel that others would benefit from this article, please share by clicking the social media buttons on your left. Happy investing!