Saturday, November 1, 2014

Recipe for Investment Success

Although the audience of this blog has been growing steadily, my latest post got very few views. I don’t know why… Maybe a lot of people have lost interest in the short term performance of the stock market; which is something to be cheered.

Really, good portfolio performance is a long term game. You buy excellent companies at a good price; collect the dividends year in, year out and one day you wake up and you realize your company’s shares have doubled or even tripled in value. Simultaneously, dividends have grown and dividend yield on your original purchase may be nearly 10 or 15%.
These are the ideal Warren Buffett investments.  Commodity investments are a different game, these are not long time holds; they are about riding the commodity cycles. You buy good quality companies such as Canadian Natural Resources or Suncor or Gold Corp near the bottom of the cycle – kind of like now when everybody shouts doom and gloom about the price of oil, copper or gold. Then you hold on for 3 to 5 years and you’d notice that suddenly everybody loves commodities again and they scream to buy those share off you for double or triple you purchase price or even higher. That is the time to sell. If the resource company you’d bought paid also a dividend (a dividend typically a lot less secure than that of non-resource companies) so much the better.
There is a lot of discussion about diversification, yet the richest people on earth became that way by investing in one or a few businesses – but these where often companies controlled or founded by those rich people, e.g. Bill Gates. For me, investing in public companies where you have no influence on the course of business whatsoever, requires standard portfolio diversification. Share-ownership of companies that are at arm’s length such as Microsoft or the Bank of Montreal should not constitute more than 5% of your stock and bond portfolio.  Shares of a public company that employs you and where you are better acquainted with middle and senior management you can own up to 20% of your stock and bond portfolio through employee stock options and/or your company savings plan.
If you see your stock holdings as long term investments with holding periods of 10 years or longer, the actual rate of annual return of individual companies is not that predictable; but you’re unlikely to lose money on such investments. Jeremy Siegel estimates an average annual return of 7% plus inflation is likely. What many stock investors describe as risk is in real live just market volatility –  buying stocks at market peak and selling at a loss in a panic at the first market correction or bear market is the standard retail investor behavior. Long term investors can mostly ignore this volatility except for making additional investment at market lows when shares are ‘on-sale’.
In terms of how much public debt such as government and corporate bonds one should own, the standard rule is 40% of your stock and bond portfolio. My personal preference, because I ignore short term volatility for which the 60/40 ratio is designed, is usually a lot less.  Right now I have less than 10% of my stock and bond portfolio invested in bonds and GICs and it is mostly in short term (1-3 year) debt. Only when interest rates exceed 5%, I may consider investing a larger percentage in debt as at those rates stock market performance often starts to deteriorate.
Of my total investment portfolio, I may hold 40 to 60% in a stock and bond portfolio and another 40 to 60% in a real estate portfolio controlled by me (i.e. not public companies that own real estate such as REITS, but rather rental and other properties administered by me or by a rental manager hired by me). The remainder of my portfolio is, ideally, in gold or silver (5 to 10%) and 5% in angel investments. To be honest, I have very little experience in angel investing at this point in time, and having 5% in angel investments such as those shown on Dragon’s Den is more of a wish than a reality for me at this point in time.
Especially, when you are approaching ‘retirement’ or better ‘financial adulthood’ your portfolio design should also consider cash flow generation capacity. This has been extensively discussed in earlier posts such as the ‘COI and ROI’ posts.

I did not yet discus investing in foreign stock markets and ETFs. This is an internal refinement of the stock and bond portion within your overall investment portfolio and this has also been discussed in earlier posts. To summarize, I think a significant portion of your stock and bond portfolio should be in market ETFs both representing Canadian stock markets such as XIU and XIC as well as international markets through Down Jones Spiders (DIA) and S&P 500 ETFs as well as in some West European and more specifically German ETFs. Your public debt and stock and bond portfolio could consist of around 40% Canadian, 40% U.S. and 20% European investments. I am not a fan of emerging markets.
An investment portfolio such as the one outlined above is going to provide you a lot of stability while maximizing your return. You probably will still see significant swings in your net worth, but a lot less than a portfolio of entirely North American stocks which lost nearly fifty percent in total value during the 2008 crisis. Remember, your return on investment is to a large proportion determined by buying investments at the right price (during market down turns), by investing for the long term, your asset allocation, and by controlling your cash flow.