Saturday, July 25, 2015

The roads to riches are numerous but they start with you!

So you want to get rich. Well you could win the lotto but what are the odds? Even if you could figure out ways to reduce said odds, you probably still are looking at astronomical odds. Well astronomical? There are more stars in the universe (or is it universes) than there are people on earth. So considering the small number of people that regularly play lotto the odds are maybe not as bad as astronomical J 

Learning from other successful investors should improve your odds compared to the odds of winning it big in the lottery.  Most often you need to save in order to have investment capital; that is why living below your means is so important to reduce the odds for getting rich. However, there are other ways of becoming rich without having lots of savings. Like buying real estate with nothing down! But that requires a lot of sweat capital and door ringing to get access to other people’s money. Many people get rich by starting their own business and working at it for years, provided they don’t go broke within the first five years. You can also get rich by saving a significant portion of your employment salary, especially when you’re apt at finding employment in successful businesses where you earn a small stake of the company(e.g. company savings plans). You can get rich through angel investing, investing in art or collectibles or by investing in gold or in your brother-in-law’s business or through joint-ventures. The roads to richness are numerous. You can even get rich by investing your savings in paper securities like stocks and bonds but that also takes a lot of thinking and sweating on your side. The odds of becoming rich through investing in paper securities are O.K. (much better than that of winning the lottery), provided you don’t drown in the morass of guru noise.
Greece, China are examples of noise lately. Also, BNN is noisy with every day at least 2 investment gurus telling often opposing views about how to invest your money over the long term or just about what to do right now. Oh and then there are numerous blogs and advisories (like this one) that tell you what to do. Reality is that the buck stops with you and that even when you do the right thing, whatever that may be, you won’t become rich overnight and you’ll quickly find out that the world of investing is akin climbing a slippery slope with three steps forward and two or sometimes four steps back.
I would say that living below your means, saving and tenacity are key ingredients for many successful investors. It is important to understand the value of money (i.e. what can it do for you and even more so, what money cannot do for you).  When reading about investment advice, realize that it depends on the point of view of the adviser which is not necessarily yours. People seem to think that I am smart, why else read my blog? But really, I must be very dumb because it has taken me close to a live time to learn about investment strategies and about applying them. To be even more honest, I must be incredible stupid, because I still haven’t figured out what the holy grail of investing is, let be that I found it! 
I guess, that each of us has to figure out what works for us. By reading a lot about investment you may recognize a strategy that fits your bill. Are you a value investor or are you technical (I call that trend follower) are you a momentum investor?  Are you a trader, a speculator or a Warren Buffett kind of guy?  Are you a couch potato investor?  Are you a real estate guy or a stock market type (these styles often seem to be mutual exclusive – I must be the exception)? So, your investment style begins with you; you have to first of all know about yourself. What you invest in may be based on what you like to do as a hobby – play with your computer, socialize, visit factories, visit art galleries or being a handy-man. Next you study the various investment strategies and select one that fits best with you. Then stick to that strategy for a number of years ( 5 years minimum). Some people think in decades others in months. Also, your circumstances in life change and with that don’t be afraid to change your strategies. There is, as always, a balance between short term and long term thinking and that balance is another thing that is very dependent on your own point of view. But once you know all those things about yourself, then you can figure out a plan to reach the goals that you want to achieve in your investment life.
Unfortunately, those goals are likely to change as well. So if this all is a bit confusing, too bad…. That is life. If it wasn’t wouldn’t life be awfully boring?

Sunday, July 5, 2015

Diversification and Portfolio Performance – The Cash Effect

In bear markets, you may feel quite the investor if you own enough cash and are in a position to buy shares of quality companies at dirt cheap prices.  But, your overall portfolio performance may still be only mediocre because you may have been anticipating this bear market for the last 6 years.  In fact, many retail investors have never returned to the stock market since 2008. Others may have held 30 or 40% cash and whatever the profits of a rare stock investment may have been, those investors probably never owned enough stock for these profits to have made a significant impact on the overall portfolio performance.

For the last two years, I have been advocating to hold up to 20% cash in your portfolio, in addition to real estate, gold, stocks and a bit in short term fixed income instruments. But there is a cost associated with so much cash and yes we’re now nearly 7 years in this bull market, but if you look at investor sentiment; investment gurus or just at this year’s tepid market performance you could conclude that a real market peak and subsequent crash is not in the cards for at least another year or two. Hmmm, that makes holding cash very expensive!
I rolled out the unavoidable spreadsheet software (i.e. Excel). A few posts ago we calculated what kind of returns you may consider realistic in a reasonably well diversified portfolio during the last five years. Now, I updated this spreadsheet to vary the cash levels in 5% increments in order to learn how cash affects overall portfolio performance.  Below are a table and a graph that shows the results.

In the first column of the table, the cash level is enumerated from 5 to 45%.  Real estate and gold are kept constant at 50% and 3% respectively thus totaling 53%.  The remainder of the portfolio is held in stocks and fixed income (bonds). But rather than using the customary 60/40 ratio, I prefer for today’s markets 82% stocks and 18% fixed income (mostly in the form of short term corporate debt and one year GICs).  With the cash level going up, the money available for stocks and bonds goes of course down while the stock/bond ratio remains constant.
Annual average return on stocks is set at 7%; cash is returning zilch; fix income returns a measly 1%; return on gold is 3% and on real estate return is 8% (somewhat like in the recent posting on diversification). You can see that with cash increasing your return on the total portfolio drops dramatically. With 5% cash the annual return is 6.2% but with 20% cash it is barely 5.3% - still better than a GIC or 5 year government bond though. If you stayed nearly entirely out of stocks then with 45% cash your return is only 3.8%. Below, the same story is shown graphically – there is a straight-line relation between your cash level and return.


Considering my personal investment goals combined with the current market conditions, I return to 10% cash.  Although a 5.9%  return is not stellar, it should still represent some portfolio growth. Maybe I’ll enhance that performance with some call and put option writing but that is an whole other topic all together.

Friday, July 3, 2015

In the middle of a Doldrums Correction this bull market has probably much longer to run

These are not easy days for Canadian investors.  The resource heavy TSX is affected by a commodity bear market with no clear end in sight. At $65 oil it appears that the rig count in North America nudged up. Also possibly due the end of ‘break up’ in Canada and the onset of good summer weather in the U.S. What will really end this commodity bear market?  Saudi Arabia cutting back its record production?  I don’t think so. 

The real culprit is lack of commodity demand because world economic growth is still too tepid. As pointed out in earlier posts, emerging markets, including China, are still dependent on foreign investment money and increased demand for their export products. That in turn depends on money from the developed world. Who else would buy from these emerging economies?  The good news is that the U.S. has clearly picked up in economic activity and the EU thanks to its own ‘quantitative easing program, and in spite of the Greek tragicomedy, is finally showing signs of life. Then, also Japan’s stock market recently reached an 18 year high – still not an all-time high - in response to Abenomics, yet another form of quantitative easing.

So, for now, Canada remains on the edge of recession and with its banks targeted by U.S. short sellers, the stock market performance is lackluster at best. Real Estate across Canada ranges from lackluster to near bubble territory so there is limited potential for investment as well. The federal government is trying to balance its budget as promised to the electorate and thus not stimulating the economy.  NDP dominance is not exactly inspiring an enthusiastic business climate in Alberta – Canada’s most recent economic growth engine. Investing in fixed income is like playing with fire at minimal yields or better, after inflation and taxes at negative yield! 
No wonder our investments seem to be going nowhere, especially now that U.S. earnings and exports are affected by the strong U.S. dollar which also depresses commodity pricing in particular for the debt-heavy U.S. petroleum industry. Now, the Dow and the S&P are also in the doldrums.  So even if you are heavily invested in the U.S. your investment returns are not great.

Don’t be depressed – instead collect your dividends and build cash! Because after the summer doldrums, there is opportunity for a renewed pick-up of the pace. By that time, the Greek noise level will have fallen; people are back fresh and re-energized from the summer holidays and Janet Yellen probably has retraced from the intent to raise interest rates. So yes, there is room for a year-end rally in the U.S. and a recovery in Canada’s financial sector (banks in particular). Many experts say that we haven’t experienced a significant correction since 2012.  I am not sure, but my guess is that we are in one right now – a rolling correction because this market certainly shows not much spirit on either the downside or the upside.
I think that the current market malaise is as much of a correction as we will see this year. So this is probably a buying opportunity. With a lot of investors being so pessimistic, I expect a major rally and certainly not an 2008 style market crash. Once you have your 20% cash position, use this summer to buy cheaply priced stock market opportunities especially when they pay decent dividends.  Canada’s banks, Brookfield, Proctor and Gamble; Microsoft, Apple, Cisco, Qualcom. There is lots of value out there. And with us being in the middle of this doldrums correction I start to suspect that this bull market has much longer to run.