I’ve commented before about how dangerous it is to give investment advice to friends and family. I keep running into people who are very bright individuals in other areas of their life, but just throw up their hands in frustration and give up when it comes to managing their money. Never one to learn from my experiences, my goal is to put together a couple of posts, one on easy to understand and set up investment strategies and the other on investing strategies to avoid unless you REALLY know what you’re doing.
Short Investing Horizon
If you had a chunk of money sitting around that will be used for something within the next 5 years, your priority should be capital preservation (not losing it!). A post a while back on Canadian Money Forums asked about investing $15k for 2 or 3 years, and the consensus seemed to be that for this short a time frame GICs or high interest savings account are the best place to put it. I agree wholeheartedly.
If a person with a lump sum of money to invest for 2 or 3 years has any debt (even a mortgage), I think an even better use would be to pay down the debt. It should PROBABLY be possible to borrow it again (assuming a decent credit rating) if the money is needed after a couple of years, plus you’ll have avoided all the interest that you would have paid in that time period (which I can guarantee will be higher than the return on a GIC or savings account).
10 Year Investing Horizon
If you won’t need the money for at least 10 years (usually this is for retirement funds) things get interesting. Equities (stock) are more volatile (meaning they can move up and down unpredictably). Obviously people prefer a guaranteed return, not an uncertain one (and prefer to make money, not lose it), and therefore equities offer a greater LONG TERM *AVERAGE* return than GICs or a savings account. To capture this higher return you need to stay in the market for longer lengths of time, to catch the periods when the market does really well (to make up for the times it does very poorly). The longer you stay invested, the closer you should be able to get to the long term expected return (which should be around 7% by some measures).
Rather than picking specific companies, these strategies focus on asset allocation. Read over these short descriptions, pick the one that sounds most interesting. Spend an hour or two reading the links in its description and you should be good to go!
Couch Potato Portfolio
MoneySense magazine has what they call the couch potato portfolio (based on a US version by Scott Burns). The idea is an intensely simple portfolio that takes minimal time or thought to maintain (they estimate 15 minutes per year and no investing knowledge required). The core idea of this is a portfolio that has very broad diversification. It is broken into four components, and each year these are “re-balanced” so that they will be worth the same amount.
e.g. say you put $100 in A, B, C and D . At the end of the year A is worth $120, B and D are worth $110 and C is worth $80, you would buy and sell until you had $105 in each of the components and they’re “balanced” again.
There are SLIGHT differences in what you choose for your four components, but it’s not worth getting too hung up on. If you want to get started with retirement savings but keep putting off “figuring out investing” and never get around to it, picking a couch potato portfolio and getting started would probably be very worthwhile.
In addition to the information at the MoneySense site, the Canadian Capitalist has summarized the portfolios.
Sleepy Portfolio
The Canadian Capitalist took his inspiration from other lazy portfolios and created the sleepy portfolio (a “fire and forget” portfolio for large sums of money, if you get a surprise inheritance this might be a reasonable place to dump it) and the sleepy mini portfolio (for small sums of money on an ongoing basis).
The sleepy portfolio is targeted for young, aggressive investors (so if you only have 10 years until retirement it might not be the allocation for you).
Others
Larry MacDonald proposed the One Minute RRSP Portfolio for those who want the barest of bare bone portfolios (it consists of 2 ETFs with an optional third cash component). Scott Burns, Ted Aronson and the Coffeehouse Portfolio each have their own version of a “lazy” portfolio that’s worth looking at if you have the time and inclination.
If you prefer to get your investing advice from a book and not from yahoos on the internet (why are you reading this blog then? 
) Unconventional Success by David Swensen, The Smartest Investment Book You’ll Ever Read by Daniel Solin (allocation overview here) and The Four Pillars of Investing: Lessons for Building a Winning Portfolio by William J. Bernstein each contain easy to assemble / maintain portfolios as well as the rationale behind their construction.
How to do it
Once you’ve picked one of the above strategies and read about it, summaries of the the actual asset allocations can be found here (for all except Solin’s and MacDonald’s). Sign up for a discount brokerage account (I like iTRADE / E*TRADE, Mike uses Questrade) and buy the ETFs that make up them up. Wait a year and rebalance. Repeat.
If you’re working with a small amount of money (maybe under $25k), follow Canadian Capitalist’s sleepy mini portfolio (or save in a high interest savings account / GIC) until you’ve got $25K, then move to one of the others.
Keep learning. If you develop a deeper understanding of investing and want to follow a more complicated approach (and manage to convince yourself that it will provide higher returns than passive investing in one of these flavours), then switch.
{ 4 trackbacks }
{ 10 comments… read them below or add one }
You start out by pointing out (correctly) that even most smart people today cannot figure out how to invest effectively.
Then you advocate the conventional investing advice (Passive Investing)!
Can we please consider the possibility that the reason why most smart people cannot figure out how to invest effectively is that they are working under the presumption that there must be something to the conventional advice (Passive Investing) when in reality it is pure nonsense that makes it impossible to make sense of any investing topic?
I’ll give one example of the problem. You say that stocks have a better chance of doing well if you hold them for the long-term. This is true at some valuation levels. Precisely the opposite is true at other valuation levels. At the prices at which stocks were selling from 1996 thrtough 2008 they were virtually certain to do poorly compared to far safer asset classes (like money markets) in the long term. Yet you are making it sound as if buying overpriced stocks eventually pays off if only the investor is willing never to correct the mistake.
It doesn’t work that way. Stocks are a good choice when they are priced to provide good long-term returns. Stocks are a bad choice when they are priced to provide poor long-term returns. To know which reality applies at any given time, you need to be willing to look at valuations in setting your stock allocation (that is, to invest non-Passively).
If you get the ABCs wrong, you get it all wrong. Our problem is that we have bought into the marketing slogans of The Stock-Selling Industry (which naturally prefers that we always buy stocks regardless of how overpriced they are) and have thereby lost the ability to make sense of this important subject. I believe that we need to revisit the basics and this time to make an effort to tune out the marketing slogans and focus instead on what the historical record teaches us about how stock investing works in the real world.
Rob
Thanks, excellent article – especially the advice to re-balance, which is key, and basically ensures that you buy low and sell high.
Thanks for the mentions.
I want to address Rob’s comment that passive investing is conventional advice. It certainly is not. Only a minority of investors hold fully passive portfolios. Most retail investors are in actively managed funds or actively manage a stock portfolio.
Also I disagree that equity valuations between 1996 to 2008 were clearly high. Equities seemed clearly overvalued only in the late nineties (compared to bonds). Back in 2007, stocks seemed fully valued based on earnings at that point. Of course, earnings plummeted but good luck forecasting future earnings. In any case, passive portfolios that are diligently rebalanced should perform reasonably well in flat, volatile markets.
Only a minority of investors hold fully passive portfolios.
I agree that most do not hold fully passive portfolios, Canadian Capitalist. But there are many millions who have bought into the idea that it is not necessary to change one’s stock allocation in response to valuation changes. It’s that idea that has caused all our troubles. And that’s the essence of Passive Investing (the thing that Passives are passive about is their stock allocation).
Rob
It’s good to learn that “all of our troubles” were caused by the failure “to change one’s stock allocation in response to valuation changes.”
Up until Mr. Bennett shared this wisdom with us I was under the illusion that the housing bubble, commodities bubble, liquidity issues, predatory lending, overleveraging, subprime mortgages, CDO’s, CDS’, credit rating agencies shenanigans–along with a host of other factors–contributed to the financial crisis. It’s good to have all the root causes distilled down to one simple factor that just coincidentally happens to support Mr. Bennett’s crusade against buy-hold-rebalance (passive investing) strategies.
It’s good to have all the root causes distilled down to one simple factor that just coincidentally happens to support Mr. Bennett’s crusade against buy-hold-rebalance (passive investing) strategies.
The causation works the other way around, Carlyle. It was learning how much damage Passive Investing has done to million of middle-class investors (and ultimately to our economic system and in recent months even to our political system) that caused me to embark on a “crusade” to rein in the power of The Stock-Selling Industry to continue to promote the Passive model 28 years after the academic research showing that valuations affect long-term returns was published.
Have you ever checked the numbers to see just how much financial ruin has been caused by promotion of this reckless “strategy”?
In January 2000, the U.S. stock market was overvalued to the tune of $12 trillion. What do you think it does to an economy to have $12 trillion of funny money floating through it?You point to things like housing bubbles and credit rating agency “shenanigans” to explain our economic crisis. Do you ever wonder whether the $12 trillion in funny money caused by the promotion of Passive Investing had any influence in causing the housing bubble or the credit rating agency shenanigans?
If you check the historical record, you will see that we have tried Passive Investing four times in U.S. history and that we have experienced an economic crisis as a result each and every time. I am beginning to detect a pattern.
Generate trillions in funny money and you are going to destroy the strongest economy on the face of Planet Earth. It happens every time. During the times when the “experts” are willing to talk straight with people about how stock investing works in the real world, all of the sorts of problems that you point to never seem to turn up. I wonder why.
Rob
The historical record shows the futility of any attempt to engage in a reasoned discussion with a persistent internet troll. Good day, Mr. Bennett.
Actually for the last 10 years, GIC’s and bonds did better than stocks on “average”. How much more “long term” can you get?
Cory: You may find this post (http://www.four-pillars.ca/2009/08/18/you-can-argue-with-results/) interesting.
A good article, though I’m not big on the portfolios that diminish Canadian equities in favour of US and EAFE equities.
My reasoning is simple: when using rebalancing as a part of one’s strategy, it is key that the different allocation groups are not typically in sync with one another. Canada’s market is generally in sync with the US and Europe, so all that these portfolios offer in my opinion is risk in terms of currency volatility. The US and Europe don’t offer significanlty better returns over the long term either
EAFE of course also includes Japan and Australia who are not typically in sync with us, but that’s about it. Japan has issues in itself. Australia though I think is the best foreign developed market for Canadians, I believe, as the AUD and CAD generally move in step with one another while the market performance varies. Of course, that’s because our two economies are very similar so Aus may offer little more than being an expanded Canadian market. Plus, there are no Aus specific ETFs available in Canada I believe.