The richest life

Not too long ago, I wrote about the way I believe we get it wrong when it comes to financial advice. If you didn’t read that post, you can find it here.

Then, in last month’s issue, the Canadian version of More magazine included advice from some female financial experts — something along the lines of ‘what can we learn from the pros.’ It was a good example of this misapprehension that the pros know what it takes to build wealth, and it was interesting to learn that these ‘financial heavyweights’ made some of the most common mistakes — getting over their heads in debt and acting on inappropriate advice.

But if you need yet further evidence, here is an article from today’s Globe and Mail that I think speaks for itself.

These are turbulent times in financial markets. So now, more than ever, we should be putting our faith in analyst recommendations instead of trying to pick stocks ourselves, right?After all, analysts are paid generously to spend all day scanning company financial statements, so of course they’re in a better position to know which stocks will rise and which will sink.

Continued from Day 15, below …
The Varieties of Risk

Many people have contacted me over the last three years to say that they’ve sold their equity investments wholesale, and have moved back into the safety of GICs. For some people, that is the very best option, but it is not as no-risk as we’d like to think. As you build wealth and move into retirement, you’ll face different kinds of risk, and a GIC portfolio only helps you avoid a few of them. We are here to help you minimise all risk by achieving an appropriate balance, depending on where you are in your life cycle. For the vast majority of us, the lowest-risk portfolio is not a “guaranteed” portfolio, but a diversified portfolio.

A diversified portfolio is one that shields us from all of the varieties of risk – let’s begin by reviewing them.

The risk we focused on during the late nineties was “opportunity risk” – the risk of not participating in the world’s largest, longest bull market, and losing out on the money to be made there. That risk, or fear, compelled us to buy at unreasonable prices, to invest more than we could afford, and to ignore another type of risk – market risk.

Today, we are all very familiar with market risk, or the idea that stock markets can decline and behave far differently than their long term averages would have us believe.

We know that North American markets – which represent our opportunity to participate in the profits of Canadian and US business growth – behave unpredictably. This is particularly true between market sectors, or industries, and even more so with individual companies. There are two primary antidotes to market and sector risk, time and diversification, and we’ll cover them both in detail later.

Another risk we came face-to-face with during the bear market is behavioural risk. Yes, as Pogo mused, “I have met the enemy and he is me.”

When we first bought those mutual funds or stocks, we probably completed a 4-page questionnaire designed to identify our “risk tolerance level.” On a Know-Your-Client form, we were asked to state our “sophistication level.” The implication was that the more sophisticated we were, the more risk we were able to withstand. We were shown colourful charts demonstrating that the ability to take on that risk would result in much higher long term returns. (And if that were not appealing enough, who could resist being seen as “sophisticated”?)

Somewhere in the small print, or in a throw-away comment, was something about the possibility of our investments declining, but then there was that chart, with its relentless upward march prevailing over meaningless short term volatility. Only an unsophisticated rube would let a little short term volatility keep them from the promised riches, right?

I know. I was there. I was one of the many advisors whose careers had begun after the long bear market of the 70’s – one of the many advisors educated by the financial industry to help people increase their risk tolerance, make more money, and enrich the financial industry (and me) while doing so. But during the process, I began to learn from experience, and from the behaviour of my clients.

For example, I learned that investors will not behave in the manner prescribed by charts and texts. Investors generally act in accordance with human nature. We do not know how to experience 10 and 20 year investment cycles – we feel, and react, in the present. We do not focus on our overall portfolio return – we cannot take our attention away from those specific components of our portfolio that are losing money. We know that buying an investment when it’s “hot” is unwise, but we can’t help jumping on the bandwagon any more than we can help cheering for the home team when they’re winning.

From a logical, rational perspective, we may understand the charts and statistics very well, but when our investments are declining in value, that understanding pales beside the intensity of our fear and anxiety. And to end the fear and anxiety, we react.

Marketing gurus know it best – we make decisions from our heart and stomach, and then justify those decisions with our head. The same is true of investing, and the result is that most investors make less money in the stock market than they would in a high yield savings account. We consistently buy high and sell low.

If we choose to avoid market risk and behavioural risk entirely, however, we run into other risks, other threats to our well-being.

To be continued…

“Money is a very excellent servant, but a terrible master.” - P.T. Barnum

(Continued from Day 14)

The aftermath has been painful. As a financial author and commentator, I hear almost daily from frustrated, disheartened Canadians. We want to be responsible, to live comfortably within our means, and to prepare for our retirements, but we are discouraged about our ability to do so.

This guide was designed to as an antidote for that discouragement, providing a series of easy-to-apply strategies to help you avoid risk (also known as losing your hard-earned money) and create wealth, without losing sleep in the process. And although it is really tempting to use big words and throw in every piece of information that has ever been written about the financial markets, we’ve made a real effort to keep it simple and relevant to the needs of individual Canadian investors. If it isn’t here, it’s because you can build wealth and generate income without it. If you want to learn more, either because you’re actually interested or because you want to impress other guests at cocktail parties, you’ll find a list of further recommended reading in the appendices.

We begin with strategies for building wealth, and then move on to strategies for creating income with that wealth. Through the liberal use of quotes throughout the book, we’ve let the experts speak for themselves. The tone throughout is conversational, because we believe that if you wanted a textbook, you’d read a textbook – and wherever we use a word that a beginning investor may not be familiar with, we’ve tried to provide a definition.

“When facing a difficult task, act as though it is impossible to fail. If you’re going after Moby Dick, take along the tartar sauce.” H. Jackson Brown, Jr. Life’s Little Instruction Book

Many people ask me what they should read in order to increase their financial IQ. It’s an excellent question, and there are some great and many not-so-great books out there.

But I think it can be simpler. Rob Carrick’s personal finance column in the Globe and Mail is usually objective, information, accessible and in tune with what we’re thinking about.

Moneysense magazine (noted in an earlier post for its Couch Potato Portfolio) section is by the the best source of personal finance and investment information for Canadians — if you don’t want to commit to a subscription, you can often find a copy in your local library.

In terms of investment websites, there is nothing better for investors than Shakespeare’s Investment Primer.

The publisher Keith Betty describes the site as a primer for do-it-yourself investors, but I’d argue that this is the kind of basic knowledge that investors should also have at their disposal when considering recommendations from a financial adviser.

“When I step out of my office at the end of the day, I’ve completed a leg in a very important race in my life. But when I step over the threshold of my home, I’ve begun a leg of a far longer and much more important race.”

Whether you want to manage your own investment portfolio, or simply have more informed and knowledgeable conversations with your adviser, it is really very easy to find out as much you need to know. (’Knowing’ isn’t the only component of successful investing, but we’ll get to that later this week.)

In the meantime — if you’re ready — here are the ONLY links you’ll need:

To buy stocks and index funds (if you don’t know what an index fund is, you can find out on the site) and learn how to evaluate stocks, visit Canadian Shareowner.

To learn how to create a solid, long-term, diversified, low-cost portfolio in only 20 minutes per year, learn about the Couch Potato Portfolio at Moneysense.

Can it be this simple? Absolutely.

You may be beginning to notice those posts are rather random. My intent is to give you something to think about each day, a thought that will — in application — increase the quality of your life through greater financial wellbeing.

Today I’d like to pontificate on the subject of investment, and though I’m hoping I can do that succinctly, I have a bad feeling this may take a while.

Twenty years ago, I believed — as you probably do today — that brokers, financial advisors and planners were professionals whose job it was to identify profitable investments. Then I spent 20 years working with the same — oh, wait, I was one — and found that it is truly impossible to identify those investments that will perform better than average in advance. That may sound like sour grapes, and perhaps it is, but the aha moment for me didn’t have anything to do with my own clients. (Perhaps the good news is that even vaguely competent advisors can generally, if they choose, keep their clients out of the worst investments.)

On the fateful day, I was doing some reorganization of my senior partner’s client files. With more than 25 years of experience, this fellow was very intelligent and informed and cared deeply about his clients. He spent hours each week using the latest analytical tools to identify the best-performing mutual funds, and then recommended them to his substantial client base. Going through those files, I realized I could tell what year each client had joined his practice by the mix of investments within their portfolio. I also realized, more upsettingly, that almost none of those investments had performed as well the year after they invested as they had the year before.

In the years since, I’ve become very clear on the fact that the investments that performed well last year are likely to be this year’s dogs, and that most advisors do not have the sales magnetism to persuade new clients to invest in last year’s underperformers.

The sales process is, in other words, at odds with the very foundation of investment success.

As disturbing as that is, there is some excellent (not just good) news in all of this: the value of financial planners, advisors and stock brokers is not in their ability to choose next year’s best-performing investments. What is their primary value? Well, for that, my friends, you’ll have to come back another day.  

In 20 years of studying the financial markets and personal financial planning, the advice that I find myself thinking about is simply that: Think.

I can’t remember where I read it, but it referenced the subject of spending less and saving more, and it was simple enough to be frustrating to today’s wisdom seekers. Think before you buy.

Wherever we land on the income/net worth scale, it is likely we can acheive greater satisfaction and a richer life by thinking before we buy. In my workshops for people wishing to heal their income/expense ratio, I recommend finding six things in your home that you regret buying. (Start with your clothes closets.) Write them down, along with their approximate price, on the back of a business card. Use an elastic to attach that card to your credit card, or just place it in a prominate place in your wallet.

For purchases over a certain amount (for me, it’s $20, but for some of my clients its been as high as $200) give yourself a 24 hour cooling off period. You’ll be amazed how the infatuation wears off in as little as a day.

Remember, restricting your purchases to items you love and that will serve you well for years to come is good for your financial wellbeing, it’s good for the planet, and it leaves space in your life for the beautiful and useful. Storage and organization aren’t the problem, folks — it’s the mountains of stuff we’ve accumulated.

The New York Times

We’re having difficulty accessing uploaded files, so if you’re trying to access the PDF exercise ‘Navigating the Human Heart’ you’ll receive an error message. I’m working with my service provider to overcome the technical gremlins, but in the meantime, please feel free to send me an e-mail at admin@richestlife.org and I’d be happy to e-mail you the PDF.