Rational Advisor

We are once again getting whacked across the side of the head, it seems like this market is trying to teach us lessons that they tried to teach before, but many ignored them.

Here are the main four lessons as I see them

1. Limit your investment to exciting but risky investments.

In recent years, investors have become infatuated with fringe sectors like emerging-market stocks, emerging-market debt, commodities, gold, oil, hedge-funds and junk bonds. There’s nothing wrong with having a small stake in any of these investments. But think long and hard before allocating more than 5% of your portfolio to any one of these sectors.

2. Your asset allocation mix should fit your risk tolerance.

Every investor should have exposure to the good Canadian equities with sound fundamentals, to high-quality bonds and to developed foreign stock markets. These three core holdings should probably account for 70% or 80% of your investment portfolio, and maybe more. How you divvy up your money among these three core holdings will depend on your tolerance for risk and your need for returns. That brings us to another lesson that gets driven home every time the market tumbles: There are, within reason, no bad investment mixes — just investors who can’t live with them. In settling on your target percentages, think about what mix you can live with when markets turn volatile. Don’t just look at the upside.

3. Being too confident and cocky hurts returns.

Investing is always an uncertain enterprise. Yet many investors are regularly able to shed all self-doubt and make the most outrageously bold investment bets - More Oil, since it’s going to $100, and Iran’s going to bomb the world! More Canadian resources, because China will increase their demand for Canadian resources forever! More Indian and Chinese exposure becasue these two coutnries are so fiscally prudent, and have the best accounting systems in the world!. In early 2000, investors bought tech and ended up as Wall and Bay Street road kill. A few years later, many people were absolutely certain that the stock market was a loser’s game. Then share prices came roaring back. By 2005, folks were adamant you couldn’t go wrong with real estate in the US and even today Real Estate in Canada is a no-lose proposition. Today, many condo flippers in the US are suffering the consequences and REITs have taken it on the chin. The markets are trying to tell us something here — and they aren’t telling us to chase performance. The message: Not only do we need to think about risk as well as reward, but also we shouldn’t be nearly so confident in our superhuman predictive powers.

4. Remember the fundamentals.

When investments are hot, it can seem like there’s no limit to the possible gains. Yet there are always limits, like I’ve said countless times, trees do not grow to the sky, economic fundamentals always win out in the end. The broad market’s share-price gains frequently outpace the economy’s growth rate over the short run. But unless investors are willing to pay higher and higher price/earnings multiples for stocks, that can’t go on forever. Home prices can climb faster than household incomes. But that isn’t sustainable over the long run.

Learn these Lessons well, because if you don’t you’ll be taught them again and again, and again.

Have good investments with sound fundamentals
Have a mix of equities and bonds based on your risks assessment on a worst case scenario
Don’t change that mix, rebalance back to it often
Stop being cocky just something did well.

Rational

Comments RSS