Trevor Abes: Writer

Tag: index funds

Young Canadian Investor #9 – Useful Investing Tidbits

1. Why own stocks? Because owning one is equivalent to buying into the productive power of that company’s employees to sell products/services and make money. The better they perform, the higher the stock’s price, the more wealthy you become, and the quicker you can do as you please with your time.

2. Bank or investment company representatives on financial television always come with an agenda, whether that’s talking up the strengths of an investment they already hold or plan to, or supporting federal or monetary policy they would end up benefiting from. The same goes for interviewees espousing the benefits of spending within your means and making regular contributions to a retirement portfolio of stocks and bonds. One avoids being whipsawed by conflicting advice by having a financial plan and sticking to it.

3. Anytime you hear anybody make a prediction about where the stock market will be in the future, you can be sure that they’re mistaken, or lucky if they turn out to be right, regardless of the credentials they hold. Consistently predicting the future isn’t within the purview of human intelligence.

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Technical analysis at work. Courtesy of wallstreetbets.

4. Unlike the USA, where buying stocks commission-free has been widely adopted, Canadians still pay anywhere between $5-$10 per buy or sell order. The best exception here is Questrade, where you can buy ETFs for free.

5. Much maligned for offering mostly super-expensive mutual funds, and fees for advice that only the gullible or misinformed should pay, Canada is slowly improving in terms of providing everyday people with access to fairly-priced investments and the information they need to understand them. Common Sense Investing and The Plain Bagel come to mind as two sources worth your eyeballs. If you’d rather read, MoneySense is a good place to start.

6. The worst thing you can do with your stocks is find yourself having to sell them when they’re down because you need the money. Another way to put this is that you should only invest money you don’t need to cover your expenses, including emergencies. That way, you’ll be able to hold on during good markets and bad and take advantage of compound interest.

7. Technical analysis, or investing based on the price movement of assets like stocks and commodities, is the financial equivalent of LARPing, or choosing to inhabit a world that runs by whatever principles you choose. Its basic premise, that you can predict buyers’ and sellers’ motives by studying price charts, refers directly back to numeral 3. 

8. If you’re interested in picking individual stocks as opposed to or in addition to owning index funds, you need to be willing to dig into companies’ financial statements. In Canada, you can find them on SEDAR, or the System for Electronic Document Analysis and Retrieval.

9. Canada’s economy is made up of roughly 35% Banks, 20% Oil and Gas, 10% Industrial Manufacturing, and 10% Basic Materials like lumber and metals. Technology is only around 4%, with Health Care bringing up the rear at 0.5%. In the USA, on the other hand, Technology represents about 20% of the economy, and Health Care is 15%, which demonstrates the benefits of diversifying your investments beyond your home country.

Disclaimer: This article is meant for general education purposes only. It does not constitute financial advice as I am unaware of your personal situation. Consult with a professional who abides by a fiduciary standard before making any investment decisions.

Young Canadian Investor #8 – The Downsides of Index Funds

Thanks to the efforts of the late, great, Jack Bogle, index funds have opened up the world of investing for everyday folks in a simple, cost-effective way.

Now, pretty much anyone can open a brokerage account, invest commission-free in a handful of index funds that own stocks all over the world, and thus piggy-back off humanity’s industrial might to improve their financial futures. 

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Tell em Queen.

That said, these funds are not panaceas. Even though they’re the best option around for %99 of people fortunate enough to have spare cash lying around to invest, they are not without their faults.

1. Most index funds that track the stock markets of entire countries are market-cap weighted, meaning that the more a company grows in value, the more of its stock the fund will have to hold. The problem here is that, since stock prices are not only based on company performance but also on investors’ expectations about how companies will perform, investors’ expectations can and do frequently lose sight of how well or poorly a company is doing. That means stocks are often cheaper or more expensive than company performance merits. But the market-cap weighted index is designed to ignore these discrepancies and simply buy or sell in line with investors’ expectations without stopping to question them. One workaround is to integrate valuation into your investing process by considering which countries are cheaper or more expensive than others at any given time.

2. Because indexing has become so popular over the last decade, the investment companies that offer these funds have become increasingly larger owners of the businesses held by the funds. Right now, Vanguard, BlackRock, and State Street (The Big Three) own a little over 20% of the S&P 500 (the 500 biggest companies in the USA). That’s an issue because shareholders get to vote at company meetings to choose boards of directors and have their say regarding future plans. If you invest in an S&P 500 index fund, it’s the fund provider and not yourself that gets to vote for the 500 companies. If three investment companies basically have the reins of the USA’s capitalist machine in their hands, that smells of antitrust, and government intervention can’t be too far off. The Big Three vote in line with company management, so there’s been no rocking of the boat, but the door is certainly open for them to. We’ll see how long that lasts.

3. Another flaw to be mindful of is that index funds concentrate investor behavior. If you’re a stock picker or active investor, you’re going to own a handful up to maybe a couple hundred stocks based on your analysis of what a business worth owning looks like. If you buy into broad indexes, on the other hand, you buy into entire stock markets, including the outstanding businesses, the mediocre, and the ugly. So if an index fund investor decides to buy or sell a portion of their globally diversified holdings, they are essentially buying or selling a tiny part of every stock in every major index in the world, whereas the stock picker would only be buying or selling the specific stocks they own. In times of market distress, such as the virus-induced stretch we’re currently living through, it’s easy to see that a wave of selling from index investors can have an outsized effect on the markets simply because they own all of them. The more people index, the more pronounced this effect will be, and the more important it becomes to brush up on your investing basics so you never let fear get the best of you, and you recognize that, when index fund prices drop, that means they’re on sale, so you should buy more shares if you can instead of running for the hills.

In spite of their flaws, index funds still guarantee you the returns of the markets they track minus very low fees. They’ll also beat the vast majority of stock pickers over the long term, so long as you maintain regular contributions, choose an appropriate time horizon and risk tolerance, and keep your emotions in check. There is no doubt that everyday investors like you and me would be way worse off without them.

Disclaimer: This article is meant for general education purposes only. It does not constitute financial advice as I am unaware of your personal situation. Consult with a professional who abides by a fiduciary standard before making any investment decisions.

 

Young Canadian Investor #7 — Some Context to Minimize Panic

Arguably, the hardest part of investing for the long term in individual stocks as well as broad stock index funds—this includes funds that track the Total US Market, Developed International Markets, Emerging Markets, or the Global Stock Market— is keeping your psychology in check during market extremes. 

When funds have been going up for a handful of years, most of us think the trend will continue and want to buy more shares. Even though we have to pay an increasingly high price to do so. 

When funds have been dropping for a long stretch, most of us figure it’ll get worse and feel we should sell. Even though prices haven gotten cheaper and thus more appealing.

Why do we act like this? Human nature.

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How do we fix it?

One. By setting a range for how high and low stock markets can go, as per the historical record, to get an idea of good lows to buy more of, and good highs to dollar-cost-average into until prices improve. Selling investments should be limited to the reason you invested in the first place. 

How much can markets rise before a recession knocks them down to fair value? Australia’s stock market went more than a quarter century without one.

How much can a country’s stock market drop, and how soon? Eighty percent is a reasonable worst-case scenario. This happened in the US over two years in the late 1920s and early 1930s with the market taking over 25 years to recover. It happened again, this time over a couple decades, during the double-digit inflation of the 1960s and 1970s. 

Historically speaking, though, any time a broad index is down double digits (over 10%) constitutes poor performance and thus a buying opportunity/sale/good deal. This with the knowledge that it could drop another 70% or more and get that much more affordable.

Two. By remembering that, excluding problems with the fund’s management or issuing company, a broad market index fund going to 0 would require the industrial complexes of the countries it tracks to go out of business too. And it’s next to impossible for that to happen, whether in Canada or Spain or South Africa. Barring an apocalypse or investment company bankruptcy, dips in your index funds’ prices per share will eventually recover. It may take many years, so it’s up to you to ensure an appropriate time horizon.

Three. By holding firm that, to benefit from investing in stocks over the long term, i.e. make money, you have to invest regularly and stay invested—continuously— in a globally diversified portfolio for a minimum of five years but ideally for a few decades or more.

That’s essentially how you watch your index funds drop in value without panic-selling to avoid the stress. Easier said than done? Perhaps. 

But when you compare how inflation currently cuts what you can buy with the money in your savings account by 2% per year, every year, with a globally diversified portfolio’s long-term expected return of 7% per year, giving into fear looks a lot like very slowly going broke.

You can learn more by reading my introduction to investing for young Canadians.

Disclaimer: This article is meant for general education purposes only. It does not constitute financial advice as I am unaware of your personal situation. Consult with a professional who abides by a fiduciary standard before making any investment decisions.

 

 

 

Getting Your Investing Mind Right

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Arguably, the hardest part of investing for the long term in broad stock index funds—this includes funds that track the total US Market, Developed International Markets, Emerging Markets, or the Global Stock Market— is keeping one’s psychology in check during market extremes. 

When funds have been going up for a handful of years, most of us think the trend will continue and want to buy more shares. Even though we have to pay an increasingly high price to do so. 

When funds have been dropping for a long stretch, most of us figure it’ll get worse and feel we should sell. Even though prices haven gotten cheaper and thus more appealing.

Why do we act like this? Human nature.

How do we fix it?

One. By setting a range for how high and low stock markets can go, as per the historical record, to get an idea of good lows to buy more of, and good highs to dollar-cost-average into until prices improve. Selling investments should be limited to the reasons you invested in the first place. 

How much can markets rise before a recession knocks them down to fair value? Australia’s stock market has gone more than a quarter century without one.

How much can a country’s stock market drop, and how soon? Eighty percent is a reasonable worst case scenario. This happened in the US over two years in the late 1920s and early 1930s with the market taking over 25 years to recover. It happened again, this time over a couple decades, during the double-digit inflation of the 1960s and 1970s. 

Historically speaking, though, any time a broad index is down double digits (over 10%) constitutes poor performance and thus a buying opportunity/sale/good deal. This with the knowledge that it could drop another 70% or more and get that much sweeter.

Two. By remembering that, excluding problems with the fund’s management or issuing company, a broad market index fund going out of business would require the industrial complexes of the countries they track to go out of business too. And that’s next to impossible, whether in Canada or Spain or South Africa. Barring investment company bankruptcy, dips in your index funds’ prices per share will eventually recover. It may take many years, so it’s up to you to ensure an appropriate time horizon.

Three. By holding firm that, to benefit from index investing in stocks over the long-term, i.e. make money, you have to invest regularly and stay invested—continuously— in a diversified portfolio for ideally a decade or more.

That’s how you watch your index funds drop in value without panic-selling to avoid the stress. Easier said than done? Absolutely. 

But when you compare how inflation currently cuts what you can buy with the money in your savings account by 2% per year, every year, with a diversified portfolio’s long-term expected return of 7% per year, giving into fear looks a lot like very slowly going broke.

You can learn more by reading my introduction to investing for young Canadians.

Disclaimer: This article is meant for general education purposes only. It does not constitute financial advice as I am unaware of your personal situation. Consult a professional who abides by a fiduciary standard before making any investment decisions.

Image by The Langmaid Practice.

 

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