Questions about investments? I’ve been asked a lot of really good ones lately so compiling a few seemed to make sense. Amazingly, I was able to answer most questions without directly saying “it depends”, because most times in personal finance, it really does.
First up:
Q: Our friends suggested buying dividend-paying stocks as a retirement income strategy. It has worked for them. Is it a good strategy?
A: Yes, BUT, it shouldn’t be your entire investment strategy. Blindly buying dividend stocks worked over the past decade, primarily because dividend paying stocks like banks, utilities, telco’s or Real-estate Investment Trusts (REITs), have increased in value as people have assigned a greater value to them. As the overall interest rate environment has declined, stocks which pay dividends become more valuable relative to the other investment alternatives out there. But if rates increase over a sustained period of time then that outperformance reverses, so it’s important to have a diversified investment strategy which yes, includes dividend paying companies, but also includes sectors or assets that perform well rates rise, like consumer discretionary stocks or rate-reset preferred shares. As a side note, the more popular ETF’s, index funds and even the crappiest mutual funds will probably have some dividend paying stocks in them.
Q: How can you tell if a fund is going to underperform or outperform a passive investment
A: I can’t and no one can. Over long periods of time, there’s generally an inverse relationship between the fees an investment manager collects and investment performance (the higher the fees, the weaker a fund’s performance tends to be) but it’s impossible to know in advance which funds will do well and which ones won’t. It’s equally impossible to know how they will perform relative to passive investment strategies, of which there are many.
Q: What is an asset-allocation
A: Asset-allocation describes the proportion of your investments which are held in stocks (ownership in a company) vs bonds (lending money to a company). Usually it is expressed as two numbers, with the first representing the percentage of your portfolio invested in equities and the second number representing the percent invested in bonds. For instance, a “60/40” portfolio has 60% of the portfolio in equities and 40% in bonds. An 80/20 portfolio would have 80% of the portfolio invested in equities and 20% in bonds. The two numbers always have to add up to 100 and while stocks offer the prospect of higher returns, they are also riskier, meaning their value can fluctuate a lot more than bonds.
Investments are talked about in a fairly homogenous way (“markets went up, markets tumbled”) but portfolios held by real people are rarely invested entirely in equities, which would be a 100/0 portfolio. Everyone has a different asset-allocation depending on their specific investment objectives, how much risk they’re willing to take on and their investment horizon (when will they need the money).
Q: Why would you recommended an investment manager that charges fees. Aren’t investment managers and mutual funds just throwing money away when you can invest passively.
A: It depends. On average, mutual fund fees in Canada are still too high. I regularly come across portfolios where the average MER is in the high 2% range and for which the person is getting no communication from their salesperson other than at RRSP time. That’s a waste of money. But there are a handful of companies in Canada which charge reasonable management fees and who really focus on letting people know what’s going on with their portfolios. They don’t claim to be able to outperform the market day in and day out, they just focus on investing your money actively and there’s value in that. Not everyone is cut out to be DIY investor. I can be brutal trying to manage the financial mediasphere and figuring out how that information relates to you. As much as I come across high fee mutual funds, I’m seeing more DIY portfolios which are a bit all over the place (to put it nicely).
Q: Is a recession coming?
A: I don’t know and no one knows for certain. The best way to deal with uncertainty and unpredictable markets is to have a well diversified portfolio.
(Which leads to the next question)
Q: So why is everyone predicting a recession is going to happen?
A: The US-led trade war with China, slowing corporate earnings growth and signals from the bond market (inverted yields and negative yields) are all indications of slowing or declining economic activity.
The trade war is legit and I think the week to week “deal or no deal” headlines divert attention from a longer-term economic war that is probably one of the few things that has some bi-partisan support in the U.S. The trade war is something that could persist well beyond the current administration and I don’t think investors are thinking about that.
Q: I thought Investment people knew how to get outsized returns? I regularly hear my friends say they get returns of 25% in their portfolio with almost no risk and “good” investment advisors should be able to earn more than that.
A: They’re mistaken.