Asking The Wrong Questions About Your Investing Strategy

If you’re anything like me you started investing because you wanted to make money and the stock market just happens to be the best place to achieve inflation-beating returns over the long term.

Investors must accept, however, that greater returns come with greater risk, along with the possibility that your portfolio might suffer losses of up to 40 percent or more in the short term.

And if you also accept the idea that an investor, even an active one, has very little chance of avoiding such losses then you’d have to wonder if you’re just along for whatever crazy ride Mr. Market has in-store.

Related: Starting your investing journey

Indeed, since none of us has a crystal ball or the ability to forecast, with any accuracy, future market outcomes, the best we can hope for is to set up a diversified portfolio of equities and fixed income, contribute to it often, rebalance whenever it drifts off course, avoid trading on noise from the media, and keep investment costs ultra low.

In a nutshell, we can give ourselves the best chance to succeed by doing all of the above, but at the end of the day we’re still at the mercy of the market and we have to accept what it gives us.

Asking The Wrong Questions About Your Investing Strategy

Investors asking the wrong questions

That’s why it’s surprising to hear investors talk about wanting to make money investing in a short period of one-to-two years.

Aman Raina blogs at Sage Investors and two years ago he set up an account at one of Canada’s robo-advisors and invested $5,000 of his own money to see how his portfolio would perform.

I found the question he wanted answered to be a bit strange, however, which was, “do these things make money for investors?

A robo-advisor is billed as an online investing and portfolio management solution, but in the most basic terms it’s an automated asset allocator.

Related: Nest Wealth vs. Wealthsimple: A tale of two robo-advisors

Robo-advisors offer portfolios of low cost ETFs tailored to your risk profile. Once you choose a model portfolio to follow, any new money added to the account gets automatically invested into the funds according to your desired asset mix and allocation. Robo accounts are rebalanced when portfolios drift 10 percent or so outside that allocation.

There’s no magic involved. Portfolio returns will depend not just on the performance of the underlying ETFs, but on the timing of contributions and any rebalancing that occurred.

Mr. Raina was not happy in year one when his robo-portfolio lost 2.15 percent, but he perked up in year two when the portfolio returned 13.2 percent:

“After the first year, the ROBO had lost 2.15 percent. It had a rough year, but in year 2, ROBO picked up its game. The portfolio generated a 13.2 percent return for the year. Much better job.”

Huh? Did the robo-advisor really do a better job in 2016 than it did in 2015? I’d argue it was the portfolio’s exposure to U.S. stocks and Canadian dividend payers that led to better returns. The robo didn’t do much of anything except stick to the investor’s initial allocation.

What exactly is the robo-advisor’s job supposed to be? In my mind, a robo-advisor’s role is to give investors inexpensive access to market returns via a diversified portfolio of ETFs that get rebalanced automatically whenever appropriate.

Final thoughts

I track my portfolio rate of return annually and expect to achieve returns of eight percent per year over the very long term. But even though we’re in the midst of an eight-or-nine year bull market, I full expect my portfolio to lose money in some years. That’s just how the markets are supposed to work.

Asking, “did my portfolio make money” is not an appropriate way to evaluate your investing strategy. The only meaningful way to measure your portfolio returns is against a similar benchmark.

Say your portfolio is down 2 percent in a year. Is that cause for panic? Disappointment? Maybe. But what if you learned that the overall market was down 10 percent? In that case you should be thrilled to only lose 2 percent!

Mr. Raina says, “the key fundamental questions that don’t seem to be asked is whether robo-advisors are more effective in generating positive returns compared to a traditional portfolio management model. Can you make money?

I think he’s asking the wrong questions.

Weekend Reading: Buffett’s Annual Shareholder Letter Edition

Warren Buffett is a living legend in the world of investing and each year he issues, on behalf of his company Berkshire Hathaway, a widely anticipated letter to shareholders. Berkshire stock was up 23 percent in 2016, more than double that of the S&P 500 index. The Oracle of Omaha has still got it!

Buffett’s annual shareholder letter is always filled with interesting nuggets and folksy wisdom. This year’s letter was no exception and Forbes dug out the seven best quotes and shared them here.

For someone who makes a living searching for undervalued companies to buy, Buffett sure loves to tout the benefits of indexing for everyone else. He writes at length about Vanguard founder Jack Bogle (“He is a hero to investors and to me.”), his million dollar bet that an S&P 500 index fund would beat a group of hedge funds over a ten year period (annual returns for the past nine years: 7 percent for the index fund and 2.2 percent for the hedge funds), and about Wall Street “helpers” and their high-fee funds.

Here’s the full 29-page letter for your enjoyment.

This Week’s Recap:

On Monday I wrote about the insidious practice of closet indexing – a high fee mutual fund that has zero chance of beating the market it tracks.

On Wednesday Marie suggested how to boost your retirement income with regular income streams.

And on Friday Marie opened up the mailbag and answered a question from a reader who doesn’t make enough money to start a savings plan.

Join 3,400 other Boomer & Echo fans who follow us on Facebook for more insightful money links and commentary.

Weekend Reading:

Downtown Josh Brown dishes some solid advice on managing your portfolio in a raging bull market:

“It’s tempting to get rid of everything that’s not rallying right now. It’ll feel good today, but it will probably cost you big tomorrow.”

Canadians love to complain about the tax they pay on RRSP withdrawals. John Heinzl explains to RRSP bashers how the math really works.

Advocis, the lobby group representing financial advisors, is stepping up its fight against a proposed ban of embedded commissions on mutual funds. The one point I’ll give them is that the insurance industry, and in particular segregated funds, shouldn’t be left off the hook when it comes to protecting Canadian investors.

Last month I wrote about using Monte Carlo Simulations in your retirement planning to account for different outcomes. Michael James says these retirement simulators may give too wide a range of outcomes. Here’s why:

“It turns out that the stock market has a tendency to revert to the mean faster than random chance would suggest. A string of years with poor returns are somewhat more likely to be followed by good returns than more poor returns, and vice-versa. When we randomize the order of the annual returns, we eliminate this effect.”

Frugal Trader from Million Dollar Journey explains how and why asset allocation works.

Jonathan Chevreau reveals some tax strategies for using spousal RRSPs.

Your kids have completed their post-secondary education and you still have $54,000 in unused RESP money. Jason Heath explains what to do next.

An American perspective but an interesting read nonetheless: An Ivy League professor who spent 4 months working in a south-Bronx check-cashing store says we’re getting it all wrong.

This CBC reporter had to leave her downtown Toronto apartment when her rent shot up nearly $1,000 per month.

What to do when retirement funds run out? This licensed insolvency trustee sees cash-strapped seniors every day. But one client sticks out in her memory.

“A gentleman of 86 came in and threw a pile of credit cards down on the table. When I asked him what the problem was, he said, ‘The problem is I’m still alive.’ ”

Finally, some lessons the tooth fairy can’t teach. Author Robin Taub says allowances can help kids learn to be financially savvy.

Have a great weekend, everyone!

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