5 Lessons Learned About Investing
Five years ago I opened a discount brokerage account – transferring $25,000 from my HSBC mutual fund account to TD Waterhouse – to start investing in individual stocks.
Here are 5 lessons learned about investing over the last five years:
A rising tide lifts all boats
I’ve learned to recognize the difference between skill and luck. When the S&P/TSX 60 went up 32 percent in 2009, many investors, like me, who went the do-it-yourself route, started patting themselves on the back.
“Hey, my lousy advisor had me in mutual funds that lost 30 percent last year! Look how easy it was for me to turn that around!”
Related: 5 challenges DIY investors face
The Canadian stock market has averaged an annual return of 8.8 percent since 2009. The Canadian Dividend Aristocrats Index, as tracked by the iShares ETF CDZ, returned 15 percent annually since 2009.
Many investors wrongly credit superior stock picking skills for their recent returns. But only through diligent tracking of your portfolio rate of return and comparing to an appropriate benchmark (like the S&P/TSX 60) can you conclude that your decisions added any value at all.
Don’t chase yield
I’ve learned about the pitfalls of chasing high yield stocks. Two of the first 10 stocks I purchased were Yellow Media and TransAlta. Both were paying out dividends well north of 6 percent – a rate that far exceeded earnings.
A high dividend payout ratio and low prospects for earnings growth is typically a recipe for disaster. Anyone with a working pulse could see that Yellow Media – publishers of the Yellow Pages phone directory – was headed to zero as advertisers fled the print directory business to focus on digital ads.
The result was predictable – Yellow Media slashed its dividend, eventually eliminating it altogether, and the stock tumbled 94 percent.
Related: Avoid these 4 investing mistakes
TransAlta, which operates power plants across North America and Australia, has been a disaster for shareholders over the past five years. Poor management, lack of long-term contracts, and plant shutdowns have plagued the company for years.
The company refused to cut its dividend while paying out well over 100 percent of earnings. The stock flirted with $24 in early 2010 and trades below $13 today. Earlier this year, TransAlta finally caved and slashed its dividend by nearly 40 percent.
Thankfully I came to my senses early with these two stocks – selling both in 2010 for a decent profit. But the lesson might be rearing its ugly head again with high yield stocks like Liquor Stores and Rogers Sugar, which have struggled this year.
Embrace simple solutions
I’ve learned to embrace simple solutions. One of the greatest stock pickers of all time – Warren Buffett – raised a few eyebrows when he revealed his plan for investing the funds left from his estate after he dies:
“My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. I believe the long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.”
We tend to reject simple solutions because, well, they’re too simple. But when it comes to investing, a simple and boring approach can work in your favour.
Complicated strategies like technical analysis and momentum trading take time to understand and execute, and there’s no evidence that you’ll come out ahead. You can pay someone to do it for you, but that comes at a steep price.
Related: TD e-Series funds – Not just for beginners
My favourite portfolio to manage right now is the RESP I have set up for my kids. Each month, I put $200 into one of three e-series funds – a Canadian index, a U.S. index, and an International index – and then sit back and watch it grow.
Avoid market timing
I’ve learned to stick with my long term strategy and ignore everything I “think” about where the market is headed.
I used to spend a lot of time monitoring my portfolio and watching daily events unfold. But over time it became clear that events like the Japanese nuclear meltdown, the Greek government debt crisis, or the flash crash, had little effect on the long term direction of the stock market.
You’ll always hear investors say things like, “I’m waiting for a correction before I buy again,” or, “I’ll wait for the economy to improve before I get back into the market.”
I’ve learned the best approach is to invest regularly and stick with a strategy for the long term. It’s better to be in the market than to try and time the market to your advantage.
What if you’re sitting on a lump sum of cash? Should you invest it all at once or gradually over time?
A study examined 20-year periods from 1926 to 2009 and concluded that lump sum investing produced superior results 69 percent of the time.
“The reason is simple: More often than not, stocks move higher. You benefit more from being invested more of the time than you do trying to avoid near-term wiggles.”
Costs matter
I’ve learned that costs have a big impact on investment returns. When you compare actively managed mutual funds to index funds and ETFs, the difference in performance often comes down to fees.
Most bank-sold mutual funds have fees in the range of 1.5-2.5 percent a year. ETFs and index funds, on the other hand, cost a fraction of that amount.
Index funds are designed to give you market returns, minus a small fee. When you buy a Canadian equity mutual fund, there’s a good chance it holds the same investments as the index itself, so you’re essentially paying your bank and advisor to own an expensive index fund.
Related: How much does it cost to build a portfolio of individual stocks?
As for buying individual stocks and ETFs, we’ve seen per-trade prices at big brokerages come down from $29 to $9.95. You can also buy ETFs for free at certain discount brokerages like Questrade. That’s a big win, especially for the small investor.
Final thoughts
I’ve learned a lot about investing in the last five years, but it will take a major stock market correction to really test my resolve.
It’s at that point when investors must have the conviction to stick with their plan and avoid the type of investor behavior that leads to bad decisions and ultimately poor returns.
Good points, and I especially like “a rising tide lifts all boats”. So true. This is one of my biggest pet peeves with actively managed funds – they usually focus on historical returns with no benchmark. If you returned 7% last year, that sounds great, but if the index returned 10% it doesn’t sound so great. Same can be said for individual investors – there’s no sense in looking at personal rates of return if it isn’t compared to a benchmark
Hi Dan, that’s one of my pet peeves, too. Guess what? Everyone lost money in 2008, and everyone made money in 2009. If you went DIY in 2009, don’t pat yourself on the back too hard and think you’re Warren Buffett.
Very good advice.
I wish I had kept a copy of it, but I remember reading a study that looked at the past 50 (or longer) years and compared an investment methodology the mirrored the flows of those years, vs. regular investing (dollar-cost-averaging), vs. random amounts at random times.
Random won every time!
@schultzter – Interesting, I think I remember reading something about that, too.
Although I don’t follow & am not a fan of index investing I think it’s probably the way to go for the masses not into DIY. It’s less stress and you get market returns while you sit back and relax.
I wouldn’t recommend Warren Buffet’s plan which he advocates for his heirs. The 90% S&P 500 10% short term bonds portfolio could have serious drawdowns depending on market strength at time of initiation in the distribution phase. Warren’s heirs will be inheriting many billions of dollars so they needn’t worry about running out of money in declining markets.
Bernie, DIY does not just mean dividend growth investing. It also includes index investing. If Warren Buffet, the worlds most successful investor advises “if you look in the mirror and don’t see Warren Buffet, invest in index funds”, I think you’d be well advised to follow that advice!
Buffet’s heirs will not likely care about massive drawdowns during market crashes, as they will have billions of dollars in their trust funds. The high equity allocation will give higher returns over time, probably the reason Buffet structured the trust that way.
Grant,
Although I’m a DGI advocate I purposely did not bring it up in my comment. It’s not for everyone. Granted, Index funds are not DIY, they are close to DIY. As I said, investing in index funds would be good for most. A more balanced mix of funds should be incorporated rather than the 90-10 mix Buffett suggested for his heirs. He did not suggest this mix for the general population.
Bernie, just to clarify, there are many investors who use exclusively index funds or ETFs. They are doing it themselves and are therefore DIY.
I agree most investors are not able to tolerate the volatility of a 90% stock portfolio and would be better of with a lower equity allocation.
I agree on both counts Grant.
No actually, they won’t!
Lots of good advice. However, I don’t think that the S&P/TSX 60 is an appropriate benchmark to compare a DGI strategy against. Dividend growth investing is a type of value strategy, and therefore should be compared against a large value index. Unlike the US, I don’t think we have such an index in Canada, but one of the dividend focused ETFs, such as CDZ would be a good substitute.
I use CDZ as a benchmark and I suspect it will outperform XIU, which tracks the S&P/TSX 60. I use XIU as a secondary benchmark just to make sure my dividend strategy beats the Canadian market as a whole.
Fair enough. I agree CDZ would be expected to outperform XIU a bit over the long term as it is a value strategy, although during periods when value underperforms the broad market, which can be many years, CDZ would underperform XIU.
There’s a very good article on Seeking Alpha about Mr. Buffett’s “90% S&P 500 & 10% bonds” suggestion for his heirs. It deals with this strategy during the distribution cycle. The article can be read here: http://seekingalpha.com/article/2263143-the-time-warren-buffett-got-it-wrong
Hi Bernie, I didn’t mean to suggest that retirees in the withdrawal phase should have a 90/10 equities/bonds allocation.
The point is that most of us in the accumulation phase would do just fine with a single fund (or two-to-three max) solution.
For sure! Our equity/bonds allocation should be patterned on several factors such as how much risk we want to take on, how long our expected drawdown period is, what other income streams are involved in our overall portfolio, etc. As you say, the allocation could be put together with one to three funds. I feel the 90/10 mix is better suited for someone in the accumulation phase with a longer time horizon.
I am leaning towards using XIU as my benchmark, own close to 50% of the holdings anyhow.
Great lessons learned here Robb.
I never really chased yield with TA, just a bad call on my part. I continue to own a few shares, enough to DRIP, but don’t and instead take the cash on this one. I figure it’s buyout at some point. It will take a few more years to right the ship on this…meanwhile, I will get paid. Frustrating stock to own but it’s my own fault 🙁
The biggest lesson for me is “costs matter”. I can choose to own a product or own the company outright. For the most part, I’ve chosen the latter but will index investing using a few indexed ETFs going-forward since it won’t be possible to own the entire stock market on my salary. I can dream though!
Cheers,
Mark
These are some great lessons that every investor can live by. It can be really hard to believe that the simplest option is usually the most effective. It’s like having a garden. If you keep digging it up to see what’s going on you won’t get anything 🙂
The next correction will be an interesting test for sure. During the crash I put in all the spare cash I had… which was about $400 🙂 Things will be a bit different next time around but I’ve made sure I’m ready for anything that can happen.
Great post. The five lessons will for sure help investors in keeping things in perspectives. What has worked for me over the years is selecting the right number of solid blue chip companies with good rising dividends with Dividend Reinvestment Plan (DRIP) so that the cash is used to purchase more shares. Making the share purchases regular and automatic has been crucial to build my stock portfolio over the years. Lastly, a point that I would add to your list is to NOT LISTEN to talking heads or so called experts or analysts and do your own research and make sound investment decisions based on evidence and not irrational feelings. You will see the results for yourself. Let’s all keep investing!