This is a guest post by Daniel who blogs at Urban Departures to help families set their personal finances on autopilot. His knack for saving fuels his love for travelling. He shares his secrets in Grow Them Savings, a one of a kind course designed to simplify investing for people with better things to do.
There has been an awakening. Have you felt it?
There comes a time for every investor to embark on a journey when they begin investing. Like the farm boy from Tatooine or the scavenger from Jakku, every investor has to start somewhere. There’s a galaxy full of different investing styles, strategies and products and it can be difficult to navigate without a little guidance. Who better to lend a hand, than our friends from a galaxy far, far away.
“Adventure. Excitement. A Jedi craves not these things.” — Yoda
A ride on a fast ship, perhaps with two droids and no questions asked, to wealth and financial freedom is an appealing proposition. Yet the potential to lose everything is an equally sobering reality. There is risk involved with investing. It is possible to pick a hot stock which leads to quick riches, but it is equally as possible for the same stock to become worthless. If recent swings in the market are any indication, uncertainty is the only thing that is consistent.
An investment that doesn’t improve your quality of life and keeps you up at night is a speculative gamble. It probably isn’t worth the time and effort.
“That’s not how the Force works.” – Han Solo
Gambling with a hot hand in Sabacc might net you a tidy sum, but investing is not a way to get rich quick. In the short term, equities can experience dramatic volatility and substantial losses. Investors, who sell at the first sign of a dip and buy during recovery, may miss out on market gains by trying to time their investments.
Yet many continue to do exactly that. These emotionally charged decisions, driven by fear or greed, come at a cost of lower returns. The chances of losing money when holding investments for a short period of time, are much higher.
Historical evidence suggests patient investors are rewarded over the long term. For the period 1926-2015, the S&P 500 has always returned a positive gain for holding periods of 20 years. The longer the investment horizon, the higher the probability of experiencing gains in the stock market.
“It’s a trap!” — Admiral Ackbar
It makes sense to seek out professional help but the wrong advice can be costly. Like the rebel attack on the second Death Star, you won’t see it coming until it’s too late. Banks operate in the best interest of their shareholders. Financial advisors earn commissions off the investment products they recommend, presenting a very clear conflict of interest.
The media only add to the commotion. The financial industry, as well intentioned as they may be, is not bound by a fiduciary duty- an obligation to act in their client’s best interest.
“Sir, the possibility of successfully navigating an asteroid field is approximately 3,720 to 1.” – C-3PO
Wall Street (and Bay Street) investment firms employ well-paid teams of PhDs, computer scientists and mathematicians that work full time developing sophisticated analyses to identify stocks to beat the market. Yet, even they don’t always get it right.
An alternative to picking individual stocks are mutual funds, where fund managers work to deliver market beating returns. While it is possible for some mutual funds to outperform the market, it is virtually impossible to know beforehand which funds will do so. The majority of mutual funds fall short of their benchmark after fees.
For the average investor, consistently outperforming the market is a pursuit with overwhelmingly high odds. Picking individual stocks and successful mutual funds has little to do with knowledge and skill and more to do with timing and luck.
“That’s not true. That’s impossible.” Luke
Not convinced? Don’t let your feelings cloud your judgement. Not many have the skillset to best highly qualified researchers in picking winning stocks and common mutual funds don’t fare much better.
Mutual fund fees in Canada are the highest in the developed world. Morningstar’s Global Fund investor Experience 2015 Report found the average mutual fund expense ratio in Canada was 2.35%. While it might not seem like much, Canada’s D- score ranks last among the 25 countries studied.
According to the latest SPIVA Canada Scorecard comparing actively managed mutual funds against their benchmarks, 60.38% of actively managed Canadian Equity mutual funds did not beat the S&P/TSX Composite index over the last 12 months studied. Over a five year period, that percentage jumps to 77.03%.
Similarly, 83.33% of actively managed U.S. Equity mutual funds underperformed the S&P 500 in one year, jumping to 96.84% over a five year period.
“Search your feelings. You know it to be true.” – Darth Vader
It is possible to outperform the market. The SPIVA study proves that 23% were able to do so consistently over the last five years with Canadian equities. Diligent value and dividend investors disciplined enough to stick to their strategy can also perform very well over the long term.
The trade off, however, is to exchange time and effort for a chance at picking winning stock or fund.
For the average investor, with limited time and resources at their disposal, it is less likely to beat the market. It is just as effective to take the guesswork and luck out of the equation all together and accept market returns with index investing. Investors who did over the last five years beat out 77% of professional fund managers, after all.
“Stop taking my hand.” – Rey
There comes a point in every personal finance journey where the need to invest becomes unavoidable. While it’s daunting to take the first steps, it doesn’t take much effort to get started with an index portfolio; a low cost, diversified portfolio can be funded with as little as $100. It doesn’t take long to become comfortable and confident in a successful strategy.
With a little effort and only a few hours to manage a year, a seasoned investor, you can be.