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moneysense.ca, 18/02/09
Blaming Peter for Paul’s mistake
In a recent story, Rob Carrick wrote about Gerhild Somann, a 67-year old investor, who was angry at receiving a letter from Franklin Templeton, which talked about the bargains in the market today. The investor was instead looking for “empathy” and felt that the investment community lacked “prudence, watchfulness and responsibility”. The column mentions that Ms. Somann’s portfolio lost 25 per cent in 2008 but she is not “mad” at her financial advisor.
It may sound harsh but Ms. Somann’s anger should be channelled elsewhere. I have no idea what her portfolio looks like but it does seem that she may have taken on more risk than she is able or willing to handle. Even if Ms. Somann had a traditional 60 per cent / 40 per cent split between stocks and bonds, she would have been down by roughly 17.24 per cent. A good case can be made that such a split is still very aggressive for an investor who is nearing 70. If she had adhered to the “age in bonds” rule and kept 65 per cent in bonds and the rest in stocks, her portfolio would have lost just 7.39 per cent.
A 25 per cent loss suggests that her portfolio was far too risky. How is that Franklin Templeton’s fault? Instead of blaming the mutual fund company, Ms. Somann should be grilling her advisor why she has taken so much market risk when clearly she doesn’t have the ability or the stomach to do so. Clearly, her case isn’t unique. A lot of financial angst reported in the press can be traced not to poor stock market returns but to an inappropriate asset allocation policy. Investors who put a portion of their portfolio in stocks should keep in mind Benjamin Graham’s advice that stocks prices will fluctuate:
In any case the investor may as well resign himself in advance to the probability rather than the mere possibility that most of his holdings will advance, say 50% or more from their low point and decline the equivalent one-third or more from their high point at various periods in the next five years.
moneysense.ca, 18/02/09
Good point about allocating blame.
Personally, I’ve gotten tired of various newspaper accounts of “poor” investors (victims?) who took a big hit last year.
I think “uneducated” investors is the proper word.
Actually I don’t subscribe to the theory that you should have most of your portfolio in fixed income as you get older. The highest bond allocation that I could imagine in retirement is 50%, with the rest spread out in stocks. If we truly experience the hyper inflation that the gold bugs have been predicting as a result of the TARP printing money press, then a portfolio with a higher fixed income allocation will suffer in real returns. The only inflation adjusted alternative for fixed income investors are TIPs.
@ Dividend Growth Investor, and CC:
In terms of inflation protected fixed income instruments, what do you think about IShares real return bond index ETF (XRB)?
I hadn’t heard about that “age in bonds” guideline before. It sort of makes sense to me but there’s a grey area where I feel it’s too high. I’m 50 years old, but I personally feel having 50% of my portfolio in bonds is way too conservative when I’m more than 15 years away from retirement. On the other hand when I’m 65 I’d probably want at least 65% or more of my portfolio in bonds so it makes sense then.
As for bonds and inflation, I think when you’re in retirement it’s more important that you don’t lose money than that you keep up with inflation. You can adjust your lifestyle to handle inflation more easily than you can adjust to handle the decimation of your nest egg.
I have a question regarding asset allocation.
I began investing with TD E-Series index funds this year for both my RRSP and my 2nd son’s RESP.
I am currently investing with a split of 60% equity and 40% bonds.
Why wouldn’t it be beneficial to invest a portion of the bond money into GIC’s? Rates for GICs can be had in the 4-41/2% range for a 5 year term.
Sorry to hijack the thread.
Someone once told me that you delegate responsibility and you don’t abidicate it. Too many people just gave their money to an advisor and then closed their eyes.
DM: If your holding period is longer such as 10 years and the amount that you plan to invest in is a bit larger (10k +), you should look into buying Real Return bonds directly from your brokerage. Ontario recently issued a 3.25% yield Real Return bond, which has a higher yield than Federal government ones with very little risk involved. Government bonds do not need diversification (according to Phil S). Ishares XRB charge a .35% MER which is very reasonable in comparison with the retail mutual funds MER of 1.5%.
Xander: GICs can be used to substitute bonds. In fact, the first 100,000 in each one of your account is AAA, because it is guaranteed by the government of Canada that has a AAA rating. I am personally concerned about using Mortgage backed Securities, because I am not sure how MBS work in Canada.
I am an advisor and nodoby is more critical of the industry than me….but there are plenty of clients who have one risk tolerance when markets are rising, and another when markets are falling.
The advisor may be at fault, but it is certainly not a clear-cut case as this post suggests. The advisor may have talked her DOWN to this level if she had friends making money in thinly traded energy stocks, etc.
Maybe the advisor was negligent, but we don’t know. The blame can go lots of places, and there is no way to reliably assess it properly based on this limited information.
DGI: Fair enough. The age in bonds is simply a thumb rule and should be adjusted for an investor’s risk tolerance. A 70-year old’s time horizon is still what we’d consider long-term: more than 20 years, so a healthy dose in stocks is still required. But I’d argue that 20% or less in fixed income, which is what the investor in the story appears to have is far too less for most people in the 65+ age group.
DM: I don’t own XRB but my understanding is that it is better to own real-return bonds directly. The reason I haven’t bought RRBs is that since I’ve been interested in them the real return never crossed 2.5%. I’ll be interested when the real return is around 3%. Check out Bylo’s website for more information:
http://www.bylo.org/rrbs.html
brad: I’m 35 and I have 20% in bonds for the precise reason you’ve outlined. But then I’m comfortable with volatility and am willing to ride it. A lot of people, even those very young, aren’t. For them a little bit more in bonds might make it easier to handle fluctuations.
Xander: GICs are a viable alternative to bonds. GICs may pay slightly more than bonds but the higher rate is a compensation for lack of liquidity (unless it’s cashable GICs which tend to pay less). Since the RESP portfolios are still fairly small, I’ve gone with bonds. Their liquid nature allows you to rebalance easily. Still, that’s just a personal preference. You can easily set up a ladder of GICs and rebalance when a GIC matures.
Me again
let’s remember too that we have no idea what her portfolio was – she could have had all GICs elsewhere or a fully guaranteed pension
we are assuming that 100% of her money was in equities which is a guess at best
I think this post should only highlight that the marketing departments of these fund companies will always be bullish – no matter what is happening – so their message should always be discounted accordingly
I know we are talking about asset allocation, but I also think that if this advisor had the person in an EFT, the Carrick article and this post would have been far mopre complementary.
Anyone looking to bash fund companies and/or advisors will get their chances from time to time….but this isn’t one a them.
@Econ Student and CC
Thanks very much for your suggestions. I hadn’t considered owning RRBs directly but will probably look into it more closely. With respect to regular corporate and gov’t bonds, do you prefer to own them directly as well or do you prefer ETFs? (such as XSB or CLF)? My general preference has been to invest in bond ETFs because they are easier to trade and do not require high initial principal (my understanding is that you need $5,000 for most direct bond purchases).
DM: Government bonds do not need diversification, but corporate does require significant diversification.
If you want buy bonds, do buy short term bonds. XSB is probably a good choice. XSB is 70% government and 30% corporate.
I’ve got the bonds of a 10 yr old.
Rob – I agree that there isn’t enough information to blame the advisor. I think that one of CC’s points is still very valid though – she shouldn’t be blaming the mutual fund company.
While everything you say is true, I can truly empathize with her complaint. I have followed the advice of one particular advisor for the last couple of years and did quite well, until the market crash. The whole time I was doing quite well, my advisor was very quick to trumpet his own successes, and in fact his website still indicates how embarassed he is because HIS TRACK RECORD IS SO GOOD. A great many of the investments that he has recommended have fallen considerably or even crashed. The portion of my portfolio that I accumulated by following his advice is down more than 50%. At no time has this particular advisor ever even mentioned that some of the the things he has recommended have turned out to be pretty bad (including AIG for example) investments. I recognize that the market has been roughed up a little, but I also want my advisor to at least show a little bit of empathy about what has happened, and maybe to even be a little bit sorry for sending his clients down a path that turned out to be troublesome. He doesn’t have to admit fault, but that’s not the same thing as feeling a little bit bad about what has happened… He has made a classic PR blunder and I for one will not be renewing my account with him when it comes due.
Rob: Fair enough. I admit that it is very much possible that the investor insisted on a riskier portfolio. If that’s the case, she has no one to blame but herself. I’m not a huge fan of most mutual funds but the point of the post is that Franklin Templeton cannot be blamed when every market is down.
If the investor had a larger portion than warranted in stock market indexes (doesn’t matter whether it was an ETF or active mutual fund), the comments would still apply. She took on too much risk and is now blaming the stock market (or ETF or mutual fund) for it. Instead she should (or have her advisor) write down a sensible asset allocation policy and stick to it.
Questions for all financial bloggers.
What should one’s “long-term buy and hold approach to investing” expectation be for market gains? How did you arrive at that number?
In the last few months, I have heard more than once people complaining that their fund manager did not sell prior to the downturn. When asked about what kind of fund/fund manager they are talking about, they usually give you the name of some equity mutual fund. When I point out that these equity mutual funds have to be fully invested (with cash being a relatively small percentage of the portfolio) and that the fund manager mandate is not to time the market, I quickly realize that investors do not understand what they own.
Pretty sad.
CSC
CSC, as an advisor I realize the mandate of many equity funds dictate that they stay invested. That said, I would expect that these experts should have had some inkling that trouble was ahead. Buffet, Schiff, Prem Watsa etc all warned of the trouble in the mortgage market and the danger of MBS, CDOs and over-leverage. Could mutual fund managers not have at least started to drastically cut exposure to financials, home builders, corporate bonds etc and bulked up on defensive stocks and maybe even some etf’s that increase in value when the stock markets drops. If they had done this they would have had much smaller loses and shown some value to having actively managed mutual funds. Just a thought.
Hey all,
One quick point on the A/A debate: it’s very common for retail focused investors/advisors to talk about age. However, age is virtually useless to consider when managing a portfolio. I know, a very radical statement to make considering conventional “retail” wisdom. However, the only time consideration that matters is “when is the capital needed?” A 30 year old that needs to supplement his income from a portfolio that he inherited needs a more conservative A/A than a 70 year old that will never spend a penny of her portfolio. The 70 year old’ portfolio can have whatever A/A that’s required to provide the rate of return goal she’d like to achieve, as long as her volatility tolerance can accept the corresponding deviation. Therefore, time horizon matters, not age.
Just MHO
P.S. And as one person mentioned, I’d take the media in these cases with a huge grain of salt. That 70 year old can have been 100% small cap growth before the advisor changed the portfolio, or she could have been sold a high-commission inappropiate strategy…who knows?
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Canadian Money: My expectations for bonds is 2% return over the next 10 years because that is the current yield and total returns are highly correlated with current yields. For stocks, the real return expectation is 3.5% (dividend yield) + 4% (earnings growth rate) = 7.5% (assuming valuations stay constant). As you can see, stocks are very attractive compared to bonds today.
FM: I doubt market timing can be done consistently. It’s funny you mention Schiff whose clients apparently lost more than the benchmark index did because he was wrong on other things. Just goes to show how difficult it is to anticipate market downturns.
DG: Fair enough. The age in bonds is just a thumb rule which I think will be applicable to a lot of investors.
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