It is not just the James Glassmans (co-author of the 1999 bestseller Dow 36000. More than 10 years later, the Dow is still stuck at the same level) of the world who do enormous damage to investor portfolios. Well-meaning folks such as David Trahair manage to inflict similar damage through their well-intentioned but incorrect prescriptions. Back in 2009, Mr. Trahair published a book with the title Enough Bull (reviewed here). In it Mr. Trahair counselled investors to dump their stock holdings and stick the proceeds in ultra-safe GICs. The message found enormous resonance with investors whose portfolios were battered and bruised by a brutal bear market that cut the value of their portfolios in half in a matter of mere months. Doubtless, many investors took Mr. Trahair’s message to heart and dumped their stock holdings and moved to safe investments. Let’s see how it would have worked out.

Mr. Trahair cites the example of the TSX Composite, which declined from its closing value of 15,073 on 6/18/2008 to 8,155 on 11/17/2008. It was a stunning decline and one we would probably be telling our grandchildren about. But, let’s see what happened since then. A little over 2 years later, the TSX Composite closed at 13,443 on 12/31/2010. In other words, the index dropped 46 percent over a six month period and gained 64 percent over the next two years. If you include dividends or better yet, reinvested dividends, investors in the Canadian stock market would have gained more than just the increase in the price levels suggest. Investors who followed Mr. Trahair’s advice would have locked in their losses and missed the ensuing recovery entirely.

Another example cited in Enough Bull to warn investors of the perils of the stock market is the decline in the price of Apple (NASDAQ: AAPL) from US$199.83 on 12/28/2007 to US$90.58 on 01/09/2009. No doubt that period would have been trying for Apple stock holders. But considering that Apple was recently trading at US$342, I doubt long-term stock holders are complaining about the blip in Apple’s stock price.

The moral of the story here is not that investors should be piling into stocks at all times ignoring the nay-sayers. Rather it is that investors in equity markets must be prepared to withstand sudden and significant erosion in the value of their stock holdings. They should not be surprised when stocks do just that and then react with extreme and drastic portfolio changes.

This article has 19 comments

  1. Interesting. I liked his first book (Smoke & Mirrors), but anytime authors start predicting
    the market, it’s a 50% bet that they will be wrong. :)

    Zvi Bodie is another guy who is anti-equity.

    Mike

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  3. CC.

    The problem with the part about not needing an advisor is generally there is no talk about risk management. Also no talk about distribtion of assets in retirement. I wrote a story in Million Dollar Journey http://www.milliondollarjourney.com/how-annuities-work.htm

    Using that one concept, non registered money can be guaranteed and GICs would have to produce at least 6% to compare even in todays low interest climate. There is is many other ideas which involve less risk and more protection with out anyout of pocket money like car insurance or home insurance. If you want to to read a book which covers more subjects. Drop me a line.

    cheers,

    Brian

  4. I’m curious about the “fool me once, shame on me. fool me twice…” principle as it relates to investor psychology. Do investors whom have experienced significant downturns in the past come out of future downturns better than those who have never experienced it before?

    Discussion over at the CMF forums often includes comments about people wishing for significant market corrections, but would any of us be able to pull the trigger if such an event (fear of total economic collapse) occurred again?

    I doubt people who experienced Oct 1987 and the dot.com bubble did any better in 2008.

    I suppose that’s why a steady-eddy approach is often most successful.

  5. @Mike: Zvi Bodie is not just anti-stock. He is a proponent of portfolios with 100% in TIPS (Real Return Bonds for us Canadians). Trouble is, RRBs return 1% these days.

    @Brian Poncelet: Agreed. Those in their withdrawal phase face a lot of risks in putting 100% of their portfolios in GICs. They can improve their withdrawal rates by diversifying across products such as annuities.

    @Sampson: I went through the dot.com bubble and it made me a better investor. Going into the 2008-09 bear market, I had a healthy allocation to bonds, better diversification in stocks and it helped me survive. I don’t mind admitting that I was even tempted to make the portfolio more aggressive but I didn’t act on it. In hindsight, maybe I should have :)

  6. Annuities are great but not without risk – you are essentially locking into a interest rate for the rest of your life – if rates rise sharply or inflation takes off, a shorter term gic can be re-invested at higher rates

    The non-registered prescribed annuity route can be a good gic alternative, but investors need to understand it isn’t without risk – good advisors will do this for their clients, bad ones won’t

  7. As a stock picker, I find that there are often both beaten-up stocks and overpriced stocks in the markets most of the time. Right now, there’s a few stocks on my watch list which are close to my “buy” price and one that I recently sold off because I think it ran up too quickly.

    I think the only problem with stock picking is that there are probably plenty of great buying opportunities out there right now, but I only have so much time available to research and monitor. So, I only watch about 30 stocks daily so that means that there are another 270 stocks as part of the index which I don’t watch.

    My point is that I can agree at a dinner party with anybody who says that it’s a good time to buy stocks just as much as I can agree with someone at the same dinner party who says it’s a good time to get out of equities. To me, it all just depends upon which 30 stocks each of these individuals may be watching. After all, we’re probably not looking at the same 30 stocks.

    • @Phil S: Care to share which stocks you find interesting now? I personally think Canadian insurers are interesting at these prices but the banks less so. Not that I’m acting on any of my “hunches”. I’m indexed after all :)

  8. @ Rob,

    As long as the government does not drop income taxes in the future, at current rates for say a 65 male you need to get 6% to 8% guaranteed. You may want to read the annuity story I wrote awhile ago. Like everything else in life, you do not want everything in on spot but to get a guaranteed paycheque every month is great, just ask anyone who has a pension from the government.

    Another alternative is using permanent insurance, which I have on my web site person A vs. person B
    non-registered. Person B has less money but a cash value insurance policy, but in retirement will pay less taxes and have at least 20% more money in retirement and take on less risk. If the market crashes he is in a safer position than person A (who has more money in the market). Since I believe the author does not understand risk mangement using insurance during retirement (which should be planned years before) this is missed.

  9. @CC. Well, I would buy Encana if it falls below $28. I would buy BMO if it falls below $56. I would buy Royal Bank if it falls below $50. All three of them are close to my buy price – Encana is currently one really bad news day away from my buy price… :)

  10. I work for one of the largest financial service company in Canada. We did an internal study recently where we looked at the rate of returns of 25000 our clients for the last 25 years. What we found is that over half of them were unable to achieve a positive real rate of return.

    Even while equities return over the long run more than GICs e.g. 10% per year most investors end up with real negative rate of returns due to fees, poor timing, taxes and inflation.

    Most investors would be better off by just investing their money into GICs for their retirement savings as David Trahair recommends.

    • @Daniel S: I’m not surprised to hear that a lot of retail investors earn very poor returns. Studies such as DALBAR consistently show this for the reasons that you point out. However, IMO, investors can correct these errors by cutting investment expenses and bringing discipline to their investments. And if investors do decide to own stocks, they shouldn’t be surprised if the stock holdings drop in value. They should certainly not make wholesale changes like selling and switching to GICs.

  11. @ Daniel,

    So equities get 10% over the long term? Ok, maybe you got same examples to share because I don’t see it. The taxes on GICs is at interest generated…so taxes generally higher than equities, add inflation you are negative.

    Currently I am in Long Beach California, the unemployment in the state is 12.4%… real estate is still going down.. So, the idea of trying to use all your money to pay off a mortgage (which is tax deductible) which Suze Orman tell Americans to do, does not help. The key is how to get more protection and have money in retirement. Putting money in GICs (which locks up your money) may be OK if you want to increase the banks bottom line. Nobody seems to know about the velocity of money. Why not get money do more than one job?

  12. @Brian: TSX Composite total returns from 1990 to 2009 is 8.0%. Okay maybe not 10% but very good returns. Even the S&P 500 in CAD returned 7.6%.

    I totally agree with the point that if equity premium is 3 to 4 percent and you are paying 2.5 percent in fees and another 1 to 2 percent in performance chasing, tax leakage etc., you might as well buy GICs. What I don’t agree with is making wholesale asset allocation changes *after* a huge drop in stock prices. But I do think investors can do better by investing in low-cost stock funds and hold them for the long-term.

    Please don’t argue that buying GICs is boosting the bank’s bottom line. Are you then implying that buying equity mutual funds is boosting a financial advisor’s bottom line?

    What’s so wrong with paying down mortgage debt? If you have a 5-year, fixed rate mortgage and are paying 4% in interest, it makes a lot of sense to pay it down. I personally would strike a balance between building up retirement savings and paying down debt but it’s hard to argue that someone concentrating on the latter is mistaken.

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  14. CC.

    The rates of return of 8% is an easy mistake to make. You need to factor the down years as well as the up years would you will find is the rate is lower than the 8%. If you factor taxes and inflation you get even less.

    The purchase of GICs may have a purpose, but banks use this money to make for money this is called the velocity of money. I could go into reasons why 2% GICs hurt retires but I will leave that for another day.

    Paying off debt is good but you need to consider money and time are limited for everyone putting your money without risk management hurts everyone. In the end if structured right one can have more money in retirement and pay less taxes with better protection.

    If you are up for reading a book and looking to be conservative and not falling in the trap of only looking at one asset class let me know and I’II send a book off to you.

    cheers,

    Brian

  15. @ Brian Poncelet

    Average Annual Rates of Return: S&P/TSX Composite Total Return Index

    30 years to August 31, 2009 – 10.76%

    40 years to August 31, 2009 – 9.77%

    50 years to August 31, 2009 – 9.80%

    In addition, IMO paying down debts is always a great idea. Unfortunately, it is hardly recommended by banks and advisors because they do not make any money out of it.

    • To add to Daniel S’ point:

      20-year S&P 500 returns: 8.2%
      20-year returns by the “average” equity fund investor: 3.2%

      The million-dollar question: does having an investment advisor, on average, significantly change this depressing outcome? I haven’t seen any studies that show it does.

  16. I thought I would revisit this post.

    Currently GIC rates have drifted even lower to 2.8% for five years.

    A five year fixed rate is 2.69%.

    We know the market goes up and down but the bar is still very low, to suggest having the money be put into GIC’s back then was missing the boat it is even worse now.

    One simple idea would be max out RRSP’s (avoid GIC’s) take tax refund put against mortgage.

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