STOP SWEATING FED MOVES
Interest rates aren’t the biggest factor in returns, writes Tom Bradley.
Last week, Peter Hodson highlighted five things that Canadian investors should ignore. I’m going to build on his list, as well as point out some factors that don’t get enough attention.
THE FED’S NEXT MOVE
The U.S. Federal Reserve and their central bank brethren have an important role to play in providing a stable business environment and just the right amount of inflation. Unfortunately, they’ve put us in a perilous position with near-zero interest rates and excessive asset purchases. We have crisis-level monetary policy in an economy that is any- thing but crisis-like. As a result, we’re left with little cushion for when the next recession comes along.
But breathlessly watching central bankers for their next move does little to enhance your returns. That’s because while Fed Chair Janet Yellen and the others try to micromanage the economy, the real world has moved on. We’ve entered a period of profound technological disruption in most industries. Assessing how it’s all going to impact longterm cash flows and dividends is far more important than the next mini-rate hike.
Two areas that are on my radar are energy and transportation. The world is increasingly demanding cleaner, more sustainable energy. Meanwhile, solar and wind, in combination with improved battery technology, have become competitive with fossil fuels in many parts of the world. We’ll continue to have boom and bust cycles in oil and gas, but if overall demand starts to decline, producers and service companies will find themselves swimming upstream.
It’s hard to believe, but electric, driverless cars and trucks are just around the corner, literally. The impact of this breakthrough will ripple through all aspects of our daily lives. I don’t have room to mention all the implications, but think air quality, safety, gas stations, parking lots, auto shops, roads, truckers, autoworkers and of course, oil demand.
Investors are prone to letting politicians and central bankers dominate the agenda, but they need to instead think about the change that’s happening irrespective of what’s going on in Washington and Brussels.
ACTIVE VS. PASSIVE
Which is better, active management or indexing? Both sides of this debate are deeply entrenched. The reality is, however, neither side has a monopoly on good or bad, cheap or expensive, simple or complicated. And both approaches play second fiddle to a lever that has a much bigger impact on investment returns. I’m speaking of portfolio construction, or asset mix.
How you execute your strategy (i.e. with mutual funds, ETFs or individual securities) is secondary to your asset mix. It only comes after you’ve answered the big questions. Are you diversified across a range of asset types, industries and geographies? Does your mix fit with your age and stage in life? And is there a deliberate strategy to keep your portfolio aligned with your goals and time frame, or is the market managing it (i.e. as stocks go up, so does your exposure, and vice versa)?
I often find myself getting worked up about active versus indexing, but I never confuse the passion with importance. Asset mix first, security selection second.
DIVIDENDS
Like everyone, I like a healthy dividend, and better yet, a growing one. But too many investors use dividend yield to value stocks. A four per cent yield is better than three per cent. I raise this ticklish issue (investors are passionate about their dividends) because the yield on a stock, unlike a bond, doesn’t indicate how much the company is worth. Rather, the value is based on the outlook for future profits and cash flows. In other words, is the company likely to survive, thrive or perish. The decision whether to invest in a company must be driven by these factors, with dividends playing a secondary role.
There’s a lot of noise in the investment world and navigating through it is an important skill set to have.
After all, investing is about getting the big decisions right, while not getting lost in the little stuff. In today’s context, this means focusing on what’s happening on the ground around you, not in the ivory towers. It means collecting dividends from companies that are worth more than they’re trading for. And most importantly, it means paying attention to your asset mix.