Get­ting mix right, and hold­ing nerve, are keys to suc­cess

National Post (Latest Edition) - - FINANCIAL POST - Tom Bradley Fi­nan­cial Post Tom Bradley is Pres­i­dent of Steady­hand In­vest­ment Funds, a com­pany that of­fers in­di­vid­ual investors low- fee in­vest­ment funds and clear- cut ad­vice. He can be reached at tbradley@steady­hand.com

Risk is one of the most mis­un­der­stood words in in­vest­ing. Con­sider the different in­ter­pre­ta­tions.

Large fi­nan­cial in­sti­tu­tions de­fine risk as volatil­ity. They worry about short- term ups and downs in the stock mar­ket and have de­signed their risk man­age­ment sys­tems ac­cord­ingly.

Some in­vest­ment man­agers be­lieve risk is the amount their re­turns de­vi­ate from the in­dex. Too much dis­per­sion, or track­ing er­ror, is bad. In­deed, it can be ca­reer-end­ing if the gap is to the down­side.

In­di­vid­ual investors too are shaken by mar­ket volatil­ity, but their big­gest worry is per­ma­nent loss of cap­i­tal.

Be­fore ad­dress­ing what risk is to you, let’s elim­i­nate a cou­ple of pos­si­bil­i­ties.


First off, high track­ing er­ror is not a risk. This one strictly be­longs to in­vest­ment pro­fes­sion­als, who are re­warded for how they do rel­a­tive to an in­dex. Beat­ing the bench­mark with­out sig­nif­i­cantly de­vi­at­ing from it is their holy grail, although it means lit­tle to you. Pos­i­tive ab­so­lute re­turns build wealth, not rel­a­tive re­turns.

Per­son­ally, I shy away from Cana­dian eq­uity man­agers who tar­get a low track­ing er­ror. Our mar­ket is skewed to a hand­ful of in­dus­tries, so hug­ging the in­dex leads to an un­di­ver­si­fied port­fo­lio.

For investors who are prop­erly di­ver­si­fied, loss of cap­i­tal is also not a risk. A few poor stock picks aren’t go­ing to dev­as­tate re­turns. Nei­ther are de­clin­ing oil prices or debt is­sues in Greece.

I say this know­ing that many Cana­dian investors get car­ried away with what’s pop­u­lar at the time. Port­fo­lios were dom­i­nated by for­eign stocks in the early 2000s ( do you re­mem­ber Clone Funds?) and were all- Canada ten years later. Along the way, there’s been over­sized hold­ings in technology, oil and gas, pre­cious met­als, banks and since 2008, cash.

There’s a rea­son why di­ver­si­fi­ca­tion is called the only free lunch in in­vest­ing. If you have broad ex­po­sure across in­dus­tries, ge­ogra­phies and as­set cat­e­gories, the ride will be smoother with­out sac­ri­fic­ing re­turns. Negative events will im­pact your port­fo­lio in the short-term, but a full re­cov­ery is all but as­sured.


If track­ing er­ror and cap­i­tal losses aren’t risks, what about volatil­ity? On this one I can’t be as un­equiv­o­cal. The an­swer de­pends on your stage in life.

A decade ago, I stepped away from the busi­ness for a short time and learned what it’s like to be re­tired. A friend told me at the time, “Tom, liv­ing off your wealth is very different than build­ing your wealth. It’s a whole new ball game.”

He was so right. Re­tired investors must think long term, but also need to ac­count for reg­u­lar with­drawals. This brings volatil­ity into the equa­tion. Down mar­kets al­ways go back up, but when the weak­ness is pro­longed, with­drawals chew into the cap­i­tal needed for full re­cov­ery. Re­tirees must man­age their cash flow with volatil­ity in mind.

For investors who won’t touch their money for at least 10 years, short- term mar­ket gy­ra­tions are not a risk. In­deed, they’re a bless­ing. Volatil­ity cre­ates op­por­tu­ni­ties to buy at re­duced prices.

This re­quires, of course, that investors stay on plan through mar­ket tops and bot­toms, both of which are breed­ing grounds for re­turn- crush­ing mis­takes.

It might sur­prise you, but I be­lieve the big­gest risk for ac­cu­mu­la­tors is not tak­ing enough risk. By this I mean hav­ing too con­ser­va­tive an as­set mix and/or not hav­ing ev­ery avail­able dol­lar in­vested to ben­e­fit from the power of com­pound­ing. It seems per­verse, but hold­ing se­cure, sav­ings ve­hi­cles is a high- risk strat­egy. It doesn’t in any way match the time frame ( long term) or goals ( build­ing wealth and slay­ing in­fla­tion).


Risk has four let­ters, but it’s not a dirty word. When com­bined with time, it’s the fuel that drives your port­fo­lio. With­out it, you’re des­tined to achieve re­turns ac­corded ‘ risk­free’ as­sets like GICs and govern­ment bonds.

But risk is a per­sonal thing. It may be different from what oth­ers are wor­ried about. To build a port­fo­lio that fits your needs for growth and in­come, you need to al­lo­cate across all four types — in­ter­est- rate risk ( bonds); de­fault or credit risk ( cor­po­rate bonds); eq­uity risk ( stocks); and liq­uid­ity risk ( pri­vate in­vest­ments). Your risk man­age­ment sys­tem is get­ting the mix right, and re­sist­ing the temp­ta­tion to de­vi­ate from it for short-term, emo­tional rea­sons.

Newspapers in English

Newspapers from Canada

© PressReader. All rights reserved.