Friday, April 29, 2016

Safe Stocks

In recent months I’ve encountered more investors than usual who see Canadian big bank stocks as safe investments. I guess the most recent one was one too many for me. I don’t believe that there is such thing as a safe stock, and as stable as Canadian banks have been, this applies to their stocks as well.

Investors in Canadian banks have been rewarded with decades of stable dividends and fairly consistently rising stock prices. This may continue or it may not. The pressure of new online banks that don’t have the costs of physical branches may bite deeply into big bank profits. This isn’t a prediction. It’s just one possible future. I don’t know what will happen to big bank share prices or dividends.

Investing substantially all of your investments in two or three bank stocks may feel safe, but it isn’t. I’m not saying to avoid bank stocks entirely. Approximately 7% of my portfolio is invested in Canadian big bank stocks indirectly through Vanguard’s exchange-traded fund VCN. But this is a far cry from investing 80% or more of your portfolio in banks.

Diversification is your friend. Many investors feel safe invested in big bank stocks, but they aren’t really safe.

9 comments:

  1. MIcheal, the number of "physical branches" still amaze me because I go there about once every 2 years on average and to the ATM once every 2-3 months. What are people actually doing in banks today (2016)? Plastic money anyone? Online banking, photo deposit etc are more efficient, fast and convenient!

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    1. @Le Barbu: Good points. The transition to easier ways of banking is happening slowly across the whole population with older people trailing. It all seems obvious to those of us who've made the switch but seems scary to those who still visit branches regularly.

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  2. You can't sit down with an adviser to have your portfolio fears quelled or sign your "best rate" (lol) mortgage agreement via digital means.

    It's also a matter of societal presence. What the cost-reward trade-off is, I have no idea. People on the street know what Scotiabank is; they get a blank look at the mention of Tangerine.

    Anecdotally, my local TD ALWAYS has a line-up usually ten deep -- always. The attached Waterhouse side...crickets -- always.

    As for "safe" bank stocks...I assume Canada has no law restraining deposit banks from operating as investment banks as well, like the case used to be in the US? I can see banks taking on more investment risk to prop up profits as their fee-based income declines due to tech etc.

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  3. I am fairly sure that few people saw banks as "safe" back in 2007/2008. That is when I bought BMO and RY. I feel a lot safer with them now as I know it will take a lot for them to become that "unsafe" again. In the meantime I am enjoying increasing dividends from them.

    RICARDO

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    1. @Ricardo: If these two stocks are a very large percentage of your portfolio, then you are at much greater risk than you realize. Feeling safe is very different from actually having a reasonable risk level. Your reaction of feeling safer with a stock at a higher price is quite common.

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    2. Hi Mike;
      At approx 4% of the portfolio I should be able to survive a downturn.
      Having said that it is obvious that losing 20% of $200K in a downturn, while still a lot of dinaro, is not as mentally trying as losing 20% of $2 million. The thing is that in a downturn just about every thing gets sucked in to the vortex. The difference being what will rebound first because it should have not gone down the drain in the first place.
      Sometimes it is hard to re-balance when you are pulling close to $25K a year from two stocks though. I suppose I will have to do it at some point in time just to even out that risk factor.

      Appreciate your articles Mike.

      RICARDO

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    3. @Ricardo: As I said in the article, about 7% of my portfolio is in Canadian big bank stocks. The problem only comes when the percentage is much higher. A downturn in the entire stock market can be scary, but that's not the risk that I'm talking about here. Any individual business may run into trouble that causes its stock to drop significantly relative to the entire market. We're not used to that happening to the big banks, but that doesn't mean it can't happen. People often offer opinions on whether this will or won't happen to banks, but I tend to ignore them. The probability of any one stock dropping significantly to too high for my liking.

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  4. "The probability of any one stock dropping significantly to too high for my liking."

    MJ, does this even apply to you? Your 7% exposure is via a fund, so your 7% is a diversified 7% versus a concentrated 7%.

    For example, your fund has a 7% exposure to RY, but this gives you only a 0.5% total exposure to the same stock; not really anything to fret about.

    Comes down to assessing risk -- concentration to capture maximum returns during a bull market vs. diversification to dampen the losses during a bear market, and their inverse effects.

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    1. @SST: If one stock cratering would cause material harm to my portfolio, then I'd consider the risk too high. My overall portfolio exposure to Canadian big back stocks is about 7%. Each bank is roughly in the 1-2% range. Even a total failure of one bank would make little difference to me, so I'm not concerned.

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