Wednesday, August 31, 2016

Thinking Differently about Investing

When I look back at the way I thought during my first several years of investing, I realize that my thinking is very different now. I started out too conservatively and quickly evolved to looking for big wins. Now I seek good returns while avoiding big mistakes. That’s not to say that I’m now scared of volatility. I go for the best returns I can get with the constraint that I try to keep the odds low that I’ll permanently lose a significant amount of my capital.

To illustrate what I mean, I’ll go through some examples of ways to lose capital and examine how my thinking has changed.

Any individual stock can drop 90% or more

Over the years I’ve owned several stocks that have dropped 90% or more. Before this happened to me, I didn’t think about this possibility. I once owned a stock that grew to well over half my net worth. Fortunately, I sold most of it before it dropped by more than 98% at the end of the tech boom of the late 1990s. With different timing, I could have lost almost everything.

Today I would never do anything so reckless. I choose to own many thousand of stocks worldwide through index ETFs. There are other ways to get adequate diversification, but this is my choice.

The entire stock market can drop 40% or more in just a few months

This is what happened in the stock crash of 2008-2009. The stock markets in Canada and the U.S. have always rebounded eventually from such crashes, but that doesn’t help if you’re forced to sell. I didn’t use to worry about losing my job or the leverage I had with my mortgage and possibly being forced to sell stocks low.

Now, whenever my thoughts drift to borrowing to invest more in the stock market, I remind myself of what could have happened if I had been leveraged in 2008. The losses would have been devastating. So, I stick to having no debt, I have a modest cash cushion, and I won’t invest money in stocks unless I believe I won’t need the money for at least 5 years.

Costs Matter

During my early forays into mutual funds through advisors, I didn’t know about MERs and other costs. Even as I began to learn about these costs, I didn’t appreciate that these small percentages add up to big money. Costs can easily consume half your savings over a lifetime of investing. Even as I moved to choosing my own stocks, I didn’t appreciate how expensive currency exchange could be. Today I keep my costs very low, and I use Norbert’s Gambit to save money on currency exchange.

GICs give poor returns over the long term

I invested my first RRSP contribution in GICs. At the time, I expected to keep all my savings in GICs indefinitely. I didn’t think of myself as the sort of person who could succeed in the stock market. I later went through a phase of overconfidence.

Now I realize how easy it is to beat GICs over the long run with buy-and-hold low-cost indexing. GICs are great when you need the money in the short-term, but if I had stuck to GICs, I’d only have a fraction of my current savings.

Analyzing stocks takes a lot of time

This is more about loss of time than loss of money, but both are important. I used to believe I could pick above-average stocks and had convinced myself that I enjoyed all the work. But the truth is that I can’t get an edge on professional investors, and I enjoyed the idea of making more money and not the actual process of combing through the details of dozens of annual reports. I haven’t studied a stock in detail in years and I don’t miss it.

Overall, I’m better off avoiding both overconfidence and being overly cautious. To get rewarded we must take some risk, but we have to be careful to avoid big mistakes.


  1. Hi Michael.

    Now that you have used Norbert's gambit for some time, have you ever sat down and verified your savings over just investing in a Canadian version of the fund?

    1. @Paul: I've never added it up before because it's not close. A quick estimate I just did has my yearly MER + US dividend withholding tax savings about 20 or so times the cost of my yearly Norbert Gambits. This is likely very different for smaller portfolios.

    2. Michael, good post. I think it's interesting and perhaps constructive to reflect on our past, current ideas/practices to help towards future plans and goals. Mine have changed a lot.

      I also went through the typical investing evolution (MF, stocks, indexing), although was 100% equity until retiring 2.5 years ago and now ~48%. Having just read through the various links you attached it seems we have some similar thinking. No debt or leverage and especially into retirement,low costs, diversity etc. FYI, I didn't get any further than you have looking into annuities. I just can't see they make sense at this age and rate environment. I too want to avoid the big mistakes, although admittedly am probably erring on the side of caution currently. I can't help thinking of Larry Swedroes comment about "winning the race", and taking on only the risk you "need".

      We now have enough FI for about 12 years planned needs (in addition to 1 unindexed DB work pension and CPP/OAS years in future)factoring in inflation of 2.5% and taking us roughly to age 70. This does not include investment income which currently accounts for about 65% of our needs, (excluding tapping capital or any gains) Discretionary spending also makes up a good chunk of our spending and we can easily cut that back if we ever needed.
      I find myself strongly considering reducing our FI portion closer to your 5 yr target, over time or as good equity opportunities present. This comes from experience in retirement, the standpoint of how long a storm we could weather without selling equities, along with realities of low interest rates.
      For planning purposes our spending drops once at age 80 to 75%, and goes to age 95 and 96 for us.

    3. @RBull: I'd be very cautious about shifting asset allocation back toward stocks after the huge run-up we've had in the past 7 years. I'm not predicting a stock crash, but sometimes changing asset allocation is just a disguised way to sell low and buy high. Spending out of your fixed income and taking your time to make decisions makes sense to me.

  2. @MJ, a small error on my numbers. 52% equity/48% FI currently.

    Exactly what I have been doing, spending from FI and being patient for better equity valuations, with a goal to eventually change the FI allocation to approx. 6-7 years FI or in the 25-30% range.

  3. Great post Michael! I can see you have learned a lot throughout your years of experience.

  4. The exchange below is reproduced to remove broken links:

    ----- BHCh August 31, 2016 at 11:21 AM

    " I won’t invest money in stocks unless I believe I won’t need the money for at least 5 years"

    So, once you retire, you will move 5 years' worth of $s into fixed income and will keep doing that on an ongoing basis?

    ----- Michael James August 31, 2016 at 11:28 AM

    @BHCh: Yes. I wrote about this some time ago:

    ----- BHCh August 31, 2016 at 2:04 PM

    Makes sense. So... If there is a crash during your retirement, you would stop selling shares and hope that the market recovers in under 5 years? Should work in most cases.

    ----- Michael James August 31, 2016 at 2:18 PM

    @BHCh: That's the way most people would describe it, but I prefer something that takes my own judgement out of the decisions. As my total portfolio drops in value, my spending will drop too. However, I plan to smooth out the spending with filtering as described here:

    ----- BHCh August 31, 2016 at 3:27 PM

    Gee... Interesting. Can't see my wife buying into this kind of market-driven month-to-month expenditure routine.

    ----- Michael James August 31, 2016 at 3:33 PM

    @BHCh: I doubt it would change things much to keep spending constant for a full year or even 2 years at a time.

    ----- BHCh September 1, 2016 at 5:23 PM

    And yet statistically, people who buy annuities live longer.

    ----- Michael James September 1, 2016 at 5:59 PM

    @BHCh: It's too bad causation runs in the wrong direction in this case. I'd happily tolerate a lower income if buying an annuity made me live longer.