We often see debates about whether or not volatility of returns is a good measure of risk.  This debate is related to what I think is a bigger issue: the difference between perceived risk and actual risk.  Perceived risk is influenced by observations and “dollar bias,” but actual risk comes from the full range of what might happen and its influence on buying power. Dollar bias and buying power In some contexts we forget about inflation and view dollars as constant over time.  For example, we tend to focus on nominal returns and think that it’s okay to spend gains as long as we leave the principal intact.  But the principal will erode with inflation if we spend all the nominal gains. Another context where we see this bias is with mortgages.  We can calculate that with a 30-year $400,000 mortgage at 4%, the first year’s payments will only reduce the principal by about $7000.  But even with only 2% inflation, the buying power of the principal will erode by abo...

There is no shortage of studies showing that average investors underperform the market averages, often by 2-3% per year.  However, Barry Ritholtz’s excellent book How Not to Invest says that average investors underperformed by 5% per year one decade and only 2% per year the following decade.  How could this be?  It doesn’t appear to make sense.  So, I started digging. The Data Here are simplified version of the chart I saw on page 382: So, average investors trailed a basic 60/40 portfolio by 2.4 percentage points per year.  This is plausible.  Investors pay expenses, and some of them do some market timing.  Here is what I saw on the next page: This time the behaviour gap is 3.8 percentage points per year for 20 years.  Ritholtz makes the point that “The longer the holding period, the greater the impact of errors that disrupt compounding.”  This is true as it applies to the final dollar value of your holdings.  After all, 20 years of mis...

The 2024 investment return for my overall portfolio measured in Canadian dollars was 18.0%, which is below my benchmark return of 19.0%.  The difference is primarily due to my choice a few years back to adopt an automated plan that shifts gradually away from stocks when stock prices are high as measured by the cyclically adjusted price-to-earnings ratio (CAPE) of world stocks .  My benchmark doesn’t take CAPE into account. In years when stock prices are high but they give good returns anyway, this automated plan costs me money.  That’s what happened in 2024.  But I’m content with this outcome.  By shifting away from stocks when they’re expensive, my portfolio risk is lower at a time when stocks are riskiest.  I don’t expect my strategy to pay off during normal times.  I’m reducing my losses if we have a scenario where stock prices are high, and then they crash.  This is a kind of insurance, and it has a price during normal times. The method I use ...

Inflation is a risk we have to face in financial planning, particularly in retirement.  We need to measure inflation risk correctly to be able to make reasonable financial plans.  The best guide we have to the future takes into account past inflation statistics.  But the field of statistics is full of subtleties, and even Dimensional Fund Advisors (DFA) can make mistakes. DFA creates good funds, and their advisors tend to do good work for their clients.  I’d prefer to find errors in the work of a less investor-friendly investment firm, but they provided a clear example to learn from.  They misapplied a statistical rule, and as a result, they misinterpreted the history of inflation over the past century. I discussed this issue with Larry Swedroe in posts on X.  I respect Larry and have followed his work as he tirelessly explains evidence based investing to the masses. A Simple Example To explain the problem, let’s first begin with a simpler example.  So...

As we’ve learned in recent years, inflation can rise up and make life’s necessities expensive.  Despite the best efforts of central bankers to control inflation through the economic shocks caused by Covid-19, inflation rose significantly for nearly 3 years in both Canada and the U.S.   Uncertainty about future inflation is an important risk in financial planning, but most financial planning software treats inflation as far less risky than it really is.  This makes projections of the probability of success of a financial plan inaccurate.  Here we analyze the nature of inflation and explain the implications for financial planning. Historical inflation Over the past century, inflation has averaged 2.9% per year in both Canada and the U.S.(*)  However, the standard deviation of annual inflation has been 3.6% in Canada and 3.7% in the U.S.  This shows that inflation has been much more volatile than we became used to in the 2 or 3 decades before Covid-19 appeared...

Benjamin Graham is widely considered to be the “father” of value investing, the process of finding individual stocks whose businesses offer the prospect of future price gains while offering reasonable protection against future losses.  Graham co-founded Graham-Newman Corp. nearly a century ago.  Stock markets have changed drastically since then. Early in Graham’s investing career, his approach was to buy stock in companies that were out-of-favour and severely undervalued.  He described these methods in his 1934 book Security Analysis . But Graham’s investment methods were never static.  As Jason Zweig explained in Episode 75 of the Bogleheads on Investing Podcast : “People criticize Graham all the time for being old-fashioned, for having these formulaic techniques for valuing stocks, … and then people say these things are all out-moded.  Nobody invests like that any more.  Nobody should.  And that completely misses the mark for two reasons.  First...

Many people like to say that passive investing doesn’t exist.  However, these people make a living from active forms of investing and are just playing semantic games to distract us.  Active fund managers and advisors who recommend active strategies are the main people I see claiming that passive investing doesn’t exist, but what they say isn’t true. There is a continuum between passive and active investing; they are not absolute properties.  We can reasonably call an investment approach passive even if it involves some decisions, just as we can call a person thin even if their weight isn’t zero.  We may disagree on the exact threshold between passive and active investing, but the concept of passive investing still has meaning. By “passive investing,” most people mean some form of broadly-diversified index investing with minimal trading.  Although passive investing usually requires substantially less work than active investing, passive investors still have decisi...

When it comes to stocks, index investing offers many advantages over other investment approaches.  However, these advantages don’t always carry over to other asset classes.  No investment style should be treated like a religion, indexing included.  It pays to think through the reasons for using a given approach to investing. Stocks Low-cost broadly-diversified index investing in stocks offers a number of advantages over other investment approaches: Lower costs, including MERs, trading costs within funds, and capital gains taxes Less work for the investor Better diversification leading to lower volatility losses Choosing actively-managed mutual funds or ETFs definitely has much higher costs.  For investors who just pick some actively-managed funds and stick with them, the amount of work required can be low, but more often the investor stays on the lookout for better funds, which can be a lot of work for questionable benefit.  Many actively-managed funds offer dec...

Authors Tony Martin and Eric Tyson have updated their book, The Canadian’s Guide to Investing , but it certainly does not seem very up-to-date.  Despite a few references to ETFs and some updated examples, most of the text seems decades old and no longer very relevant.  There are some good parts, but there are better choices for investment books. The book makes reference to many things that used to be true.  Extensive discussion about “funds” is almost exclusively about mutual funds with little about ETFs.  Buying stocks is “costly unless you buy reasonable chunks (100 shares or so) of each stock.”  You can “call the fund company’s toll-free number” and invest by “mailing in a cheque.”  “A great deal of emphasis is placed on who manages a specific fund” – this is mostly a thing of the past.  “Invest in a handful of funds (five to ten).”  There is discussion of real estate “declines in the late 2000s.” There are repeated references to MERs of 0.5% t...

Suppose a casino offered the following bet.  You roll six fair dice.  If anything but all sixes shows up, you get $20.  But if all sixes show up, you lose a million dollars.  There are a number of practical problems with this game.  The casino would demand a million dollar deposit in advance, and the odds are way too sensitive to imperfections in the dice and to player skill at not throwing sixes.  But this is a thought experiment designed to shed light on real world financial events. Initially, few people would play this game, because losing a million dollars is too scary.  But if you watched someone playing, even all day, you’d likely never see a loss.  You’d just see the player collecting $20 every 10 seconds or so building up to many thousands of dollars.  The fear of missing out (FOMO) would set in for some and tempt them to play. Over the long haul, the casino expects to pay out $933,120 for every million dollars it wins.  So playi...

Tony Robbins’ latest book, The Holy Grail of Investing , written with Christopher Zook, is a strong sales pitch for investors to move into alternative investments such as private equity, private credit, and venture capital.  I decided to give it a chance to challenge my current plans to stay out of alternative investments.  The book has some interesting parts, mainly the interviews with several alternative investment managers, but it didn't change my mind. The book begins with the usual disclaimers about not being intended “to serve as the basis for any financial decision” and not being a substitute for expert legal and accounting advice.  However, it also has a disclosure: “Tony Robbins is a minority passive shareholder of CAZ Investments, an SEC registered investment advisor (RIA).  Mr. Robbins does not have an active role in the company.  However, as shareholder, Mr. Robbins and Mr. Zook have a financial incentive to promote and direct business to CAZ Investm...

One of the ways that investors seek status through their investments is to buy into private equity.  As an added inducement, a technical detail in how private equity returns are calculated makes these investments seem better than they are.  So, private fund managers get to boast returns that their investors don’t get. Private Equity Overview In a typical arrangement, an investor commits a certain amount of capital, say one million dollars, over a period of time.  However, the fund manager doesn’t “call” all this capital at once.  The investor might provide, say, $100,000 up front, and then wait for more of this capital to be called. Over the succeeding years of the contract, the fund manager will call for more capital, and may or may not call the full million dollars.  Finally, the fund manager will distribute returns to the investor, possibly spread over time. An Example Suppose an investor is asked to commit one million dollars, and the fund manager calls $100...

My investment return for 2023 was 13.0%, just slightly below my benchmark return of 13.2%.  This small gap was due to a small shift in my asset allocation toward fixed income.  I use a CAPE-based calculation to lower my stock allocation as stocks get expensive .  This slight shift away from stocks caused me to miss out on a slice of the year’s strong stock returns.  Last year, this CAPE-based adjustment saved me 1.3 percentage points, and this year it cost me 0.2 percentage points. You might ask why I calculate my investment returns and compare them to a benchmark.  The short answer is to check whether I’m doing anything wrong that is costing me money.  Back when I was picking my own stocks, I chose a sensible benchmark in advance, and after a decade this showed me that apart from some wild luck in 1999, the work I did poring over annual reports was a waste.  Index investing is a better plan. The next question is why I keep calculating my investment re...

There are many mistakes we can make when investing in mutual funds or exchange-traded funds.  Joe Wiggins discusses these mistakes from a unique perspective in his book The Intelligent Fund Investor .  He covers some familiar territory, but in a way that is different from what I’ve seen before.  Although most of the examples in the book are from the UK, the points of discussion are relevant to investors from anywhere. Each of the first nine chapters cover one topic area where fund investors often make poor choices.  Here I will discuss some of the points that stood out to me. “Don’t invest in star fund managers.”  There are many reasons to avoid star fund managers, but I never thought of lack of oversight by the fund company being one of them.  “Individuals working in risk and compliance have little hope of exerting any control – they are likely to be relatively junior and considered expendable.  If they go into battle against a star fund manager, ther...

Occasionally, a friend or family member asks for help with their investments.  Whether or not I can help depends on many factors, and this article is my attempt to gather my thoughts for the common case where the person asking is dissatisfied with their bank or other seller of expensive mutual funds or segregated funds.  I’ve written this as though I’m speaking directly to someone who wants help, and I’ve added some details to an otherwise general discussion for concreteness. Assessing the situation I’ve taken a look at your portfolio.  You’ve got $600,000 invested, 60% in stocks, and 40% in bonds.  You pay $12,000 per year ($1000/month) in fees that were technically disclosed to you in some deliberately confusing documents, but you didn’t know that before I told you.  These fees are roughly half for the poor financial advice you’re getting, and half for running the poor mutual funds you own. It’s pretty easy for a financial advisor to put your savings into some...

My portfolio lost 4.9% in 2022, while my benchmark return was a loss of 6.2%.  This small gap came from my decision to shift to bonds based on a formula using the blended Cyclically-Adjusted Price-to-Earnings (CAPE) ratio of the world’s stocks .  After deciding on this CAPE-based approach, all the portfolio adjustments were decided by a spreadsheet, not my own hunches.  I started the year 20% in fixed income, it grew to a high of 27% as the spreadsheet told me to sell stocks, and now it’s back to 20% after the spreadsheet said to buy back stocks.  This cut my losses in 2022 by 1.3 percentage points. My return also looks good compared to most stock/bond portfolios because I avoided the rout in long-term bonds.  My fixed income consists of high-interest savings accounts (not at big banks), a couple of GICs, and short-term bonds.  If long-term bonds ever look attractive enough, I may choose to own them.  My thinking for now is that I prefer the safe part ...

When I’m asked for investment advice and I say “nobody knows what will happen to an individual stock,” I almost always get nodding agreement, but these same people then act as if they know what will happen to their favourite stock. In a recent case, I was asked for advice a year ago by an employee with stock options.  At the time I asked if the current value of the options was a lot of money to this person, and if so, I suggested selling some and diversifying.  He clearly didn’t want to sell, and he decided that the total amount at stake wasn’t really that much.  But what he was really doing was acting as though he had useful insight into the future of his employer’s stock. He proceeded to ask others for advice, clearly looking for a different answer from mine.  By continuing to ask others what they thought about the future of his employer’s stock, he was again contradicting his claimed agreement with “nobody knows what will happen to an individual stock.” Fast-forwa...

FP Canada Standards Council puts out a set of portfolio projection assumption guidelines for financial advisors to use when projecting the future of their clients’ portfolios.  The 2022 version of these guidelines appear to be reasonable, but that doesn’t mean they will be used properly. The guidelines contain many figures, but let’s focus on a 60/40 portfolio that is 5% cash, 35% fixed income, 20% Canadian stocks, 30% foreign developed-market stocks, and 10% emerging-market stocks.  For this portfolio, the guidelines call for a 5.1% annual return with 2.1% inflation.  This works out to a 2.9% real return (after subtracting inflation). We’ve had a spike in inflation recently, but these projections are intended for a longer-term view.  The projected 2.9% real return seems sensible enough.  Presumably, if inflation stays high, then companies will get higher prices, higher profits, their stock prices will rise, and the 2.9% real return estimate will remain reasona...