Have you:

  • Spent a sleepless night thinking about your investments ?
  • Considered getting out of the stock market and never going back?
  • Contemplated that your target retirement date will have to be deferred?

If your answer is “yes” to any of these… read on!

Most of us like to see our lives progress in some orderly fashion… too slow can cause ennui and too fast can cause stress. We would like our investments to understand our nature and act similarly. Unfortunately, the stock market does not! Much of the time, it lurches in fits and starts, up and down, usually over-shooting the enthusiastic times upward as well as the pessimistic times downward…. never getting it “just right”. The last four years have been thus, and presently we are in a serious and prolonged dip, with a long list of characters and events upon which to cast the blame.

In the dot.com euphoria a few years ago, the meteoric rise in the markets was justified at the time by saying that “Now everything is different. The past cannot be extrapolated to the future. Valuation models ought to change to reflect the New Economy versus the Old Economy.” You don’t hear those terms “old and new” much these days. This time, in the depth of market despair, we hear pundits predicting a prolonged wasteland of equity returns because “Things are different. The past cannot be extrapolated to the future.” Innovation has been the constant foundation of economic growth in the last century. If anything, the rate of innovation is accelerating. For instance, desktop computing is only twenty years old and spawned significant wealth opportunities. Will there be something else in the next twenty years? Bet on it!

If you follow the newspapers or read the Trendline graph to July 31, 2002, you will see that the various indices of world equity markets are all bad….Canada and the Pacific Rim leading the pack at –10%, Europe at –18% and the US at –22%. Meanwhile, bond returns are 4 to 5% and inflation is approximately 2%. If your equity holdings are actually tracking these indices, then you are suffering badly.

This is when the investment advisor trots out the ole “balance and diversification” line… yup… here it comes again, because it makes sense in a sometimes senseless world.

We have prepared 153 annual reports from October through July, which encompasses a period of significant gloom. The vast majority of these portfolios are “balanced” in some measure. In that ten month collection of reports, there were only three negative-return months (last Fall) for the median return (the average that downplays significant outliers, i.e. really high returns and really low returns), and those were in the –2% range. The other medians were all positive, as high as 5.55% in March and 3.56% in July. The simple averages were a little worse, but only marginally so. The worst month was –3.7% (October) and the best was 5.22% (March).

Let’s look further at some specific examples of asset allocations and returns drawn from our portfolios over the last five years. The following table shows results for five actual clients with different asset allocations in their portfolios. The last column shows the end value of their portfolios if they each had started with $100,000 at the beginning of the five years.

Asset Allocations: Annual returns:
 Client  % FI  % CE  % FE  1998  1999  2000  2001  2002  End Value
A  100%  0%  0%  4.26%  5.34%  6.04%  5.77%  5.40%  $129,833
B  80%  10%  10%  2.93%  4.17%  4.06%  6.59%  5.93%  $125,981
C  55%  25%  20%  18.14%  1.42%  18.98%  2.11%  -0.45%  $144,912
D  40%  40%  20%  17.28%  1.09%  10.81%  11.69%  -2.29%  $143,372
E  0%  75%  25%  34.60%  9.09%  29.50%  4.64%  -3.90%  $191,215

FI=Fixed Income CE=Canadian Equity FE=Foreign Equity

As can be seen, Client E has ended up with the highest end value with 100% of the portfolio invested in equities; yet, in 2001 and 2002, this client had returns lower than the majority of other returns. Also, this client’s returns varied most widely over the five years. Client A had the least volatility in returns due to the low percentage of the portfolio invested in equities and ended up with the lowest end value. The 5-year compound returns ranged from 5.3% to 13.8%, with the balanced portfolios (Client C & D) at 7.5%. As the golden investment rule goes, the potential for higher returns comes with taking on additional risk— and, how well the last five years have taught us that lesson!

The Press is full of advice on what one’s asset allocation should be. For instance, a recent article in the Globe&Mail suggested that those under 45 should be 100% in stocks and those over 76 should be 100% in bonds and cash. While such advice is generically interesting, it is useless for the individual investor. Why? Because every situation is different. Someone with a healthy company pension until death has a different situation than an entrepreneur living off an RRSP until death. Someone with considerable wealth and no risk of out-living their capital in fact is implicitly or explicitly accumulating wealth for their estate. Thus, it may be appropriate to invest that wealth to match the risk profile of the ultimate (younger) beneficiaries.

The asset allocation plan that is right for you is a combination of a bit of soul-searching plus some hard fact-gathering that purposefully answers the question “What is the money for?” Proper financial planning and retirement forecasting are at the root of a good answer.

In conclusion, while a 3% return on a balanced portfolio does not seem very inspiring, it does exceed inflation, it is a long way from the –20% for a 100% equity portfolio, and it is at least “asset-sustaining” through a period of wreckage. Also, it will place you strategically ready for when the markets turn up again. Remember that history long has proved that when the markets wake up, they do so in dramatic fashion, not in gradual crescendo, so you have to be there when it happens.

Article Published: Fall 2002