Wednesday, 24 December 2008

Investing During Deflation

How quickly things change. A few months ago, the big fear was inflation as gas, food and other prices climbed drastically. Suddenly deflation is on the minds of governments and central banks - see Canada Faces Deflation Threat from

Deflation is the opposite of inflation. Instead of rising prices, deflation is generalized and persistent falling prices, reflected in negative changes in the Consumer Price Index. With deflation, a dollar tomorrow is worth more than a dollar today.

Just as inflation presents challenges and opportunities for the investor, deflation does too. The investing winners and losers differ, and thus also the investments to survive and thrive in that environment.

Creditors (those who have lent out money) benefit, and debtors (those who have borrowed) suffer. Owning debt securities pays off, even when interest rates may be low since part of the payoff is that the future dollars are worth more. The longer the debt lasts and deflation continues, the greater the benefit, so longer maturity debt benefits most.

However, the conditions that create deflation, like a precipitous fall in demand in a weak economy with attendant job cuts, business failures and such, also considerably raise the risk of default. The safer the debt, the better. At the top of the list is government debt or government-guaranteed debt, the theory being that governments can avoid defaulting by raising taxes. Some governments are, of course, more likely to pay your money back than others, the top of that list generally considered to be the US government. Debt rating agencies do rate government debt - see previous post Seeking Safety. Due to risk of default, corporate debt tends to do less well, though debt of companies perceived to have the ability to survive, like many utilities, may be ok.

Sample investments: Government of Canada 30 year maturity (see various options at, US 30-year Treasuries, GICs

Equity - the debtor effect carries through into companies/equity. Some companies will struggle and others will thrive.

  • Companies with a lot of debt on their balance sheet.

  • Companies with lots of cash or free cash flow will be able to acquire the weak at bargain prices.
  • Companies able to maintain profit margins will do well. That includes those which can reduce their costs as quickly as their prices fall and those which can maintain their own prices even as prices fall generally.
It is impossible to make statements that entire sectors are good equity investments during deflation. The only way ultimately is to dive into the financial innards of each company. The disciplines of fundamental analysis and value investing serve the investor more than ever,

One interesting security that stays fine in either inflation or deflation is real return bonds issued by governments. In addition to their safety, when there is inflation, the government ratchets them up by CPI to maintain purchasing power and when deflation occurs, they go down by CPI, but again their purchasing power stays the same. You neither win nor lose, just get a steady return in real terms. More at ByloSelhi - RRBs.

Though the idea that things might cost less is certainly attractive from a consumer point of view, deflation is symptomatic of problems in the economy. Governments and central banks are highly likely to step in to stop deflation so in addition to the best type of investment, one must consider whether it will actually occur.

Further reading:
Implications of Inflation and Deflation for Investments from Yanni Partners
How Does One Invest for Inflation and Deflation? at Mish's Global Economic Trend Analysis

Monday, 22 December 2008

Closed-End Funds - Opportunity vs Risk

A Closed-End Fund (CEF) is an intriguing beast that currently offers potentially highly attractive investment returns but, as usual, there are risks.

The CEF is similar to the mutual fund and the exchange traded fund (ETF), as seen in the following table.

What makes the CEF intriguing is that unlike both mutual funds and ETFs, a CEF's market price may vary considerably from the sum of the values of the securities held by the fund, called the Net Asset Value (NAV). Most commonly the CEF's market price is lower by 2-6% than the NAV, which is termed trading at a discount. Sometimes, however, there is a premium.

The following partial list from GlobeFund's Closed-End Fund report, sorted by discount/premium, shows that the divergence at the moment is extreme with many enormous discounts.

More than half of 225 Canadian CEFs are currently trading at over 10% discount. NAV is supposed to represent the true value of the fund holdings and CEFs are obliged to report changes as often as the market price of their holdings change. Buying a heavily discounted CEF is an opportunity to buy a bargain. The "% off" sale may now be at a peak.

Why the steep discounts and is the opportunity real? The answer arises from the risks of CEFs:
  • Illiquidity - CEFs trade in lower volumes and may be harder to sell quickly, especially so with smaller funds; this is considered to be a permanent reason for a small discount
  • Leverage - some funds use leverage or borrowing to enhance returns, which works fine in good times but punishes in bad times; the credit crunch combined with leverage is what appears to be the undoing of Bayshore Floating Rate Senior Loan Fund (TSX: BIF.UN) first on the list at a 92% discount and about to be wound up
  • Credit Quality - fixed income CEFs may suffer when worries about credit quality of holdings increase, even if the official ratings stay the same
  • Equity Concentration - a CEF with a high concentration of shares in a sector or a particular company will have higher volatility. Perhaps this is what is affecting (66% discount to NAV) First Asset PowerGen Fund (TSX: PGT.UN), which has around half its assets invested in a private company developing wind farms and other renewable power generation
  • Market Sentiment - since a CEF's price is market-determined separately from the NAV, the CEF as a vehicle may fall out of favour independent of its holdings; many CEFs do not have redemption privileges or repurchase schemes that keep price in line with NAV, unlike ETFs; the "flight to safety" of the current financial crisis may be especially harming CEFs. If fear is driving higher discounts, in some cases there may be true long term bargains amongst CEFs.
What I think CEFs are best suited for:
  • bargain hunting, where the discount is large and where the NAV appears to be solid after due diligence research into the CEF and its holdings
  • specialized sectors such as high yield bonds, US municipal bonds, emerging market equity and debt, small cap companies, where a fund is desired but low-cost ETFs or mutual funds are not available; some asset classes where CEFs are more numerous and successful -
  • a long term investment to produce regular income at a higher return (from the discounted NAV)
Where to Find:
Listings & CEF Company Links

Sunday, 30 November 2008

ETF and Mutual Fund Distributions Explained

Investors who own ETFs and mutual funds in taxable accounts (i.e. this does not apply to tax-protected accounts such as RRSPs) may be surprised and puzzled this year to receive T3 tax slips that show capital gains to be reported on their income tax return. After all, in 2008 stock markets had one of the worst years in living memory with the TSX down 35%. How could there be any gains one might ask?

Even in normal years of market advances, an investor may wonder why there are taxes to be paid if none of the investment was sold and no cash received.

The explanation revolves around distributions. Confusion arises because the word distributions is used to refer both to cash paid out to investors and to income attributed to investors for tax reporting purposes. In both cases, distributions consist mainly of capital gains, interest and dividend income generated during the year by the stock or bond holdings within the fund.

All Income Taxed as if Received by Investors
All ETFs and most mutual funds are structured as trusts, which means that to minimize taxes they pass along all income to investors to be taxed in the investors' hands. "Pass along" often means an actual cash payment to the investor but it may not.

Income Reinvested Automatically by Mutual Fund is Taxable
Mutual funds offer investors who want to reinvest income the convenient optional service of automatically buying more fund units with the profits instead of going through the complication of sending out cash only to have the money sent back to buy more units. The investor never sees the cash but receives the profits so it should not be disappointing to be required to pay taxes on the profits.

In the case of ETFs, interest and dividends are always paid in cash to investors either monthly, quarterly, semi-annually or annually. There is no option to have this income automatically reinvested as with mutual funds. The Managing Taxes document from iShares Canada explains why.

Cash Distributions May be Boosted by non-Taxable Return of Capital
It happens fairly often that funds distribute more than their income in a year. The excess is in effect paying back some of the investor's original investment and is termed a Return of Capital. This is not taxable.

Taxable Capital Gains When the Fund Sells: Investor Sees no Cash
Capital gains (or losses) arise when the fund sells and makes a profit during the year; the investor has not sold anything, the fund has. The net of all the sales during the year is calculated by the fund and the capital gains are attributed to the investor for purposes of tax reporting. Such gains are not usually paid out in cash to the investor; instead they get reinvested within the fund through new purchases.

The TSX had reached a peak in mid-June 2008, so stocks sold within a Canadian equity fund up to that point could well have made a capital gain and if few stocks were sold at a loss during the subsequent downturn before the end of the year, the fund might be reporting a net capital gain for 2008. That does turn out to be the case for instance, with the popular iShares Canadian Large Cap 60 Index ETF (symbol XIU). A press release of Dec.24 says XIU has generated a reinvested distribution of $0.14652 per share, which investors will soon see in box 21 on a T3 slip from their broker to be included on their tax return.

Taxable Capital Gains When the Investor Buys(!)
An investor who buys a fund late in the year just before the year-end capital gains distribution can end up paying tax for gains made much earlier in the year. Funds use the list of owners as of a certain date (termed the record date) to parcel out the year's gains, most often December 30th. The T3 the investor receives tells the tale. It may be better to defer the purchase till the new year. Fund companies normally publish year-end distribution estimates in advance of the record date so that investors can avoid the nasty surprise if a big capital gain is in the offing.

Taxable Capital Gains When the Investor Sells: Investor Sees Cash
A separate taxable capital gain (hopefully! or perhaps a loss) occurs when the investor sells all or part of a holding in a fund and the proceeds exceed the net purchase cost. The investor will NOT receive any T3 tax slips from the fund company to use on his/her tax return. It is up to the investor to calculate and report the gain.

Additional Info:
ETFs - iShares Canada Distribution History links for each fund - e.g. for XIU
Claymore Canada Tax Information Guide for 2007 (2008 tba) covering all its funds

Mutual Funds - follow links to fund companies at and look for Tax or Distribution info at each company's site; a typical handy guide is Mackenzie's Mutual Fund Tax Guide

As always, this post is not to be taken as advice. If you are unsure how to handle distributions, contact an accountant or other financial professional.

Thursday, 20 November 2008

ETFs - What are They Good For?

ETFs are in the news these days. Jonathan Chevreau's November 6th column at the National Post described the curious situation of significant net withdrawals in September and October by Canadian investors from mutual funds while certain Exchange Traded Funds (ETFs) saw large net purchases.

Their being in the limelight does raise the question of what ETFs are, their strong and weak points and why they might be attractive to an investor.

What are ETFs?
Exchange Traded Funds are funds that hold numerous individual stocks or bonds. ETFs are bought and sold as shares on stock exchanges (thus the name). Each share owns a tiny part of dozens, hundreds or even thousands of individual stocks or bonds. ETFs are built to copy the compostion of an index, such as the TSX60, the S&P500, the Dow Jones or some other index, such as the UK FTSE, the Eurozone, the Far East, commodities, currencies, large/small companies, or sectors such energy, mining, financials, real estate etc.

The number and variety of ETFs is growing steadily. As of early November 2008, there are over 800 US-exchange traded ETFs and 60-odd Canadian-traded ETFs available to a Canadian investor through any discount broker.

More background:
Strengths and Weaknesses of ETFs
The following chart should be self-explanatory, except for the last line, which is deliberately repeated! An index fund will necessarily do no better (actually, a little less by the amount of costs the fund incurs) than the index it tracks, the average of that particular market. That is bad in the sense that you will never get rich quick through amazing returns. But it is good in the sense that the vast majority of mutual funds over any extended period of years under-perform the market (see the latest results from Standard and Poor's SPIVA Canada Scorecard where for example, only 6% of activle-managed Canadian equity mutual funds outperformed the TSX index over the past 5 years ).

What ETFs are Best Suited For
Given their characteristics in comparison to individual stocks and bonds and mutual funds, here is how I believe ETFs can most be most useful to an individual investor:
  • Buy and hold passive investing with low time and attention needed for portfolio management
  • Portfolio-oriented investing where diversification, deliberate asset allocation with non-overlapping funds, infrequent rebalancing (max once a year) and risk control are key to the investment approach
  • Long-term investing
  • Fixed income bond holdings (and like all fixed income, ideally held within a registered account to minimize tax from interest income)
  • Equity holdings in taxable accounts
  • Larger new amounts to add to a portfolio (e.g. a $10 commission on a $1000 purchase is 1% initial cost, about the max I would accept for myself)
  • Larger market cap equity holdings and developed country markets, since these are the most efficient and where it is most likely that mutual funds will not outperform; conversely, small caps and emerging markets are where mutual fund managers have better chances of outperforming
Whether it is the inherent qualities of ETFs or some other factor that caused people to buy them while mutual funds were being sold off recently is open to debate but their value and usefulness is certain.

Thursday, 13 November 2008

Time to Put Readers to Work ... and There's a Reward!

There isn't only one answer or source of information when it comes to investing. A diversity of views and good ideas can come from many sources, both professional and amateur.

This blog would like your input and as a reward, two people selected randomly from those who answer, one for each category, will receive a copy of Dr. Sherry Cooper's well-regarded recent book The New Retirement. See reviews on Chapters Indigo, Amazon, CanadianFinancialDIY.

Your task: in a Comment at the bottom of this posting, either,
  1. Name either your favorite investing book and a one line summary on why it is useful to you as an investor, or
  2. Name and provide a link to your favorite online investing website, whether it's a blog, news site, data site etc and again say in one line why it is useful.
That's it.

I will use the responses to build some permanent lists and links to make this blog more useful for everyone.

Use something other than "anonymous" as your comment name so I can get in touch with the winners and mail out the book, which will require having the winners' postal address. You will not be put on a mailing list or be receiving ads, junk mail or anything else except the book. The contest closes in a week from this post on November 13th, i.e. midnight on November 20th.

Thursday, 6 November 2008

Not Everything is Down! Some Stocks are Up!

The seemingly unceasing gloomy financial news and plummeting stock markets could easily cause one to conclude that every stock has lost ground. Take heart, there are some winners in the markets!

The two screenshots below show the results of searching through the Toronto and New York stock exchanges for any stocks that have not gone down over the past year and for 2008 to date, i.e. that have survived the general meltdown. In both cases, I also specified that the company would have to be a reasonable size with active trading to eliminate the wacky, probably anomalous holdings.


USA (NYSE only)

In both markets, there are many companies, though they are decidedly a small minority compared to the overall number in the market, that have held their ground or even advanced significantly. Moral of the story - even in the worst of times like right now, there are still winners. And some may surprise - note some financial companies doing well, like Bank of America (NASDAQ symbol: IKL) in the US and Fairfax Financial (TSX symbol: FFH) in Canada.

The trick is, of course, finding them in advance (since finding them after the fact is like getting to the scene of a great dinner party the morning after - there may be a few leftovers but the good stuff has already been eaten).

Finding the winners requires research. A good way to start is to use the stock screeners with which I zeroed in on this year's year-to-date winners. Stock screeners let you specify criteria, for price, company size, sector, growth rates, profitability, usually along with analyst ratings. They allow searching through ETFs and mutual funds too. The best free one I know of for the Canadian market (it covers US markets too) is at GlobeInvestor. For US markets, an excellent free screener is Google Finance's, which has visual sliders that tell you how many companies are left as you go along. When you sign up with a discount broker, there is a screener tool available online as part of the package. In the today's example, it is BMO Investorline's, where I happen to have an account. BMOIL uses the enhanced Gold version of GlobeInvestor.

What your research aims to uncover in order to identify those winners is the million dollar question, easy to say in principle but very hard to assess in reality and a fine topic for future posts. For today, it's enough to remind ourselves to stay the course and not lose heart.

Thursday, 30 October 2008

A Falling Canadian Dollar Can be An Investor's Friend

The week of October 6th to 10th was remarkable in several respects. Stock markets around the world suffered horrible record-breaking declines as government attempts to deal with the credit crisis seemed not to be working. No market was immune. The Toronto TSX Index fell 16% in the week, the US S&P 500 Index dropped 18%.

The Canadian dollar (CAD) also fell off a cliff compared to the US dollar (USD). From a value of about $1.10 Canadian on Oct.3, by the end of the day on Oct.10th, the USD rose (i.e. CAD fell) to $1.19, an unprecedented 9% shift. But that fall in CAD was actually beneficial to the Canadian investor with foreign holdings.

Here's how this benefit worked. In the chart below, I've taken a popular Exchange Traded Fund similar to the S&P 500, the Vanguard Large Cap Index Fund (with NYSE trading symbol VV) and graphed it in its original USD value as well as its value converted to CAD. The result - instead of the 18% drop, a Canadian owner of VV would only have lost 9%.

On October 10th, the value of VV in Canadian dollars actually rose despite the continued decline of VV in US dollars because the currency effect was stronger.

Naturally, the effect can work the opposite way too. As the Canadian dollar rises against the US dollar or any foreign currency, as has occurred more gradually over the last several years, the value of foreign holdings will be reduced. The net effect depends on whether the currency shift is greater than the stock market movement.

The currency effect extends to all currencies, not just the US dollar. An investor with a holding such as iShares Europe, Australasia and Far East Index Fund (traded in the US on AMEX under symbol EFA and available to Canadian investors) sees its value change according to foreign stock market results in those countries as well as the movement of the many national currencies such as Great Britain's pound sterling, Japan's yen, Europe's euro etc against the Canadian dollar. Note that EFA, despite being sold on a US exchange in US dollars, is actually not influenced by the US dollar, only the Canadian dollar and the other foreign currencies. CanadianFinancialDIY explains why this is so.

In the past year, the Canadian dollar has gone down simultaneously against most currencies. The chart below shows CAD vs other currencies from the RatesFX website.

This has helped cushion the brutal declines in stock markets around the world for an investor with internationally diversified holdings.

Although it is possible to buy funds that remove the fluctuations due to currency by hedging - an example being the iShares Hedged EAFE Index Fund (symbol XIN on the TSX), which is the same as EFA except with currency effects removed - most professional fund managers do not think the costs of hedging worthwhile. Currency swings tend to run out of sync with market moves and reduce the volatility of a portfolio with international holdings. This is a benefit to the investor, as seen during the gut-wrenching week of October 6th to 10th, 2008.

Thursday, 23 October 2008

Seeking Safety: Assessing Default Risk

How safe is safe? The current market turmoil and the spectre of numerous failed, acquired and bailed-out banks in the US, the UK and Europe, though not in Canada, raises questions about the safety of investments, even those considered the least risky.

When looking for "safe" investments, most people have in their minds whether or not the invested capital and any interest owing will be paid back, which is termed credit or default risk. But any guarantee is only as good as the strength and reputation of the party making it, which may or may not be the institution where you invested the money. So what are the assurances or guarantees and who are the backers for some common securities?

Equities are very high risk in terms of default risk since no one makes any promise to pay anything back.

Brokerage Account Cash - the industry-funded body Canadian Investor Protection Fund (CIPF) promises to reimburse investors up to $1 million in cash (or other holdings) per account at member companies in case of their insolvency. This includes US dollars or other foreign currency, unlike CDIC coverage. At the end of 2007, CIPF had over $500 million available, which seems like a lot but it has to cover $1.3 trillion of assets at brokerages, most of which is invested in federal and provincial bonds. Is that enough? Since 1969 CIPF has had to pay out only $36 million in total. Is that past a guide to the present? The FAQ answers many questions about coverage.

T-Bills, Federal/Provincial Savings Bonds, Real Return Bonds, Federal/Provincial Bonds - their safety all depend on the credit-worthiness of the federal or individual provincial governments. And they are not all the same. In addition, there are numerous federal and provincial agencies and crown corporations (e.g. Ontario Hydro) issuing bonds and their riskiness is unique to each organisation.

Corporate Bonds - they all depend on the strength of the individual company but are almost always below government bonds.

Obviously, it is impossible for any investor to keep track of and perform risk assessments on all these issuers. Enter the ...

Credit Rating Agencies - companies that assign credit ratings on the issuers of debt as well as the obligations themselves. The main ones are:
Each has a number of classes according to the level of risk but they may give different ratings for the same organisation - after all it is estimation of what will happen in the future and there is judgment involved. Despite their best efforts they can be wrong. The government of Canada's is in the very best class but various provinces are rated lower, though still considered to be high quality. DBRS rates the City of Montreal the same as Enbridge Pipelines at A+ (high).

Like many things in life, safety is a relative and shifting measure.

Wednesday, 15 October 2008

Investing in a Recession and Avoiding Depression

Recession talk is common these days. The CBC reports that the OECD has forecast minimal growth for Canada in 2008 and is heading for a recession, while in the USA the Boston Globe says Economic Data Point to Recession.

Stock markets have suffered accordingly and you may be feeling like this man contemplating the decline in the Toronto Stock Exchange Index and the US S&P 500 (chart from Google Finance and photo from the Santa Barbara Independent).

So what can an investor do to minimize losses and take advantage of opportunities?

Stay in the Game - that may sound ironic, a prescription to lose more money and go down with the ship but ... is the ship really going down? The market may take years to recover but it almost surely will. When stock prices have gone down and negative sentiment prevails, it is an even better time to invest than when markets are rising and high. Buying now is buying low, maybe not the absolute lowest but getting attractively low, especially in the US and the UK. I strongly believe that someone investing for retirement years away should continue with a regular saving and investment plan.

Own Sectors with Staying Power - some types of companies and investments tend to hold up well even in bad times. Products and services that are essential will continue to be bought. Others may even leap ahead, either because they are a cheaper substitute for more expensive consumer goods, or because they provide a diversion or small luxury to replace the big ticket items that people defer buying.
  • Consumer staples - food, beverages, personal care and household products - see this Motley Fool article
  • Utilities - power generation, pipelines
  • Alcohol and tobacco
  • Pharmaceuticals
  • Bus transportation
  • Entertainment
  • Precious Metals, Timber and Commodities - see NuWire Investor
  • International markets - not all countries are equally affected by downturns; diversifying with the addition of foreign holdings will lessen the downward drops
  • Fixed Income in general and High-yield aka Junk Bonds - read this SmartMoney column to find out why
  • Banks!! - this may seem strange since this recession is due to the banking crisis. Bank stocks have been hammered in consequence so why buy? The opportunity stems from the fact that good bank stocks have been dragged down with the bad so this is an opportunity to buy low. The challenge is figuring out the good banks from the bad. Research and thought will be required. Check out Canadian Banks and Insurance blog for data, news and analyst reports. Online brokers like BMO Investorline and others have plenty of data and research reports on banks in Canada and the US.
Diversify - In my opinion, the most important strategy is to hold a diversified portfolio of investments and to exercise patience for the economy and markets to recover. It is well-nigh impossible to tell in advance when markets will recover from recessionary losses. By the time you can be certain of a recovery, it will already have happened (see a table of past US recessions and how variable they were in Wealth Daily's Recession-Proof Investments).

With wise action by the authorities, the economy should avoid depression (see CBC's report Replay of Great Depression Unlikely: TD Bank Says). With wise investing, there's no need for an investor to suffer depression either.

Monday, 29 September 2008

Riding the Investment Roller Coaster

If you are a stock market investor, lately the ride has felt distinctly like a roller coaster - gut-wrenching daily swings up and down, things going topsy turvy as major financial market players with long histories go bankrupt or get acquired in distress sales. It would be no surprise if you feel like the "I can't look" mother and terrified daughter on the real coaster in the photo.

In the last year, markets worldwide have suffered significant losses, as the chart below from Google shows (the blue line is the Toronto TSX Index, the red line is the US NASDAQ, the orange line the US S&P 500 Index and the green line the Exchange Traded Fund from iShares that tracks the EFA Index representing Europe, the Far East and Australasia).

What, therefore, should an investor do to make the ride less stressful, since unlike a roller coaster, which is just a trivial amusement, serious savings for retirement, a house or education are typically at stake?

Short-term Tactics
  • Protect against drops (hedge) with options - e.g. buy put options (see Put on Investopedia); like all insurance, there is a premium so this can get expensive
  • Protect against drops in stocks you own using various types of Stop Orders (see BMOIL's FAQ on Stops)
  • Do the "buy low" part of the old dictum Buy Low, Sell High - the survivors of the current financial debacle might well get stronger; the challenge is figuring out whether an individual company is a winner or a loser. Diligent homework and perhaps a bit of luck is required.
Long Term Strategies
  • Acknowledge the difference between short term swings and longer term market upward movement and stay in the game. The Google chart below shows the same market indicators since 2002, a mere six years ago - they are still significantly positive. Cast your mind forward six years, or better 10 or 25 years, and ask yourself whether the markets will be up. Nothing in life is guaranteed and markets could stay down a long time (Japan since 1990 being an example) and if you are convinced that is the case, pull your money and stay out. The worst thing to do is to try pulling out temporarily until better days arrive - many studies have shown that investors who try to time markets this way end up losing money compared to simple buy-and-hold (e.g. How to Handle a Market Gone Mad by Jason Zweig). The roller coaster always returns intact despite the scary ride. Trying to jump out of the coaster in motion is not advisable!

  • Adopt a portfolio suited to your psychology - if your ride creates real fear, maybe you should be on a tamer coaster, i.e. with less volatile investments. Maybe the girl should not have sat in front. Note in the photo how the lady in the second row seems to be calm and smiling to her child and the kids in the back are whooping it up! Partly, I believe this is a matter of getting used to it - having gone through the tech slide in 2001/02 this downturn is much less stressful for me.
  • Diversify your portfolio - as noted before in this blog in posts about portfolio design, having a number of stocks will dampen the swings and minimize the impact of disasters like the Lehman bankruptcy. Mixing in fixed income will further reduce variability and downward movements.
Ultimately, the stock market is not like a roller coaster - it does not return you to where you started out, it tends to end up higher.

Monday, 15 September 2008

Investments to Protect against Inflation

Inflation has been mercifully tame for years but the recent spikes in gas and food prices has raised the menace of this scourge, which eats away at savings and investments by reducing purchasing power.

What are some ways for an investor to gain protection from inflation in a portfolio?

Real Return Bonds: this is the surest and safest inflation-fighter. Such bonds (in Canada) are issued mostly by the government of Canada with a few offerings by provinces. They are thus ultra-safe. The critical component of inflation-protection is ensured by the continual adjustment of both the interest payment and the principal for Consumer Price Index inflation. RRBs do not pay a high return - the real yield is hovering around 1.6 to 1.7% currently. They are best held in an RRSP or other registered account since the interest is taxable. To buy them you would need to phone the bond desk of your brokerage, as they are likely not available online. Minimum purchases are usually $5000. Get more info from CanadianFinancialDIY, ByloSelhi and current yields at

Equities: in the short term, inflation will harm the stock market, driving down prices but in the long term (i.e. ten+ years) companies can and do increase their prices to restore their profits and stock prices recover accordingly. This is an overall effect and individual companies can suffer lasting harm so the protection is more at a portfolio level. To benefit from this protection you need to have a broadly diversified portfolio, more or less the entire stock market. I believe the best way to achieve this is through market index mutual funds such as these listed on ByloSelhi, or similar ETFs, some of which are traded in Canada on the TSX, such as iShares Canada's and others on US exchanges. Seeking Alpha has a comprehensive list of worldwide ETFs.

Commodities: The agricultural products, industrial and precious metals, livestock and oil / energy goods that make up commodities tend to rise in price along with inflation. Indeed, the current inflation surge comes directly from energy and food price increases. Gaining protection from commodities fortunately does not require storing a big pile of wheat in the garage since there are funds focused on commodities. To invest, there are US-traded ETFs such as:
The Canadian stock market itself, apart from the financial sector, is about two-thirds composed of resource companies and most of the main commodities are represented within those companies. A company's profits do not exactly match resource price swings but there is nevertheless a fair degree of inflation protection from commodities in the TSX. To give more weight, consider these ETFs:
  • iShares Canada - Energy (XEG), Materials (XMD) and Gold (XGD)
  • Claymore Canada - Global Mining (CMW), Oil Sands (CLO) and Global Agriculture (COW ... nice to see a sense of humour with the symbol!)
There are other investments sometimes touted as inflation hedges - tangible assets like fine art, wine, land and real estate. Apart from real estate, such assets can be hard to buy/sell (illiquid) and difficult to diversify. Real estate often doesn't rise with inflation, now being a prime example, so it is not nearly as good protection as the main options above, which should do an effective job relieving you of the worry of inflation. It's annoying enough to drive up to a gas pump these days. Having a little gas in your portfolio can salve the pain.

As usual, these are my thoughts and opinions, not investment advice to you. Make your own choices.

Thursday, 31 July 2008

A Written Investment Policy, Don't Invest a Cent Without It

Once you have done all the homework described in the preceding posts, it makes sense to capture the conclusions and to write down how you will manage your investments - the objectives, the assumptions and the rules by which you will buy and sell. The fancy title for this is the Investment Policy Statement.

This need not be a daunting 20-page document. In fact, try to make it too long and detailed and it won't get done or followed (think of how well those 500 page policy manuals at work are followed!).

Below is a table with two fictitious examples of how such a policy might look. Please note that they are for illustration only and should not be taken as advice. You need to do your own.

Note how the examples differ according to the different circumstances of the investors. They reflect objectives, risk tolerance, time horizon, capacity and interest in actively managing the investments, existing assets and expected returns or income.

One thing not included but which could be is "who decides". Most times, it is an individual decision, but with a couple, it might be valuable to discuss and decide together. If you can't convince your better half, then maybe a buy or sell isn't very good. Men and women think differently and sometimes we men are too action-oriented, sometimes even too aggressive.

Two important benefits came out of doing my own. First, it made me think about what should be in each box and come up with a logic and a reason. My investing is more coherent and less random or impulsive. Second, once written down, it becomes much easier to stick with, especially in times like now when stock markets are not doing so well.

It is important also to realize that a perfect plan may not exist. A "pretty-good" plan is much better than no plan at all. Get started and do one, then improve it later.

The policy should be good for years, though it should be revised when major life changes occur, such as marriage, the arrival or departure of children, a major job shift, illnesses, deaths, retirement, inheritances.

Thursday, 24 July 2008

Asset Allocation: the Most Important Investing Decision You Will Make

Asset allocation is the process of splitting up investment dollars into the buckets called asset classes. It is the most important investment decision since the allocation will determine both the level of return you can expect and the amount of variability and risk the portfolio will have.

Some of the main asset classes to consider for a balanced diversified portfolio:
  • cash / Treasury bills

  • bonds, with further useful (i.e. with diversification benefits) subdivisions into real return, corporate, government and international

  • equities, with useful subdivisions into large cap, small cap, value, international Europe, Australasia, Far East (EAFE) and emerging markets

  • real estate, purchasable primarily in the form of Real Estate Investment Trusts (REITs), though one's home can be considered an investment to a degree

  • commodities - energy, minerals, foodstuffs, gold, basic materials (steel, aluminium)

How much to allocate to which asset classes? There is no single determinate right or wrong answer. The approximate right answer depends on how much risk you should and can handle and your investing goals, as discussed in previous posts.

To get an idea what the different asset classes might return over the long term future, look at this table from a 2005 presentation by the Chief Actuary of Canada at a National Academy of Social Insurance Conference. Real returns are net of inflation. The Bank of Canada's inflation target is 2%, the middle of an allowable 1-3% range. Note that the asset mix or allocation then determines the overall expected portfolio return according to the portion in each type of asset. These are numbers the Chief Actuary uses to monitor the Canada Pension Pension Plan Investment Board's performance investing your CPP contributions to eventually pay you CPP, so we can assume that a lot of thought and considerable caution has gone into the numbers. There are no double digit returns to be expected no matter what you invest in!

Some tools that you can use to get you started with the allocation process and help you develop your own mix:
TD Waterhouse Portfolio Planner - answer 8 questions and get a sample asset allocation
Bank of Montreal Investor Profiler - choose a family scenario like your own and get a sample asset allocation
iShares Asset Class Illustrator - pick from a list of asset classes and see how that combination would have done in the past

Thursday, 17 July 2008

How to Diversify without "Diworsifying"

Diversification is the name investing theory gives to the principle "don't put all your eggs in one basket". Let's expand the analogy a step further.

Buy More than One Egg: When buying investment "eggs" it is a good idea to buy more than one - if one breaks or goes bad there are others to eat so you do not go hungry. Similarly an investment in one company is risky since management may mess up. Buying more than one company's stock is a wise thing. That is the first way in which diversification reduces risk while allowing you to obtain the benefits of higher return investments.

If you buy several mutual funds and they happen to hold the same companies within them, then all you have done is buy more of the same companies and you have achieved diworsification. Buying more of one company increases your exposure to that company's fortunes and makes your overall holdings riskier and therefore worse. When you buy any collective investment like funds, you need to look inside at its holdings to verify that it is substantially different from what you already have.

Buy More than Just Eggs: Ever notice that when good or bad economic news comes out, often the shares of a whole sector such as banks or oil companies go up or down together, or perhaps even the whole stock market? That phenomenon is called correlation. Investments that change value or move up and down independent of each other are said to be un-correlated and if they move in opposite directions (if one goes up the other goes down, but only temporarily since all investments should move up eventually - each has its day to shine), they are termed negatively correlated. Combining un- or negatively-correlated investments, such as real estate and stocks, smooths variations and reduces risk. A grouping of investments that behaves similarly is known as an asset class. Thus the second way to diversify is combining in a portfolio these non-correlated investments, non-eggs in our analogy. In investing, as in food, eating only one thing, though it may be good for you, is likely to give indigestion or worse. A balanced diet is advisable and a combination of ingredients, or asset classes, can make a tastier dish than a single ingredient. The combination is better than the sum of the individual securities.

Diversifying amongst multiple asset classes for a given level of return will minimize the risk. It is important to note that the correlations among asset classes can vary tremendously from year to year despite the long term tendencies. However, despite the fact that the investing world is not fully predictable or stable, it is possible to build a darn good diversified portfolio that will give excellent stability and higher return.

In the next post, I'll describe the major asset classes and how to combine them in a portfolio.

Further reading:
Investor Solutions - Chapter 5 Travels on the Efficient Frontier
Richard Ferri's book - All About Asset Allocation
InvestorHome article on Asset Allocation

Friday, 11 July 2008

Risk: What Can You Afford and What Can You Put Up With?

Risk is the chance of loss. Loss only occurs when you sell the investment, not during fluctuations in value, such as happen every day in the stock market. Unfortunately, it may be difficult to decide whether a decline is permanent or temporary - is Nortel ever going to bounce back to its former lofty heights? - and how long "temporary" might be.

Some investments, like GICs, do not change much in value, always moving ever so slowly upward. No problem there. With equities, however, there is variability, often quite a lot, even though over the long term, stocks do gain by much more than GICs.

This dilemma can lead to several undesirable outcomes. First, if you actually sell after a decline, there may be less cash than needed for an investment goal like education. Second, if you get worried, panicky or impatient, you may sell prematurely, what might be called buying high and selling low, the exact opposite of the dictum to "buy low and sell high".

These two outcomes should lead any investor to examine him or herself from two perspectives:
1) What you can afford to lose without disastrous financial effect, the rational weighing of the ability to bear risk and possibly sustain losses? Here are the factors to consider -
  • financial assets - the more you already have, the less the impact of a loss and the more you should be able to bear risk
  • present and future income - the more you earn and especially the more you have as disposable income now and looking ahead, the better chance you have of bouncing back from losses
  • time horizon or length of time before you will need the money - the longer you have, the more you can afford to wait through the fluctuations of the stock market, for instance ten years or more
  • liquidity needs - similarly, the less you might need at once, the more it is possible to look to riskier investments
2) What you can sustain psychologically in periods of downturn for investments like equities? Some factors here:
  • sleeping at night - how much of a decline does it take to ruin your peace of mind; apart from the mental anguish, a weaker stomach can lead to selling too early, so often it seems just before things begin to go back up.
  • impatience - if you get frustrated and fed up when declines last many months or even several years, investing in stocks that do periodically experience such declines will probably lead you to sell prematurely at a loss, only to miss out on the rebound
There are a number of free risk tolerance questionnaires available that anyone can use to get an idea how the above can lead to a suggested list of types of investments (typically cash, fixed income and various types of equities) and a percentage allocation to each category. Try several and compare results.
Bank of Montreal Investor Profiler - gives separate pre- and post-retirement recommendations; no registration required
IFA Canada Risk Capacity Survey - three versions: ultra-short (5 questions), long (49 questions) and RRSP (19 questions); requires registering to get the results
Edmond Financial Group Risk Tolerance Questionnaire - no registration; very quick to do
MSN Money Risk Tolerance Quiz - 20 questions; gives portfolio composition suggestions

It is significant that knowledge of investing principles increases the tolerance, in both the above senses, for risk. Setting proper expectations about likely rates of return and especially the possible multi-year down periods, gives a greater peace of mind of mind and patience to ride out variability. Knowledge also enables the construction of a portfolio of investments that has less variability and risk of loss and very good long term returns, as will be explored in future posts.

Thursday, 26 June 2008

Investing Principles - Minding the Immutable Forces

If you pretend that the laws of physics don't apply to you and try to fly off your roof, you will be in for a painful surprise. Similarly, ignore certain economic forces and you will suffer investing losses or fall far short of financial goals. Use the forces to guide your investing, and success, while not guaranteed, is much more likely.

Force # 1 - The Risk vs Return Tradeoff
To obtain higher returns, you must be prepared to accept more risk. If you want no or ultra-low risk then returns will be low, perhaps so low that all you may effectively achieve is to preserve the value of the money that you save. If you have figured out that you can save enough to fund your goals, even with miniscule returns, then by all means do so. Most people, unfortunately require appreciable growth and that requires riskier investments.

Force # 2 - Diversification Will Reward and Protect You
Diversification means two things: having numerous investments, not just one or two or three and; having different kinds of investments. The first factor protects against potential problems of one company by spreading things around - the not-all-eggs-in-one-basket principle. The second factor takes advantage of the fact that some years stocks do well, some years it is bonds, other years it is real estate and so on. Right now, for example, the front-runner seems to be commodities, oil especially. The different winners at different times extends to countries as well. Diversification will smooth out market variability and enable you to take on higher return investments.

Force # 3 - Inflation is a Stealthy, Debilitating Menace
Inflation has been low for some time but the recent rise in oil and food prices is worrying. If inflation suddenly shoots up to 6%, 4% interest on a seemingly safe GIC is losing you 2% a year. Bonds and T-bills with their fixed interest return, are susceptible to inflation. The real damage happens over many years. A 2% loss after inflation prolonged for five years will erode the purchasing power of the $100 GIC to $90.57, including the interest, per the Bank of Canada Inflation Calculator. Some solutions for inflation: diversification, equities and real return bonds.
Resource: Libra Investment Management's spreadsheet - shows real (after inflation) and nominal (before inflation) returns on various types of investments 1970 - 2007

Force # 4 - Costs Matter, a Lot
As an investor you will incur various costs: trading commissions, management expenses of mutual funds and ETFs and possibly account administration fees. Every 1% extra in avoidable costs is a 1% reduction in net return. The first post in this blog pointed out the large effect of a 1% difference in return can have over a long period. Calculate your costs and ask yourself whether the cost item is too high; maybe it isn't but sometimes it is.

Force # 5 - Taxes Should Shape but Not Determine
Taxes are a constraining and shaping factor. Since interest income is taxed at the highest rate, income investments should be held in accounts with tax protection, such as RRSPs, RESPs and the new TFSA (to start in 2009). But conversely that doesn't mean you shouldn't buy equities in an RRSP just because they generate capital gains and capital losses cannot be deducted to offset capital gains within the RRSP. Investing in something primarily because it generates a tax benefit is a bad idea - it needs to be a good investment first.
Resource: - tax rates and account info

Friday, 20 June 2008

Investment Building Blocks - Securities

Securities are the things an investor can buy. There is a mind-boggling array of securities available to a Canadian investor, but never fear, that potentially paralyzing complexity can be simplified.

Consider a food analogy. At the most basic level, there are ingredients - sugar, carrots, peas, beef, lamb etc which can be grouped into vegetables, meat and so on. Thus we have T-Bills, corporate bonds, government bonds, common and preferred stocks, grouped into categories - money market, fixed income and equities.

Those ingredients can then be bought one at a time or as products grouped and packaged in various ways, e.g. tomatoes by themselves or in a pasta sauce along with beef and perhaps sugar. You can thus buy shares of Bank of Montreal by themselves or within a mutual fund, combined with other stocks or with government bonds or both. Much of the confusing complexity arises from all the available combinations.

The chart shows common securities (i.e. it is not comprehensive). The rows are the basic securities and the columns are the product packages, ranging from an individual security to collective investment structures that combine many securities and many investors. The x's in the chart indicate roughly what can be bought in each product.

Basic Securities:
  • Money Market - you lend money short-term (days to a few months), to the government by buying T-Bills, or companies through commercial paper, and get back interest
  • Fixed Income - you lend money for years to governments or corporations by buying various types of bonds and get back interest payments plus your original investment, which may go up or down if you sell out before the bond maturity date (repayment date) - Details of GIC and CSB on InvestorEd
  • Equities - you buy part ownership in a company through shares and get back profits through dividend payouts or through appreciation of the shares as the company grows ... or not get any dividends and see the shares decline in value if the company does poorly. Details of Split-Share on Wikipedia
Product Packages:
  • Individual - you buy a bond or share of one government or company either directly or on a market
  • Mutual Fund - you buy units from the fund company itself (though usually you do so through a brokerage, agent or financial planner), which passes through any profits to you each year
  • Closed-end Fund has a fixed number of units, essentially shares, that are bought or sold on the stock market
  • Exchange Traded Fund (ETF) is, surprise, a fund that is traded on a stock exchange; unlike the closed-end fund has features that ensure the buy/sell price is very near what the stocks/bonds inside are worth
  • Income Trust - a corporate structure in which a company passes through all its profits to you the investor (on which you pay taxes, of course)
As you can see, there are many ways to satisfy your investing appetite!

Resources and Further Reading:
Shakespeare's Investment Primer
Gail Bebee's book No Hype: The Straight Goods On Investing Your Money

Thursday, 12 June 2008

Reviewing Your Financial Assets

A key step to getting organized for investing is to list what you have already - your assets. Your assets include extra cash (above what you need for your immediate spending), GICs, mutual funds, stocks and your pension. The paid-off portion of your house should be on the list too. There are two reasons to do this:
  • to find the gap between total current assets and your total investment goals - how far is there to go?
  • as a basis for filling in the gaps or making changes to the mix to achieve a balance - what is called diversification or spreading of risk - of your investments.
The most valuable asset of all, especially if you are young and just starting your career, is YOU! Why? Through your talent and energy, you are a money-generating machine. You must therefore consider your age and earning power when choosing your investments. Furthermore, the type of work you do should influence how you invest. (Read more: Human Capital and the Theory of Life-Cycle Investing by Paula Hogan of Hogan Financial Management)

Your income and what you can take out of it to invest is another decision to make. Regular, small amounts over many years can grow to huge totals. Use the Advantages of Early Investing calculator at the Fiscal Agents website to play with the numbers and see what amount would get you to your goal. Above all, just get started, no matter how small the sum, and make the setting aside automatic. Don't rely on yourself to "get around to it" because if you are like me and most other people, it won't happen.

In my opinion, these are the resulting investment do's and don'ts:
  • if your job is relatively secure and unaffected by the stock market and you will be receiving an inflation adjusted defined benefit pension that will provide most of your retirement spending needs(does this sound like you, teachers, government and health care workers?), then do invest in the stock market/equities, not GICs or other forms of fixed income
  • if your job is susceptible to downturns, do include a healthy proportion of stable fixed income in your investments; especially do not invest only in your employer's stock or even that industry (as a former high tech worker who got laid off and had a lot of plummeting high tech shares, including those of my company, I can tell you the ouch factor is high) though stock purchase plans can be a worthwhile exception
  • do invest in stocks when you are young and can take the extra risk of stock investing for the potential higher long term returns of stocks to reach the large amounts needed for a comfortable retirement
  • if you are just starting out investing with small amounts, then you are better off in collective investments like mutual funds and Exchange Traded Funds (explained in the next post) that spread risk over many companies
Please note that the above is my opinion only and should not be taken as investing advice. Consult an advisor registered with your securities commission if you need help.

Thursday, 29 May 2008

Setting Investment Objectives

First things first, what are your investing goals? What will you want to spend on in future and when? The big chunks of money matter most, naturally. Think of big life events which have financial implications.

1) Retirement - retirement is an inevitable voluntary or involuntary point when investment build-up turns to withdrawal (an exception perhaps is the richest man in the world, investor Warren Buffett, going strong at age 78). To figure out the investment nest egg – your objective - estimate your retirement spending, subtract pension income sources, then obtain the lump sum objective by multiplying the missing income by 25, which assumes a conservative 4% withdrawal rate that should avoid ever running out of money. (e.g. in the simplified chart below, the green amounts are what might be required for a current $75,000 salary). The estimation process can get more sophisticated, and a future post will get into more detail. Given the large lump sum that most people would need, this is, or should be, investing priority one.

InvestorEd Retirement page on How Much? - unbiased advice, includes downloadable budget spreadsheet
FiscalAgents Tools - have fun with four different retirement calculators
The New Retirement Book by Sherry Cooper - especially chapter 9, How Much is Enough? - summary at BMOIL, review, buy

2) Education - an undergrad university program costs over $6200 a year on average according to a Stats Can press release. Add in books, possibly residence and the total can climb to $15,000 p.a., or $60k for the degree. The wildcard is how much you plan to have the kids finance themselves through summer or part-time jobs, or loans.

3) House - the investment target usually will take the form of a down payment, no less than 5%, better 10% or more (see The ABCs of Mortgages at the Financial Consumer Agency of Canada). The amount you will need (house price booms excepted) and when you will need it is under your control.

4) Inheritance/Legacy/Charity - as people get older, consideration often turns to what they will leave behind. Our friend Mr. Buffett decided not to die first and announced a few years ago that he was donating $31 billion! to charity. Giving is perhaps the easiest investing goal to handle since the amount - whatever is left over - and the timing - whenever you kick the bucket - can be completely passive and flexible.

5) Vehicle, Sabbatical, Wedding, Funeral or other significant future expenditure. Smaller and more controllable amounts but they can enter the mix.

What does the above imply for the Investor?

You should consider:

  • a mix of types of investments with faster growth over the long haul, like equities and those with stability, like bonds or cash, for shorter term objectives;

  • use of retirement accounts, like RRSPs, education accounts like RESPs and flexible accounts like the new TFSA.

  • setting priorities and possibly deferring some items, as total spending may exceed your saving capacity and the maximum realistic returns on investments

Thursday, 22 May 2008

A Process to Build a Sound Investing Plan

"If you don't know where you are going, you might end up someplace else." Legendary baseball player and manager Yogi Berra's words (and other delightful quotes here) apply perfectly well to DIY investing. A bit of simple and straightforward planning will yield significant benefits - having the right amount of money at the right time in one's life. It will also provide the confidence and peace of mind to withstand the inevitable shocks along the way.

Following a certain sequence of steps or a process will make it all seem natural and will avoid going down the wrong path, saving the DIY investor time, effort and money. This blog will therefore go through a series of posts illustrating and explaining these topics:
  1. Setting Investment Objectives: why are you investing? retirement, education, sabbatical, inheritance/legacy, house, vehicle, other significant future expenditure; or perhaps even gambling / speculation / entertainment; this determines, or helps determine, target amounts, time frame, types of investments / portfolio mix, type of accounts (RRSP, RESP, TFSA etc)
  2. Taking Financial Stock: what do you have now and what is available to invest? assets vs liabilities; income vs expenses; effect of job stability and work pension or stock purchase plan; human capital; investing monthly cash or a lump sum
  3. Investment Building Blocks: the Range of Securities & Products Available: "the ingredients", such as stocks, bonds, cash, GICs, T-bills, CSBs, Income Trusts, preferred shares; mutual funds, ETFs, REITs, ETNs, PPNs, seg funds
  4. Investing Principles: what are the important rules for success in the investing world such diversification, risk vs return relationship, taxes, inflation
  5. Risk - How Much Can You Afford and How Much Can You Put Up With?: risk as loss and volatility
  6. Diversification and Avoiding "Diworsification": the difference between many holdings and different holdings; non-correlated assets and asset classes
  7. The Written Investment Policy, Don't Invest a Cent Without It: asset classes to hold and in what proportions, under what conditions and/or how often to buy or sell; benchmarks for tracking and how often to review
  8. Account Choices: Regular/taxable, RRSP, TFSA, RESP, Informal Trust, Formal Trust, Mutual Fund, Wrap/Discretionary
  9. Broker Choices: comparative factors - trading costs, admin fees, range of accounts, research tools, service and telephone support, foreign exchange in registered accounts; convenience or fee reductions for family holdings, links to banking
Hopefully, we can thereby avoid later saying as Yogi did, "We made too many wrong mistakes" and instead become competent investment players who hit for a decent batting average.

Friday, 16 May 2008

Why Be a DIY Investor and What Does It Take to Succeed?

As the inaugural post on this blog devoted to DIY investing, a good question to answer is why do it in the first place, why not just leave it to an adviser? Another pertinent question is what kind of personality is needed to succeed?

Why DIY?
  • 100% focus on your own interests - most financial advisers are honest and conscientious about catering to your financial needs but DIY offers you the unlimited opportunity to tailor your investments to your own needs and circumstances with as much fine tuning and departure from standard solutions as you wish.
  • cost savings - the DIY approach using a discount broker such as BMO Investorline and others that only execute trades and provide no advice can save you money and boost returns; one of the objectives of this blog is to find and discuss those ways. Even a small savings compounded over many years can have a dramatic effect. The attached chart shows that a seemingly insignificant 1% extra return per year boosting returns from 7 to 8% can create a one third greater end amount after 30 years - $10,000 grows to $100,000 instead of only $76,000.

  • pride of self-reliance - just as business owners often remark on the satisfaction they receive from being in charge, a DIY investor can gain satisfaction from the feeling of being in control of his/her own destiny; it's the "I did it my way" feeling.
  • intellectual challenge and fun - there's no need to play Monopoly when you have the stock market; it's real money and the thrill is all the greater. Not only that, if you play the game properly - another aim of this blog is to show how that is done - you can minimize the chances of losing. Successful DIY investing can be done quite simply, but it also offers to those who get hooked, a wonderful world where you need to read, to learn and to think. For many people with more free time, such as those reaching retirement, it offers an enticing way to keep the mind active, broadening and deepening knowledge in an ever-changing field.
  • community and socializing - there are many DIY investors around; most are happily passive, reading news, websites and blogs such as this one but for those who wish, the web welcomes all comers with comments, questions and opinions. Hang around a while, participate and you get to know others and enjoy the pleasure of a shared interest.

What Kind of Personality is Suited to DIY?

Your personality and behaviour is the crucial issue. From the early days of investment giant Benjamin Graham in his book The Intelligent Investor, through all the academic research that has detailed it since (summarized neatly by Richard Deaves in his book What Kind of Investor Are You?), all agree that the key to success is how you handle yourself. You must avoid the errors of over-confidence, impatience, procrastination and being too emotional. If you are among those who are naturally planners, who look forward and are willing to defer immediate gratification and wait for longer term results, who are self-controlled and self-disciplined, who can accept that not every investment will turn out a winner and who are able to bounce back from setbacks, who do not assume they automatically know better than everyone else and are willing to learn, who tend to keep an even keel and not have excessive reactions to losing or winning, then you are among those most likely to succeed as a DIY investor.