By Gordon Pape, Editor and Publisher
Why do you invest?
Every investment decision, from asset allocation to the specific securities you choose, revolves around that critical question. If you do not have a clear purpose in mind, you will never develop the focus and discipline you need to build a winning portfolio that is appropriate for your needs. There is no single security that is suitable for every investor, no one-size-fits-all portfolio. It all turns on what you are trying to achieve. That’s why we cover a wide range of investment possibilities in this newsletter. They won’t all be right for everyone, of course. Each person has to decide which recommendations fit with his or her personal objectives and which are not suitable. Here are the five most common answers to the question why invest? I’ve included some suggested strategies to employ in each case.
Why invest? Long-term growth.
The aim is to increase the value of your portfolio over the long term, with an acceptable degree of risk. The money may be used eventually for retirement, education, estate planning, or some other future need. The time horizon may be as long as 50-60 years.
Strategy: The asset mix should favour equities over fixed income, although the latter should not be ignored. A simple approach would be to create a small portfolio of conservatively managed mutual funds from low-cost companies like Beutel Goodman, Mawer, and Steadyhand, combined with some bond ETFs. If you want to build a stock portfolio, focus on industry leaders and ensure you have good diversification. As we saw in the collapse of energy stocks after the oil price drop, it’s a bad idea to concentrate too high a percentage of your assets in one sector, no matter how good it may look at the time. Keep trading at a minimum; commissions can eat up profits at an alarming rate.
Why invest? Short-term growth.
In this case the goal is to achieve a decent return but within a relatively short time frame, say five years. The ultimate objective may be a major purchase such as a home, a car, etc.
Strategy: You have to balance off the desire for growth with the risk factor. If you’re saving for a down payment for a home, for example, you don’t want to see your money go down the drain in a market crash. Balanced mutual funds are a good choice here. Balanced ETFs would be even better because they are less expensive but there are only a few available.
Why invest? Capital gains.
Here the objective is to score big profits. Of course, everyone would like to achieve nice gains but most are unwilling to accept the accompanying risk. Those who declare this to be their primary goal have a get-rich-quick mentality, not dissimilar from that of the folks who buy lottery tickets. It’s the greed side of the investing equation.
Strategy: Unless the circumstances are highly unusual, such as the sky-high interest rates of the early 1980s, bonds are not a part of this mentality. They’re too dull and don’t have the fast growth potential these people want. Mutual funds and ETFs don’t fit either; their growth is usually too slow. The key focus here is the stock market, often on highly speculative equities like penny mines or through day trading. It’s possible to make money that way but only the very smart or the very lucky can manage it.
There’s a better and less risky way. Buy cyclical stocks when they are out of favour and trading at deep discounts. Then wait. In the stock market, what goes around comes around. It never fails. Stocks that are dogs today will be stars tomorrow and vice-versa. For example, no one wants mining stocks right now. You can buy shares in Teck Resources on the TSX for around $6. Less than three years ago, the same stock was trading in the mid-$30s and it will eventually be back there again. It’s just a matter of time, and cycles.
Why invest? Income.
The fact our population is aging made headlines last week with the Statistics Canada report that there are now more seniors (65+) than there are children (15-) in this country. But there’s nothing really new about that. The trend has been evident for years; all we did was cross a demographic threshold. More seniors means more people whose main interest is to generate income from their investments. The problem is that with rates so low, that’s not easy to achieve.
Strategy: With GICs and bonds offering such low returns, the temptation is to seek out high-yield securities in order to obtain the desired cash flow. But that adds risk at a time in life when most people can’t afford large losses. The asset allocation should reflect that, with greater emphasis on cash and fixed income securities, even though returns are lower. Income oriented mutual funds and ETFs are useful securities in this context. Just be sure the distributions are not at a level that consistently erodes the net asset value (NAV). If that happens, you are basically being paid with your own money. If you want to add dividend-paying equities, look at banks, utilities, and REITs but don’t lose sight of the risk.
Why invest? Asset preservation.
All some people really care about is preserving what they have. They aren’t interested in big profits or even in cash flow. They just don’t want to lose money.
Strategy: It’s really very simple. Avoid risk. Keep most of the money in cash and spread it around among various financial institutions to ensure full deposit insurance coverage (CDIC provide protection up to $100,000 per participating institution).