Rob Carrick – The Walker Report

Correlation: Or How I Learned to Stop Worrying About the Market and Love Diversification

140617strangelove — The look of a nervous investor who needs more diversification

This year has seen further gains in the stock market both in Canada and the United States. But after five straight years of gains (the US is having its third longest period without a 10% drop) many are calling for an end to the party.

Calling for a correction in the markets isn’t unheard of, especially after such a long run of good performance. The question is what should investors do about it? Most financial advisors and responsible journalists will tell you to hold tight until it 1. happens, and 2. passes. But for investors, especially post 2008, such advice seems difficult to follow. Most Canadians with any significant savings aren’t just five years closer to retiring than they were in 2008, they are also likely considering retirement within the next 10 years. Another significant correction in the market could drastically change their retirement plans.

Complicating matters is that the investing world has yet to return to “normal”. Interest rates are at all time lows, reducing the returns from holding fixed income and creating a long term threat to bond values. The economy is still quite sluggish, and while labour numbers are still slack, labour participation will likely never return to previous highs as more and more people start retiring. Meanwhile corporations are still sitting on mountains of cash and haven’t really done much in the way of revenue growth, but share prices continue to rise making market watchers nervous about unsustainable valuations.

In short, it’s a confusing mess.

My answer to this is to stay true to principles of diversification. Diversification has to be the most boring and un-fun elements of being invested and it runs counter to our natural instincts to maximize our returns by holding investments that may not perform consistently. Diversification is like driving in a race with your brakes on. And yet it’s still the single most effective way to minimize the impacts of a market correction. It’s the insurance of the investing world.

This is not you, please do not use him as your investing inspiration.

The challenge for Canadians when it comes to diversifying is to understand the difference between problems that are systemic and those that are unique. The idea is explained well by Joseph Heath in his book Filthy Lucre. Using hunters trying to avoid starvation he notes that “10 hunters agree to share with one another, so that those who were lucky had a good day give some of their catch to those who were unlucky and had a bad day…the result will be a decrease in variance.” This type of risk pooling is premised off the idea “that one hunter’s chances of coming home empty handed must be unrelated to any other hunter’s chances of coming home empty handed.” Systemic risk is when “something happens that simultaneously reduces everyone’s chances of catching some game.” This is why it is unhelpful to have more than one Canadian equity mutual fund in a portfolio, and to be cognizant of high correlation between funds.

The question investors should be asking is about the correlation between their investments. That information isn’t usually available except to people (like myself) who pay for services to provide that kind of data. But a financial advisor should be able to give you insight into not just the historic volatility of your investments, but also how closely they correlate with the rest of the portfolio.

Sadly I have no insights as to whether the market might have a correction this year, nor what the magnitude of such a correction could be. For my portfolio, and all the portfolios I manage the goal will be to continue to seek returns from the markets while at the same time finding protection through a diversified set of holdings.

July 24, 2014 by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

Why Buy an ETF?

It’s become an excepted fact amongst business reporters that the best investments to buy are ETFs, otherwise known as Exchange Traded Funds. What is an ETF and why are so many journalists convinced that you should buy them? Well an ETF is a fancy way to describe an investment that looks very similar too, (but isn’t quite) a stock market index. Unlike mutual funds, the ETF is bought and sold like a stock, but mirrors the performance of an index of your choosing, and by extension all the companies that make up that index. In that respect it shares the (supposedly) best aspects of both stocks and mutual funds. It is traded quickly and is quite inexpensive compared to a traditional fund, but unlike a stock is widely diversified and so should have reduced risk compared to a single company.

In the aftermath of 2008, many journalists that cover the investment portion of the news have touted ETFs as a better investment than traditional mutual funds, citing underperformance against respective benchmarks and the significant discount on trading costs for holding ETFs. ETFs represent a “passive investment”, meaning they don’t try to out perform their mirrored indexes, instead you get all of the ups, and all of the downs of the market. This message of lower fees and comparable performance has had some resonance on investors, and questions about ETFs are some of the most frequent I receive, however while I am not opposed to ETFs I am very hesitant about giving them a blanket endorsement.

That’s because I don’t know anybody who is happy with 100% risk. In the great wisdom of investing the investor should stay focused on “long term” returns and ignore short term fluctuations in the market. But investors are people, and people (this may shock you) are not cold calculating machines. They live each day as it comes and fret over negative news, get too excited about positive news and are generally greedy when they shouldn’t be. In short, people aren’t naturally good investors and being encouraged to buy an investment like an ETF exclusively on cost alone opens up all kinds of other problems for people who find that the market makes them nervous, or may be closing in on retirement. The passive nature of an ETF may be right for some people, but that decision will rarely depend solely on the cost of the product.

The hype for ETFs is therefore more comparable to buying a car exclusively on price based on the argument that all cars function the same way. But depending on your needs there may be multiple aspects you want to consider: size, safety, speed, etc. Investments are similar, with different products offering different benefits its important not to let greed set all of your investment designs. Investing is typically about retirement, not about maximizing every last dollar the market can offer. Reaching retirement is about balancing those investor needs with their wants, and frequently providing less downside at the expense of some of the performance is preferable to the full volatility of the financial markets.

April 4, 2014 by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

It’s Official, Young Canadians Need Financial Help

It must be terribly frustrating to be a twenty-something today. It’s hard to find work; you probably still live with your parents and a whole culture has developed around criticizing your generation. But beyond the superficial criticisms directed at twenty somethings, there are structural shifts going on within the economy that are making paupers of the next generation.

Some of these shifts do extend from things like a lack of good paying jobs in manufacturing and an increasingly reliance on service sector jobs. There are many university graduates that now find themselves in work that they are overqualified for and underpaid in. But some of the changes also come from an increasingly high cost of living that is making it financially untenable to move out of a parents’ home. This phenomenon has been dubbed “boomerang kids”, or “boomerang generation.”

The challenge that the Millennial generation is facing is that costs are rising as a proportion of their income. Consider the cost of a house in Toronto. In November of this year the average cost of a home sold in Toronto was $538,881, up 11.3% from November of last year. Assume you make the minimum downpayment to get a home, 5%, your downpayment would then be $26,944 (roughly). Your monthly payment on a 25 year fixed rate mortgage would be $3,077 per month, or close to $36,924 per year. If we factor in real-estate tax and an average heating cost, that would bring annual costs to roughly $43,000 a year. That would mean that to qualify for the mortgage with a bank you would need to be earning at least $134,375 before taxes. The average income in Canada is $47,000.

We can quibble about how accurate these numbers are, but it would still amount to the same end. It costs a lot today to be like your parents. Buying a house for the first time is incredibly expensive and forces young people to make different choices about how to spend their money. For many millennials this has meant “postponing” growing up, financially as well as spiritually. But what today’s young generation actually need is a working budget that lets them get a big picture of their spending and allows them to set and reach financial goals. There are free services, like Mint.com (which I am very much in favour of), but even better is that young people should be encouraged to seek out professional financial help. People with a small amount of savings often feel discouraged about seeing a professional, but getting this guidance early on can lead to significantly better financial outcomes, comfort with the markets and wiser tax efficient planning!

Want to discuss your future planning?

Go back

Your message has been sent

December 4, 2013February 24, 2014 by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc