Well, this it it, the final post in the Passive Income series! To recap, here are the talking points leading up to the grand finale:
Passive Income Part One discussed what investing can and can.t do for you
Passive Income Part Two illustrated the importance of keeping costs low
Passive Income Part Three gave three sample portfolios based on your attitude towards risk
Passive Income Part Four surveyed types of investment accounts and how to open them
Passive Income Part Five showed you how to trade
In Part Six, I.ll answer some frequently asked questions and lay bare thoughts on how the market works.
FAQ #1 I opted for a 70:30 equity/bond asset allocation. What do I do with subsequent deposits?
Congratulations, that.s the same equity/bond asset allocation that I use. My parents’ portfolios (since they.re more risk averse) are set to 35:65 in favour of bonds. If you.ve decided that a 70:30 equity/bond asset allocation is right for you, top off future investments to maintain a 70:30 equity/bond asset allocation. And if you need to sell (hopefully never), sell whatever.s gone up the most to maintain the preselected ratio. This process is called rebalancing. It forces you to buy low and sell high. And it takes the emotion out of it.
FAQ #2 The news is saying bonds are going to get thumped when interest rates rise. Why should I hold bonds?
Bonds are the ballast in your portfolio. When you batten down the hatches and they don.t hold (e.g. 1987 Black Monday, 1999 tech bubble, and 2008 Great Recession) you.ll be glad you had them. No one knows for a certainty when the next stock market collapse will happen. You don.t hear of many (if any) people who make a living short selling stock market catastrophes: the reason is that, well, unknown events are unpredictable! And by the way, the ‘experts’ have been saying interest rates will rise since 2010. They.ve been wrong five years running. I.m sure they.ll be right one year but even a broken clock gets the time right twice a day.
FAQ #3 I heard that there are dividend or low-volatility based ETFs that outperform the traditional market-cap based ETFs
The vehicle for Canadian stocks I recommended was the BMO S&P/TSX Capped Composite Index ETF. It has a MER, or combined expenses, of 0.09% a year. I bet these other ‘smart beta’ products cost five or six times more, with MERs ranging from 0.6% up to 1%. Even if they.re better, they have to overcome their higher costs. Different investment types will, over time, either outperform the broad market. But nothing can outperform the market forever, since if it does so, it simply becomes the market. So you.re safe with going with a traditional market-cap based ETF such as ZCN. VCN from Vanguard Canada is also a good choice.
FAQ #4 I hear that stock markets are high right now. Should I wait to invest?
Who knows? To me, the best time to invest is when you.ve got money. I.m constantly in an ‘all-in’ position. That is to say, if I have money, and the stock market is at an all-time high, I invest. And if the stock market is plunging to new lows every day, I invest. Basically, I have my asset-allocation of 70% stocks and 30% bonds and I invest to maintain that ratio. It doesn.t really concern me too much what.s going on in the news. If the market is at all time highs, my new investments are going to be more expensive. But my existing investments will be worth more. If stock markets are hitting new lows, I.m happy that my new investments are bought ‘on sale’. Ignore the noise; maintain your asset allocation.
FAQ #5 Why should I listen to you?
I have a no nonsense approach focussed on keeping costs low. The theory of asset-allocation and broad market based index investing is backed by modern portfolio theory and the efficient market hypothesis. Modern portfolio theory basically says not to look at your individual holdings, but to look at the risk profile of your portfolio as a whole: the name of the game isn.t to make the biggest returns, but to have a responsible asset-allocation that is commensurate with the amount of risk you.re happy with. The efficient market hypothesis basically says that it.s no use trying to time investments. The price of a stock or a bond is set by the aggregate intelligence of all market participants. If you think it.s under- or over-valued, you.re making a bet against the whole market. Unless you have access to classified information (which you shouldn.t) no one else has seen, you can.t do better than the market and will likely do worse. Furthermore, the investment philosophy presented keeps transactions to a minimum. And what is more, no continuing research into this or that stock is necessary, freeing you to to what you want to do with your time.
FAQ #6 How did you get started?
I talked my folks into opening my first brokerage account when I got my first job at age 14. It was a tough sell since to my dad the stock market = gambling. The first investment was the Cundill Value Fund, an mutual fund overseen by Peter Cundill, a legendary value investor. It was after getting this that I learned that superior past performance does not necessarily translate into superior future performance.
As my investments grew (mainly from me putting more money into them from the dishwashing job), I sought the advice of expert financial advisors at RBC. They steered me into gold and tech stocks. When BRE-X collapsed in 1997 and the tech bubble blew in 1999, I started to get the feeling that the experts were not so expert after all. They.re just salespeople. The experience turned me off investments for many years. In fact, though I didn.t sell them, I no longer looked at them.
In 2005 while working on my masters at Brown University, I happened to take a look at my fallow portfolio. It had grown. But I hadn.t been doing anything. It occurred to me that maybe it was by not doing anything that was the key to success. I did some more research and discovered the efficient market hypothesis and index investing.
Instead of writing my thesis, I read books such as Malkiel.s Random Walk Down Wall Street. This was my investing renaissance: with portfolio theory, index funds, and the efficient market hypothesis, I could see how to invest in a way in which I understood and that I was perfectly comfortable with.
The big test was the stock collapse in 2008. Some of the indexes (S&P 500 and emerging markets) collapsed by 50% or more. I stuck with the asset allocation and kept plowing hard earned money into what was dropping the most. By 2012 or so it had payed off: a lot of the hard hit indexes more than doubled from their lows.
FAQ #7 Is there something I can read to learn more?
Absolutely! An excellent beginner.s book written in a story-telling style by the Princeton Economist Burton Malkiel is how I started. A Random Walk Down Wall Street is a great read and one of the few books I.ve read and re-read with pleasure. It.s now in it.s eleventh edition. Read it! It.s in the library too, if you want to keep costs low!
So there you have it! This concludes the Passive Income series of posts. Until next time, I.m Edwin Wong and I am Doing Melpomene’s Work.