Many of our clients are business owners. These people are a hardy breed. Instead of opting for the regular nine-to-five grind, they took the road less travelled, and set up their own businesses.
As many of you may know firsthand, running a business is no cakewalk. Whether you have your best month in years or fail to make a single sale, your payroll remains the same, and the rent still has to be paid.
If that wasn’t bad enough, your suppliers and employees are always demanding increases in costs and salaries to keep pace with inflation. Yet most businesses face a constant downward pressure on what they can charge their customers, from sources ranging from unexpected new competition to cheaper imports or low-cost online providers.
For the few tough souls that stick through the hardships and stress, however, the rewards can be substantial. Businesses can earn significant revenues for their owners, and fetch millions more when they’re sold. But because of everything they’ve had to overcome in order to succeed along the way, one of the biggest challenges business people face when they first become investors is accepting that the investment world is an entirely different game – one that comes with its own unique set of rules.
We’re all familiar with the expressions “buy and hold” or “invest for the long haul,” for example. These little gems of wisdom sound good. But they can be tough to hold onto, especially if you come from the hard knocks school of running your own business.
If you own a business, a bad quarter means you have to immediately find out what went wrong, and fix it. Two bad quarters means something is really amiss. Four bad quarters in a row, and it’s probably time for a wholesale change.
As a result, many of the most successful business people will try to bring the same mindset with them when they invest their wealth in stocks. The problem is, while the “let’s do more of what’s working and cut losses where we’re falling behind” approach might work great if you’re running a construction company, it can be a recipe for disaster for your investment portfolio.
In an investment portfolio, diversification means that you’ll always have something that appears not to be working at any given time. That’s a good thing, because when whatever sector or security that’s currently shooting the lights out inevitably turns south, that seemingly underperforming part of your portfolio will be ready for its day in the sun.
Sure, we’d all love to have only winners in our portfolios, which never go down and always generate huge returns year after year. But it’s not all bad news. Because diversified portfolios reflect the entire market, they might go up or down in the short term. But they also offer much lower volatility than individual stock “picks,” and potentially very little long-term risk. That’s why 90% of active strategies don’t beat the market over time. As the saying goes: individual companies go out of business all the time. Markets don’t.
In the stock market, you can have three years of zero (or even negative) returns. But once you start stretching the timeframes out to 15, 20, or 25 years, stock markets actually give more consistent returns than Treasury bills.
Think of it like flipping a coin. If you flip a coin ten times, you may get five heads and five tails. But it’s more likely you’ll get eight tails and two heads, or four heads and six tails, or maybe even all tails. That’s because ten flips is just too small a sample to get to the five-heads, five-tails long-term average.
The equity markets aren’t much different. In the short term, markets are random. But if you’re willing to invest in a diversified stock portfolio and simply leave your money alone for 30 years, there is a high probability of a compounded annual return of around 10%.
Business owners have a difficult time letting go of the quarter-by-quarter approach. And rightfully so! If they take their eyes off the ball in their working lives and allow a few bad quarters to pass by without making any changes, they could find themselves facing financial ruin – and maybe taking their families and employees down with them.
But when it comes to investing, the most advantageous strategy is to just hold a diversified portfolio, and wait. After all, as Warren Buffett says, when it comes to equities, the best holding period is forever.
Alan MacDonald an investment advisor with Richardson GMP Limited, helps investors with over $500,000 of assets make smart decisions about money. Alan is the co-author of “The Copperjar System, Your Blueprint for Financial Fitness” available on Amazon.
For more information please visit www.alanmacdonald.ca or email Alan at Alan.Macdonald@RichardsonGMP.com.
All material by Alan MacDonald, Investment Advisor at Richardson GMP Limited. The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP or its affiliates. Past performance is not indicative of future results.
Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.
