Over the course of my 30-year career in financial services, I’ve had a lot of investors find a remarkable number of different ways to ask me what amounts to the same question: is there any way I can make more money from my investments, without taking any additional risk?
These questions sometimes take the form of forecasting or prognosticating, such as: “can your firm get me out of the market when things are going to go south, and then get me back in again when things are looking better?” Other times, they’re part of a seemingly innocent search for an investment product that sounds just a little too good to be true, like: “I’m looking for something that will pay me three times as much as a GIC, but without any risk to my capital. What can you suggest?”
Unfortunately, many investment professionals (and investors) try to pander to these requests, by saying something like “we have a real estate fund that would be great for you, no one ever loses money in real estate” or “our bond fund is low-risk and has a 10-year track record of six per cent!” What they don’t say is that plenty of people have indeed lost money in real estate. And that bond fund? Just because it earned six per cent over the last ten years doesn’t mean it will continue to boast the same returns over the next decade. If it did, everyone would buy it, and the rest of the bond market would just disappear!
Of course, the correct response to any investor who’s looking to get higher returns without higher risk is: “No. You can only get a higher rate of return by accepting some form of real risk.” Or to put it another way – there’s no such thing as free money.
People will always believe that there must be some secret way around this iron rule of investing. For example, they may “feel” there’s no risk in real estate, because they can get in their cars and go drive by the homes or buildings their money has purchased. What they aren’t seeing are all those nice houses that are sitting empty because no one wants to buy them, or that lovely $300,000 home in downtown Detroit that’s now on sale for $40,000. A more accurate statement would be: “I know there are risks in real estate, but I’m comfortable accepting those risks as opposed to the other types of risks I might have to take on to beat inflation and taxes.”
When it comes to the stock market, people try all kinds of things to escape volatility and avoid the inevitable ups and downs. What they don’t realize is that, by doing so, they’re systematically robbing themselves of all the long-term gains they would’ve earned if they had simply left their investments alone, and stopped trying so hard to avoid any short-term losses.
Take the perennially favourite technique of “market timing” as an example. This involves selling off your investments at the first whiff of any bad economic news, and then trying to re-enter the markets at the exact moment they begin to recover. Sounds tempting, right? Sadly, in my experience, what usually ends up happening is that the investor sells their stocks at a loss, then misses out on the rally and finds themselves having to buy back in again at an even higher price than they sold for.
There’s another term for this. It’s called “buying high and selling low,” and it’s supposed to be the very first thing every investor knows not to do. Yet sure enough, as soon as the talking heads on all those 24-hour news networks start telling us the sky is falling, investors will trample over each other in the rush to sell their holdings, and give up all the growth they worked so hard to earn.
If you want to see the real cost of avoiding volatility in action, just take a look at the options market. If you want to get a protective put option on a stock (a “put” is the right to sell that stock at a later date for a fixed price, regardless of what the actual price might be), then your cost of buying that option goes up the closer it gets to the actual price of the stock. This is proof-positive that the best protection from volatility also costs the most. If you want 100 per cent protection, the cost will usually be roughly equal to the return you would’ve otherwise gotten from the market over time.
If your reaction to all this is that you’d prefer to just keep all risk out of your life and stick with GICs (or hide your money in a hole in your backyard, which pays almost the same these days), then I have some bad news for you. In reality, this doesn’t get rid of any risk at all. All it does is trade one kind of risk (market volatility) for another, far more devastating risk: the risk of inflation, which is going to roll like a glacier over your squirreled-away cash, and take away half the value of your money every 20 years.
The good news is, despite (or rather, because of) short-term ups and downs, a properly diversified investment portfolio will, over time, offer secure returns that are well in excess of inflation. To achieve those returns, we just have to be ready to deal with all the bumps along the way. Rather than wishing volatility away, informed investors are secure in the knowledge that all those short-term bumps are the fair price they’re paying for a higher long-term return.
Hey, wait a minute – so maybe there is a way around that iron rule, after all….
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.
