PETER DOLEZAL: Chasing equity markets – one step behind?

For many, the shift in investment strategy has come several years too late.

Just as certain as the annual migration of caribou in Canada’s north, is the recent migration of investor capital from fixed-income products to equity-based investments.

In the past few months, fixed-income investors have been reacting to the 7.2 per cent total return of the TSX Index in 2012, and its continuing advance in early 2013 — prompting many to return to equities. A smart move? Possibly. However, for many, the shift in investment strategy has come several years too late.

From September 2008, the TSX Index had, in just five months, dropped to its low of 8,123 by early February 2009 — a precipitous decline of 31 per cent. During this period many  investors fled equities and moved to fixed-income products — often booking significant losses in the process. The TSX Index rebound ultimately resulted in a 57 per cent climb to a February 28, 2013 level of 12,800.

While many who fled equities lost financially with their strategy, those who invested in bonds or low-cost bond funds at least received a respectable interest yield. Those who had fled to savings accounts or GICs however, paid an even heavier price in foregone opportunities.

Having missed out on the huge equity market rebound of the past four years, investors are now once again flocking back to equity markets. If this wave continues, it is likely that markets will continue to strengthen for some time yet.

For how long? Consult your crystal ball. No one can predict when that inevitable market adjustment will occur. But when it does, we can be sure that many will again flee equities, in the naïve belief that they can somehow predict the next upturn. History tells us that most of these “market timers” are likely to lose ground once again.

Over the last 60 years, it has consistently been proven that those investors who rode the cycles of the market, staying invested in prudently-selected equity products, have outperformed those who moved in and out of equities in response to market shifts. Estimates of the performance difference range as high as 40 per cent of portfolio value.

There are legitimate reasons for investors to change the focus and mix of their investments at different stages of life. Thinking they can improve portfolio performance by accurately timing the ebb-and-flow of equity markets is not however, one of them. It bears repeating — trying to time the markets is a mug’s game, rather than a sound investing strategy.

Relevant to these facts, it is instructive to note that mutual funds have the universal objective of striving to outperform their relevant indexes. Inherent in that goal is a significant effort at timing market moves — a long-shot at best. Not only is this strategy questionable, but also, when combined with a 2.5 per cent average Canadian MER cost, the chances of these strategies benefiting the investor are rather slim.

The combination of the element of market-timing, in conjunction with very high holding costs, is the primary reason why only about 20 per cent of Canada’s mutual funds beat their comparable index in any given year. Independently tracked by Morningstar over longer periods such as three and five years, this already-dismal performance record plummets even further.

The message for the prudent investor is twofold. For the equity component of a portfolio, strive to minimize holding costs, while staying invested for the long term — ideally in carefully selected, dividend-paying Exchange-Traded Funds (ETFs) or Index Funds. Such low-cost funds simply track selected indexes, rather than trying to beat them.

When markets make their inevitable negative correction, the investor will continue to earn a healthy dividend — effectively, being paid while awaiting the equally inevitable market upswing.

A retired corporate executive, enjoying post-retirement as a financial consultant, Peter Dolezal is the author of three books. His most recent, the Smart Canadian Wealth-Builder, is now available at Tanner’s Books, and in other bookstores.

 

 

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