Questionable Investment Rules

Let me briefly review my investment history so you will know where I am coming from with my reviews of the rules that I have selected to question. My career was focused on evidencebased outcomes—what worked to accomplish the stated goal—and I applied it to investment activities starting 56 years ago. Its success can be seen in my becoming a millionaire in 20 years while earning an average of about $25,000 a year and never having a taxable income from work over $ 50,000. My investment focus on Wealth Creation has a portfolio that has exceeded the Toronto Stock Exchange every year for the past five years, averaging 13 % and not losing any money for me during the recent recession. The focus on Wealth Preservation with considerable attention to tax avoidance produced an over 50% reduction in income tax. I have been contributing articles to Canadian MoneySaver for 15 years and have nothing to sell to readers.

• ‘Sell Half Of A Stock When It Has Doubled In Value’

This may be helpful for early investing as it locks in your earnings and helps to rebalance your portfolio. The downside is that research has shown that this approach usually loses you money and takes time and expenses to organize the change and pay tax on the sale. Finding a suitable replacement stock can be difficult and time consuming. It also means you always have very limited amounts of your best performing stocks and that can be a serious wealth creation handicap. Better to check once or twice a year and hold on to your winners if there is no evidence-based reason to sell them.

Let’s now go back to the beginning of your investment career and consider the style that works best for you, your partner and family, and the lifestyle you choose. Creating wealth is usually one of the important goals of most people but there are different attitudes and practices with which to work on it. In brief, they range from serious, by-the-book practices with highly structured rules, timetables and predetermined practices to flexible, open and experience-based, learning-by-doing methods that are less serious and more fun. With the latter you are likely trying out different investment allocations and diversifications and perhaps buying a cottage, more education, vacant land, antiques, art or jewelry. Your success is not based on unfathomable secrets and it helps to identify the B.S. [beguiling statements] that the media perpetrates for marketing purposes at your expense.

• ‘Canada Is 3% Of World Stock Markets And You Must Invest In Global Funds Using Expert Help’

This ‘rule’ is usually sponsored by mutual fund sellers or financial advisors. Most Global Mutual Funds start off with a hefty fee and they have difficulty matching or beating the related market. Exchange Traded mutual funds appear to make more sense. The next question is which exchanges to use. How many investors know that the China market has been flat for two years and is 65% below its peak, while the German market has doubled in the past five years? A recent 30-year comparison of global investing with the U. S. stock market showed the latter the winner. A noteworthy alternative to extensive global investing is to substitute blue chip Canadian stocks that have large global activities. Bombardier is bigger globally than in Canada, Scotia Bank is big in China, and TD has more banks in the U.S. than in Canada.

Why bother with foreign exchange, taxes and politics when a select group of Canadian stocks can do it all for you and reduce your ordinary income tax by 50% or more up to an income of $82,000 [2013] with your dividend tax credit that is only available for Canadian stocks?

• ‘Dollar Cost Averaging Is A Good Way To Make Your Investments’

Dollar cost averaging means buying your investments at regular intervals in equal amounts. Thus you don’t need to worry about the dips and jumps in the price of the investments you are purchasing. It also avoids sitting on your cash for ages waiting for the investment to go down—a very real situation for many investors. Dollar averaging provides a solid structure to help break through ambivalence and build investment discipline.

However, a recent study by Vanguard in the U. S. reported that dollar averaging lost money two-thirds of the time. This plus the additional cost of the several buy fees make it a questionable rule and not a ‘must do’, but worth considering when sitting on a bundle of cash earning maybe one percent interest.

• ‘Investors Require Education To Create A Policy Statement, An Item-By-Item Investment Plan, Clear Goals And A Strategy For Achieving Them, And A Timetable With Projected Income For Retirement’

These are clearly activities to pay attention to and seriously consider the extent to which you choose to make them ‘hard and fast’ rules. How many high-achieving investors and well-off retirees have all of these in place? The investment market and the economy have changed during my five decades of investing and, if anything, the changes are now taking place more frequently. Exchange traded funds, split shares and balanced funds hadn’t been invented when I started investing and bonds have paid from 1% to 18% interest. No one yet has been able to predict the market’s future. Four out of five ‘experts’ managing mutual funds can’t beat the Toronto stock exchange over five years. Locking yourself into a highly structured predetermined future sounds unrealistic and makes it difficult to modify your investments as times change and your wealth creation is handicapped.

An easier and more flexible planning arrangement that is a pretty safe and comfortably profitable place to start investing is with a Couch Potato or Canadian MoneySaver’s model portfolio of exchange-traded funds. David Stanley’s and Ross Grant's 10-stock ‘Beating the Toronto Stock Exchange’ approach that has earned an average of 12.5% a year for the past 25 years could be another easy starting choice. As more money becomes available for investing, future choices could reflect increased knowledge of the importance and use of diversity, balance, asset allocation and tax avoidance. Best of all it could help reduce the tension couples might otherwise have in selecting their investments and lead to some fun choices in the process— a cottage, house remodelling, a sailboat, etc.

• ‘Prepare For Retirement By Using Your Age To Determine The Percent Of Bonds You Should Hold With The Remaining Portion To Make 100% In Stocks.

The changing financial scene has made this ‘rule’ as outdated as the 18% government bond during the Trudeau era. It means at a retirement age of 65 you have that percent of your pension paying 2% in safe bonds while only 35% is paying twice as much in stock dividends. These dividends are taxed at maybe half the interest rate if held outside an RRSP and have the dividends increasing at a higher rate than inflation. Many solid blue-chip stocks with strong dividends continued to pay them during the last serious recession and a few even increased their dividends. The genuine risk/reward rule (safe investments usually earn less than higher paying riskier ones) comes into play here as you and your partner establish a flexible but more appropriate balance for your retirement, leaving this rule behind.

• ‘Investment Activity Must Include Asset Allocation, Diversity, Balance And Regular Rebalancing’

It is important to understand the need to plan for and consider all of these areas but not get locked into unproductive activity and paper work. My bias on rebalancing was touched on in the first point above—selling half of your best stocks on their increases—and as my present strategy is ‘buy and hold’, a review twice a year of holdings suffices for any minor adjustments. Rebalancing global stocks (see point 2) can be difficult as mentioned and some sector allocations may continue to be unproductive for decades. Perhaps a sale of a small portion of an equity would determine if it is continuing to under achieve or is about to do so.

• You Should Spend As Much Time Avoiding Tax As Picking An Investment.

This rule is important to me because it is questionable only for those people uninterested in their investment’s real results and the money in their pocket. Picking a stock, as several experts have said, is less productive than staying the course with your investment strategy. Tax avoidance likely saves half your income tax every year, increasing your ‘real, real return’ considerably. Middle class couples could find income taxes cost them about as much or more than the house they purchase, and in any case more money than fiddling around with what a stock or two earns. Yet most investors focus solely on making investment money, not preserving it with tax avoidance. Think of all the chit-chat about investments you have ever heard and identify how many, if any, have included tax avoidance. Many couples do not know how to split income, the comparable tax rates of capital gains at the nine tax levels, how to get a pension tax credit if you have no pension or how to defer tax for 10-15 years with split share stocks? Once you have learned the rules1, your tax savings continue year after year with a little yearly adjustment. This rule remains questionable, I hope, only for those people not interested in the future use of their preserved investments.

Good luck! Comments and questions are invited.

Hedley Dimock, MA, Ed.D, Guelph, ON. hdimock@teksavvy.com

1.See H. Dimock’s article Reducing Income Tax by 50%, Canadian

MoneySaver, June 2013.