Don’t Be A Faith-Based Investor (This Has Nothing To Do With Religion)

Faith-based investing is a “thing”, but it’s not the thing we want to talk to you about today. There is another form of faith-based investing which is even more pervasive than the religious form. This form of “faith-based investing” is backed by the belief that “the markets always go up” so “just participating is basically good enough.” Financial planners say things to people like “invest the money when you have it”, or, “over time, it will all work out” and “no one can time the markets”. The only problem with all this is: will all these comments come true within your investment time horizon?

Most Canadian “investors” don’t get serious about investing much before age 40 (and some later). They wake up to the fact that they are not immortal and if they don’t want to be on a Kraft dinner diet in retirement, they will have to have some money to live on. Consequently, their goal is to save enough money to enjoy a comfortable retirement. They are looking for a reasonable return on the money they save, with steady growth over time, to achieve that goal.

Most people don’t have much of a plan when they start investing: they just start by putting some money in the bank. Next thing they know, if they contribute on a regular basis, it starts looking like something that needs a bit more attention.

Maybe they get some help from the local bank planner, constructing a basic financial plan and directing some of that savings to some mutual funds, possibly in a Registered Retirement Savings Plan (RRSP).

So How Does That Process Go?

The bank planner probably asked them some basic questions to determine their comfort level with risk. This led to a pie-chart assessment which allocated them to one of 4 to 6 risk categories. Next, the planner selects some mutual funds which comply with the risk profile. Then they recommend and set up automatic contributions. Then, relieved that everything was taken care of, the bank customer walked out of the bank branch, content that they could forget about it. From what they understood, all they needed to do was to keep adding money to the program and their retirement would be assured.

Is It Really That Easy?

Think about your own experience. Do you remember going through a process like this yourself? Worse, is this the same process you allowed to occur, even much later on, when those funds you had accumulated had become your “life savings”?

Did your planner use an Andex chart showing 100 years of data, to justify just staying fully invested all the time? But have you got 100 years or is your timeline for accumulating the assets you need for retirement more like 20 to 25 years… or less?

What happens if 10 years in to that 20-or 25-year timeline, the markets go into a long slump? Let’s say they pull back 20% or 40% then go sideways for close to 10 years? How would that effect that nice retirement plan? What if there was a better way? Did the planner discuss any strategies that could help you not fully participate in a Bear market when it occurred? How much difference do you think it would it make to the portfolio, if the worst slumps could be avoided?

Next, what if you were getting close to retirement, or were already retired, and depended on the income from your portfolio? How do you suppose taking the full effect of a 10-year slump in the markets would affect your retirement income? Would you also prefer to accept more modest returns on your invested capital in return for increased safety of that capital?

With these thoughts in mind, have you asked yourself why the investment industry is always telling retail investors that they should stay fully invested, when all its pundits are spending so much time talking about where the markets might be going next? Isn’t that a bit disingenuous? Clearly the “institutional (smart) money” is trading the markets, profitably, while the poor retail investor sets those trades up by sitting still?

Are You Still Comfortable Being A “Faith-Based Investor”?

Now, after the market has just delivered the most negative return for December since 1931, has your “faith” been shaken a bit? We all know that interest rates have barely recovered from all-time lows. So, since the key historical driver behind the recovery of portfolio losses during past market corrections has been falling interest rates, how is that likely to play out this time?

These agonizing questions are your emotions talking. Our emotions play nasty tricks on us. They usually enter the equation just when things start getting bumpy, and they shake our resolve. So, if we do not have a solid plan to address those uncertain times, to help us to take our emotions out of the conversation, our “faith” may get shaken and start to dissolve. The PIE-CHART investment providers have no choice but to preach the faith. Is this all the investment industry can provide?

What if there were a strategy you could apply, which acknowledged that the markets were unpredictable, that you could incur loses that you might never recover from and did something about it? Would it not make sense to take advantage of that information to de-risk your portfolio? After all, since the only reason we invest in capital market securities is to grow our net worth, surely our objective should be to attempt to minimize big losses, in pursuit of that goal.

For most people, the only way to trump our emotions would be with a discipline that included a solid strategy, that accounted for the changes which we cannot control.

How About Replacing “Faith-Based” With “Trend-Based” Investing?

Let’s replace an emotional response with a pragmatic one: how about replacing blindly hanging on, with a strategy that requires action to be taken based on market trend changing signals. The big advantage of this psychologically, is that we “see something being done” when circumstances are changing. No one wants to be on the Titanic blasting on at 30 knots towards an iceberg. Would the captain have acted differently if he had had radar to alert him to the dangers that were ahead?

You may have heard about trend-based investing. Maybe you even know someone who spends hours in front of their computer everyday, in their underwear, trading minor movements in the markets. This is not what we are suggesting. Trend analysis is NOT market timing.

So, coming back to the captain of the Titanic, this is like putting radar at his disposal: When the seas are clear, it’s full speed ahead, but when large icebergs show up on radar, the captain requests an appropriate reduction in speed and/or if necessary, a course change to avoid the biggest ones. Once clear, open the throttle again to make up time. Faith-based investing encourages you to act like the 1915 Captain, who had no radar, and pile on, full speed ahead and hope there are no icebergs in the way.

So how do we relate this to our investing strategy? We start with research, just as any sane investor should do. Next, we establish our sectors weightings, then the companies in those sectors which are performing better than their peers, and finally we use longer-term crossing moving averages to let the market tell us whether it would be favorable to own those investments or not. We do the same for the fixed income portion.

In other words, we let our “radar” point us in the right direction: no icebergs? Stay on course, full speed ahead. Signs of big ice in the water? Slow down, change course if necessary, until it is safe to pick up speed again. Analogously, whether we are focused on stocks, bonds, mutual funds, currencies, commodities or something else, we monitor the long-term trends. When those trends turn negative from a long-term perspective, we build cash. When the trend turns positive, we get invested again. If we follow the discipline, we should tend to avoid the major downturns and participate in the major rallies.

Granted, what we propose here is not as easy as just buying a mutual fund and looking at it once a year to confirm it’s still there. A Trend-based strategy does require some knowledge and periodic maintenance to keep it running correctly, but so does our ship require regular maintenance! The intended result we are striving for is more consistent returns over time and avoidance of major losses in our wealth… just what we all need. Don’t be afraid to get educated and prosper.

Tom Dusmet is a business writer and creator of www.localwealthprofessionals.com. Tom is passionate about providing factual, unbiassed information to Canadians to help them make better choices when investing their money.