It is tempting to move into cash, as major equity market indexes set new highs and the fears of a correction looms, but sitting on the sidelines means high inflation will eat away your wealth and could affect your lifestyle or estate goals, if it proves to be not as transitory as most expect.
Retail investors, and even the pros, often make decisions that could have negative long-term consequences. Fund managers are bought and sold solely on their return rankings, and many miss out on gains simply because they choose to sell and take profits or lock-in losses due to loss aversion. We have three golden rules that we implement in our investment-decision process to help you avoid this happening to your portfolio.
Marks absolutely nails it in his update with this: Charlie Munger, vice-chairman of Berkshire Hathaway, points out that selling for market-timing purposes actually gives investors two ways to be wrong: the decline may or may not occur, and you have to figure out when the time is right to go back in. If you missed only 10 best days over the entire period, your return would have fallen to a paltry two per cent. Missing the 20 best days resulted in your return sinking to zero. We always try to compare return opportunities with risk levels when making our buy and sell decisions and rarely, if ever do we move to cash unless a client needs funds in the near term. We avoid selling based solely on valuations, particularly those on companies that continue to be leaders in their industry by using innovation and disruption to constantly adapt. There are times when there may be better return-to risk profiles elsewhere, especially when certain threats emerge. For example, we have recently been highlighting the risks of inflation and rising rates to long-duration sectors such as long-dated bonds, and even those companies in the technology sector that depend on cheap and readily available capital to grow their businesses. There is a level of complacency, particularly in the clean-tech space, and shrugging off the risks that are reminiscent of the 2000 tech bubble days.
Oil and gas companies are generating record amounts of free cash flow to be used for dividend hikes, share buybacks and debt repayment, and the oil market is actively backstopped by the Organization of the Petroleum Exporting Countries. On a relative basis, we see better return-to-risk parameters in the energy sector versus tech. We avoid this altogether by moving to a model where we don't try to beat the market, otherwise known as alpha, and instead deploy a pension-plan approach. This is contrary to the traditional method that Marks highlights in his letter. What kind of return do you think you can make in an equity portfolio? The standard answer was 12%. The stock market returns about 10% a year, according to us. We should be able to improve on that by at least 20%. There is no truth in that, as time shows. A little effort didn't add anything. In most cases, active investing detracted: most equity funds didn't keep up with the indices, especially after fees. We trust that following these three rules will be as helpful to you as they have been for us, but recognize that they aren't for everyone. Goals-oriented investing backed by solid financial planning is a great way to remove the dangers of allowing emotions to creep into your portfolio that creates risks in achieving your objectives. Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc, operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit oversight and advanced tax, estate and wealth planning.