Three golden rules to help you avoid some common investing pitfalls

three-golden-rules-to-help-you-avoid-some-common-investing-pitfalls

Martin Pelletier: Goals-oriented investing backed by solid financial planning a great way to remove dangers of allowing emotions to creep into your portfolio

Sitting on the sidelines because of market correction fears means high levels of inflation will eat away the value of your wealth. Photo by Timothy A. Clary/AFP via Getty Images It’s tempting to move into cash as major equity market indexes set new highs and the fear of a correction looms, but sitting on the sidelines means high levels of inflation will eat away the value of your wealth and could have a material impact on your lifestyle or estate goals should it prove to be not as transitory as most expect.

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Human behaviour is driven by fear and greed masked by the misguided rationales we tell ourselves when defending our bad decisions. Legendary investor and co-founder of Oaktree Capital Management LLC Howard Marks offers some brilliant insight on this phenomenon in his recent email update to clients while dismantling the old “buy low, sell high” adage.

Retail investors, and even the pros, often make choices that could have negative long-term consequences. Fund managers are bought and sold solely on their return rankings, and all too many miss out on gains simply because they choose to sell and take profits or lock-in losses due to loss aversion.

To help you avoid this from happening to your portfolio, here are three golden rules we deploy in our investment-decision process.

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Always stay invested 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 an investor two ways to be wrong: the decline may or may not occur, and if it does, you’ll have to figure out when the time is right to go back in.”

Simply put, you face a serious risk of not growing your wealth if you don’t stay invested. For example, JP Morgan Asset Management’s 2019 Retirement Guide, as highlighted in a 2019 Motley Fool article , showed that the annual return on the S&P 500 was 5.6 per cent during the 20-year period between 1999 and 2018. However, your return would have fallen to a paltry two per cent if you missed just the 10 best days over this entire period. Missing the 20 best days resulted in your return sinking to zero. Let that sink in.

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Article content Base your decisions on relative considerations We always try our best to compare relative return opportunities with risk levels when making our buy and sell decisions and rarely, if ever, do we move to cash unless a particular client requires funds in the near term.

This means we avoid selling based solely on valuations, particularly those on companies that continue to be leaders in their respective industry by using innovation and disruption to constantly adapt. But there are times when there may be better return-to-risk profiles elsewhere, especially as certain threats emerge.

For example, we’ve recently been highlighting the risk of inflation and rising rates to long-duration sectors such as long-dated bonds and even those companies in the technology sector dependent on cheap and readily available capital to grow their businesses. There is a level of complacency, notably in the clean-tech space, and shrugging off these risks that is reminiscent of the 2000 tech bubble days.

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Article content Concurrently, 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.

As a result, on a relative basis, we see better return-to-risk parameters in the energy sector versus tech.

Give up index benchmarking We avoid this altogether by moving to a model where we give up trying 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%. Why? ‘Well,’ we said (so simplistically), ‘the stock market returns about 10% a year. A little effort should enable us to improve on that by at least 20%.’ Of course, as time has shown, there’s no truth in that. ‘A little effort’ didn’t add anything. In fact, in most cases, active investing detracted: most equity funds failed to keep up with the indices, especially after fees.”

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Article content Battle between commodity and tech sectors heats up — time to choose sides Canada needs fixing as the digital transformation takes hold How to prepare your portfolio for what could be a very volatile year Looking for opportunities amidst the Omicron noise and policy-makers’ nosiness We set a predetermined goals-based target return based on market conditions at the time while trying to mitigate the risks as much as possible. In today’s environment, this is very difficult to do since real yields are the lowest they’ve been in 47 years. Central bankers are doing their best to get you to take as much risk as possible, such as buying high-yield junk bonds, going all-in on high-flying tech stocks like Tesla Inc., or, in the case in Canada, leveraging up and speculating on real estate.

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We trust following these three rules will be as helpful to you as they have been for us, but recognize 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 create 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.

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