There is a saying among the DIY community to buy the issuer and not the product. In other words, you are better off profiting from the investment follies of others than to become a fool yourself. It has also been a long standing opinion that the financial industry is rifle with conflicts of interest. What happens when these two concepts collide?

William Bernstein in his excellent book, The Investor’s Manifesto, looked at the performance of mutual funds issued by publicly traded, private and nonprofit firms. He tabulated the percentage of mutual funds which received 4-5 stars by Morningstar (a good rating) and those which received 1-2 stars (a bad rating).

Of the 18 firms he profiled, 5 were not publicly traded. They placed 1st, 2nd, 3rd, 6th and 9th. Positions 10-19 are littered with big names like Goldman Sachs, ING, AIM Invest and John Hancock; likely big names because they sell high-fee product delivering poor performance to the investor but with large profile margins to the issuer. Putnam, the much troubled shop owned by Power Financial, placed dead last.

The lesson being not to buy mutual funds from publicly traded firms.

The explanation is straight-forward. Take a look at all the stakeholders a mutual fund issuer has to deal with on a daily basis: regulators, shareholders, debt-holders and customers.  Short of fraud or regulatory non-compliance of a material nature, who has the ability to hire or fire the directors and officers of a company?

Right- it is the shareholders. So who’s interest will a mutual fund company tend to first? The shareholders by delivering profit quarter after quarter. In and of itself, this fact is not good or bad. It only has a bad meaning if one happens to be a customer being sucked of every dollar the company can part from you. It has good meaning if one owns the stock but not the product. If one happens to own both the stock and the mutual fund the company issues, essentially, one is taking money from the right pocket to place in the left pocket and things more or less even out although with a love/hate relationship as shareholder/mutual fund holder.

Lest a ETF supporter beat his chest proudly and declare “another reason to pick ETFs over mutual funds,” we stand at an interesting point in history. Those who have followed ETFs for the last 3-5 years are slowly watching an industry being eroded by the excesses of the industry.

As the mutual fund industry goes sideways, more financial service firms are simply buying ETF issuers or becoming one themselves spreading “mutual fund-itis” with symptoms such as fee creepage, overly exotic products and an over- emphasis on the intermediary’s interest rather than the investors.

The remedy to mutual fund-itis is to be educated, aware and keep things simple.

The recent marketing wars between the mutual fund industry and supporters of exchange traded funds adopts a rather dogmatic characterization of the two products akin to the Star Wars movies. The mutual fund Empire, inherently evil and a scourge to all low-fee loving citizens of the galaxy, is a lumbering giant weakened greatly by some clumsy attempts to sell its mutual fund way of life; akin to the Stormtroopers weak defense an Ewok attack (yes, this makes personal bloggers Ewoks in my analogy; I have the full geek press on). The rebellion, forces of good and lovers of all low fee loving products, are devoted to the cause of setting the investing world free by the ETF force.

There seems to be a problem with pitting mutual funds vs. ETFs this way. Both are created by the same industry and, to quote Jason Zweig: “Sooner or later, Wall Street turns every good idea into a bad one.”  More accurately, Wall Street turns every good idea into a self-serving execution of the idea. The idea of both mutual funds and ETFs are, stripped of industry excess, both fine. The issue is that where the execution of mutual fund products are now awash in high fees for low service, the ETF industry is now awash in too many products.

But variety is good right?

The problem is that when the ETF market becomes so fragmented and specialized, the investor may end up with similar issues as buying a mutual fund (often referred here as mutual fund-itis). Take, for example, the much criticized Dent Tactical ETF, a high fee and actively managed ETF with an investment strategy based on Harry Dent Jr.’s analysis on future trends (who recently admitted he’s having a rough 2009 on the prediction front). On November 6, its trading volume was 1,791 shares.

ETFs with thin trading volumes tend to suffer from larger than normal bid-ask spreads leading to distortions in “true” pricing, issues unwinding large positions and potentially higher trading costs by being forced to sell in tranches due to limited demand. Generally, many experts believe any ETF should have a trading volume of over 100,000 shares a day to be a viable ETF in the long run.

The problem is not as isolated.  As the Wall Street Journal reported in August of this year, the ten largest ETFs account for approximately 40% of assets under management and 2/3 of all trading volume. In other words, the law of averages dictates that the more ETFs one holds, the more likely they will own an ETF that accounts for 90% of product issued but a mere third of trading volume. In real numbers, over 200 ETFs had such small trading volumes that their bid-ask spread was 0.5% or over; this spread is so high that it negates the cost advantage of an ETF over a mutual fund (Claymore Securities in the US seems to be particularly bad- 7 of 34 ETFs had a bid-ask spread of over 2% in August of this year; in essence, you de facto bought a high fee mutual funds if you equate being on the wrong side of a spread with MER).

Thinly traded ETFs can be caused by several reasons: over-specialization, high fees, poor investment strategy and, as Preet pointed out, an ETF with too few holdings to properly diversify (incidentally, that ETF, zeb.to, is also thinly traded at under 40,000 share on November 6). The problem becomes more pronounced over time as new market players- BMO and Charles Schwab to name two- begin to pile on and need to differentiate themselves from existing ETFs by issuing more exotic offerings.

As the number of thinly traded ETFs grows, the options of an ETF issuer typically are: (i) do nothing and let the investor suffer in the market; (ii) wind up the ETF and redeem at net asset value (possibly triggering an unintended tax consequence); or (iii) merge the ETF with a larger ETF and report the better results of the large ETF, resulting in survivorship bias in returns.

Exotic products issued at the industry’s peak that few people bought. Hard to liquidate product. Hidden costs. Unintended tax consequences. Many new market participants. Survivorship bias in returns.  Sounds awfully like the mutual fund industry doesn’t it? Of course it does. The same people who created one are now creating the other.

The moral of the story is that no product should be generalized as good or bad and buying an ETF does not necessarily mean you bought a better product than a mutual fund (as several writers have commented rightly though this is not an apples to apples comparison). The devil is always in the details  and a knee jerk mutual fund = bad, ETF= good is an overly simplistic analysis to take.

As for a solution, ETFs work best when they are broadly based with low fees. Canadian Capitalist, who is a ETF Jedi, ran an excellent series comparing global equity mutual funds with broad based indexes. But note his methodology- he used as his basis of comparison broad indexes. His approach, and mine, to ETF investing is to stay out of the excess of the industry and invest in ETFs which are broad and low costs which is the underlying reason for investing in an ETF in the first place.

Picking a small business banking account can be like eating at a buffet. There is something for everyone but it is hard to tell which offerings are the best for you given that they are so diverse. The issue is compounded by the fact that small business banking is not like personal banking. A small business typically requires a lot more services than personal banking and there should be, from the customers’ perspective at least, there should be a balance between paying the lowest small business banking fees and deriving value.

I have used 5 different banks and 1 credit union for small business banking. As a lawyer, I have dealt with all the major banks on either transactions or written nasty letters on behalf of clients to these same institutions. From all these experiences I would make the following observations about picking the right small business bank account.

Not all small business bank accounts are built the same; every bank has a niche. As one of the comments in Million Dollar Journey’s  linked post noted, every bank has a professionals division (banking for doctors, dentists, accountants, lawyers etc. etc.) or some type of niche they serve. The plans for these types of industries are different than other businesses. Lawyers, for example, need to have no holds trust accounts (for example, a real estate lawyer has to be able to deposit mortgage funds in trust for a purchaser and then immediately pay it out to the vendor soon after deposit).

Some banks are great at servicing these types of industries (Scotiabank is traditionally the leader for servicing doctors and dentists; RBC is very active in this same industry). Others have a particular niche; TD is still my favorite for banking on-line. HSBC is a very good bank if you have business internationally (there is an extremely long hold period if a USD cheque is deposited from a non US bank; HSBC has a plan that avoids this issue). The key is to ask around and see who does what well because…

You need a good account manager. Forget purely a narrow focus on fees. Ask instead what someone is going to do for you for those fees. Most entry-level tellers have limited clearance; for example, most cannot process a deposit  over $500 without a supervisor signing off. This is not a large deposit for a business.  In other words, the person you see on the other side of the counter has limited authority to solve your problems.

A good account manager can authorize deposits with typos on them, release holds, transfer money from one account to another (with your authorization) if your account goes into the negative, waive fees (yes, it happens if you ask nicely), shift you from one fee schedule to another periodically and refer you clients (if you tell them what you want). I have requested or experienced every one of the above. The key is to maintain the relationship. Since an account manager’s compensation is partially based on their book of business, they have a vested interest in seeing you succeed as well.

Branches actually make a difference. There is a particular branch from a particular bank that consistently dropped the ball on client transactions: great bank, bad branch. Years later, I met an entrepreneur for the first time who complained about their bank. Sure enough, it was that same branch! Your analysis should not stop at the institution but the branch you are using.

My personal experience is avoid a large branch unless you have huge accounts. You are just another number and you are probably pretty far down in the pecking order of your account manager. Co-ordination is also an issue; right hand often does not know what left hand is doing in large branches. Avoid the small branches or credit unions with overwhelmingly personal accounts.  Small branches or these type of credit unions are not use to larger deposits, frequent deposits and withdrawals (they think you are kiting because they don’t understand cash flow of businesses) and what small business needs from their financial institution.

As a side-note about credit unions, they are good alternative to the traditional banks but not all credit unions are built alike. For smaller to modest sized accounts, they can be good choices but some credit unions are not built to service the small business account.

Picking the right branch comes down to word of mouth. Who are your neighboring businesses using? As everyone knows, there always 2-3 banks at every major intersection. But, if a large number of people are using the same bank and have nice things to say about it, it means that branch is doing something right.

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Obviously, there will be certain small businesses that do nothing more than a few deposits and a few withdrawls each month. In this context, a focus on minimizing fees is warranted. But, for those requiring other banking needs, I would focus on the above in picking your small business bank account.

I bought a silver coin this week as a small token of appreciation for someone. Having never done it before, here’s a quick and dirty of my experience. I don’t remotely pretend to be an expert in buying and selling precious metals so please feel free to comment if you have anything to add to buying silver or physical gold.

I bought my coin at Scotiabank’s main branch at Scotia Plaza. They have a separate foreign exchange and precious metals desk. If you are not a customer of the bank selling you a silver or gold coin, you will have to bring two pieces of id (one of them has to be photo id). I am sure you have to pre-order for much larger orders (there is an item in the bill for “armoured car” charge; I wonder how much gold or silver you have to buy to be charge with that charge!).

I bought a 1 oz silver maple coin. Here is the catch. Even though the coin is Canadian (hence, a maple coin), the price is quoted in U.S. dollars. I am told bullion and coins are quoted in USD no matter the country of issuer. In other words, factor in the exchange rate.

The price per oz was $20.41 that day. Exchange as at 1.115%. Commission is $5.00 up to $2,000 then, according to the employee behind the desk, from $200.01 to $5,000.00, commission is another quarter of a percent and then an eighth of a percent above $5,000.00.  Sales tax of 8% was also charged. The total ended up being $30.60.

Under the law of unintended consequences, there are two developments that may actually doom the exchange traded fund market to mutual fund-itis. As reported by Preet previously, regulators in various jurisdictions are proposing to eliminate mutual fund companies from paying commission to investment advisors to secure sales or to accept trailers.

More locally, as of Monday, National Instrument 31-103 (NI 31-103) will be in force across Canada.  NI 31-103 harmonizes the byzantine Canadian securities regulatory when it comes to registering market participants by  requiring anyone who is in the “business” of securities (a wide regulatory net than merely selling securities) to register in one of five classes of registrations.

In particular, those who administer mutual funds will be required to register for the first time ever in a newly created “investment fund manager”  registration class. The compliance requirements will be quite costly as it requires the hiring of compliance officers, registration and policies and procedures (both new and updating of old ones) to be implemented.

Both the move to disclose or limit mutual fund commissions and trailers and to require greater registration commenced in 2006. The results, as a whole, can be seen as a pincer movement on the mutual fund industry. On the one hand, regulators are  trying to slow revenue growth by  limiting enticements to push product and, on the other hand, increasing expenses through more compliance measures (undoubtedly, NI 31-103 has cousins in other countries).

Regulation alone has never stopped the financial services industry; history shows that as soon as the regulators close down one loophole, the player move to a greenfield product that has little to no regulation and it takes the regulators years to create another regulatory framework. If not for the credit crisis, Congress would still be talking about how to regulate hedge funds.  More to the point, while regulators are adding regulation to mutual funds, lawmakers are scratching their head over how to limit commodity ETF that may be distorting market prices.

Thus, the fact you have the regulators protecting the public interest in product that is most likely on a downward side of a product life cycle  (although very slow decline) while Congress scratches its heads about the public policy consequences of  ETFs  (“….Mr.  Speaker, I thought ETF was a branch of the Department of Homeland Security…),  means that the industry may move away from the regulators to something they don’t quite understand yet and has legs. This is the ETF market.

I do not think regulatory pressure on the mutual fund industry alone will cause a wholesale shift to the ETF market. But it will be a factor (the degree of influence is up for debate). If this happens, history indicates that the financial industry will basically ruin ETFs with excess and sell the sizzle and forget the steak.

Sadly, excess is already here. As Larry MacDonald reported, there are now actively traded, non-benchmarked, high MER ETFs on the market based on demographic trending (the 1.96% annual operating expense seems low given the prospectus states underlying ETF fees and expense are 0.17%; if turn-over is high, this seems like a low estimate). Given 1 million units were traded in the first 4 days of trading- a relatively modest volume given that Vanguard Total Stock ETF traded almost 1.9 million shares yesterday-it seems to prove the theory people will buy anything if packaged right.

As a smart investor, if poorly designed EFTs becomes the rule rather than the exception, please remember why you would invest in these products to begin with, mainly:

1. You have no intention to beat the market which, statistically speaking, will not happen to most investors but matching the market will put you in a better position than most active investors;
2. Broad exposure to markets; and
3. Low fees.

If a new mutual fund, dressed up in ETF clothing for sales and regulatory purposes, is pitched to you, please review the above list and see if it passes the test.

I mused early this year whether exchange traded funds (ETFs) were contracting mutual-fund-itis: a product mangled by the excesses of the financial services industry.  It is not that either mutual funds or ETFs are, at their very core, inherently good or bad for the investor. It is that the execution of these products have evolved to favor the issuers and distributors (i.e. the advisor) to such an extent that it make little sense for the average investor to purchase most of the products on the market (and, yes, there are good mutual funds on the market but they tend not to be pushed to most retail investors).

For the ETF industry, we may have hit the tipping point of, to paraphrase the title of the 1990’s television show, when investment products attack! Both Jonathan Chevreau and Larry MacDonald have recently highlighted some of the larger issues of badly designed ETFs: leveraged ETFs not suited for most retail investors and ETFs developing larger than usual differences between their share price and net asset value (although the example MacDonald cites is due to regulatory issues). Finally, there is the usual issue of many competitors chasing the same dollars: excessive financial innovation leading to exoticism of product which may not suit many investors (my much cited ETF which tracks the airline industry-an industry that single-handedly keeps the bankruptcy lawyers employed-as example A).

Does this make ETFs scams, bad products, Madoff-esque in dealing with your money? No. As I indicated, the idea is fine. It is the execution which may be faulty.

Remember why anyone purchases ETFs:

1. Broad exposure and diversification;
2. Low fees; and
3. Easy ability to re-balance your portfolio.

Add to this list the investing maxim buy what you understand.

If the ETF you are considering purchasing does not fall within the above then take a pass. Otherwise you could end up with an ETF which tracks a very narrow index/industry/region with high fees relatively speaking or exotic ETFs that you don’t really understand (which most of the double, triple leveraged ETF’s are).

ETFs are following the evolution of most financial products (see hedge funds, mutual funds, corporate bonds issued by securitizations of receivables etc.): take a simple idea, begin selling product which mimics that idea closely, attract money, money attracts competitors, product begins to deviate from original idea, more money attracted, excess point reach with product now designed for issuers and distributors and not for investor. History has a way of repeating itself.

Thus, it is always important to think, for all investment products, why you are buying this product above and beyond making money.  If the product does not fall within why you should be buying the product, you may want to take a pass.

File this post under “obscure personal finance reading”  or “why dividend stocks continue to be your best bet.” A Swedish undergraduate research paper written earlier this year posed the question of what quantitative measures an investor should look at in determining which stocks will outperform the market in the 12 months after the end of the recession (…and to think I spent 90% of my undergrad on women, drugs and booze and the other 10% of the time I wasted…).

Using a very small sample size of the stock market recovery in the Swedish OMX exchange in the 12 months after the dot com bust, the researchers attempted to look at factors such as price to book ratio, price to earnings ratios, enterprise value/EBIT, debt levels and dividend yields and applied these financial ratios and factors to the study group to determine if tracking any one ratio would give an investor insight into which stocks would out-perform the market in the preliminary stages of a recovery.

The findings came down to three factors which they stressed should not be read together:

1. 12 month trailing performance. The worst the stock performed prior to the market hitting bottom, the more likely it would outperform the market during the recovery period.
2. High dividend yield stocks. Stocks that paid high dividend yields during the downturn tend to out-perform the market during the recovery.
3. Price to earnings ratio. Low p/e stocks tend to do better in recoveries but is a factor with less weight than the other two.

The sample size and study group are far too small to draw any definitive conclusions but the above does make sense. Given that poor performing stocks, which one assumes have lower p/e ratios than their peers with healthier balance sheets, tend to a longer ways to go to recover than stocks that went sideways during the downturn. Thus, when the recovery starts, the relative and absolute bounce is greater than their industry peers.

As for dividends, the paper did not address what a “high” dividend yield was or how high was too high. But, similarly, their findings do make sense. A dividend yielding stock that can maintain its dividend during downturns shows the market that it has its house fundamentally in order and, assuming that investors are more cautious in the embryonic stages of a recovery, there may be an initial overweight towards safer dividend paying stock when cash goes back into equities.

Applied against the run-up since March, what are we to make of all of this? Certainly, low p/e stocks in financial services and oil/gas have made a recovery, returning most of the paper losses for those who hung on. The dividend paying stalwarts of the market also seemed to have held on and done quite well since March.

But, with the S & P 500 p/e ratio at approximately 18, have we already peaked on the stock market recovery?  The stocks that under-performed may have already risen if the S & P p/e is approaching 20 and there may not too much more upside. Contextually, historical p/e is in the mid-teens and a p/e at 20 has never been sustainable for long periods of time.  Predicating the future is a mug’s game but food for thought.

The entire paper on stock market research is certainly very interesting and quite an accomplishment for an undergrad paper.

Scotiabank became the second Canadian bank, after RBC, to begin selling insurance by building insurance retail operations next to their existing bank branches. The rather strange result of having adjoining retail frontage operated by the same business, but selling different products, is a means to circumvent rule not allowing banks to sell insurance out of existing bank branches.

Is this growing trend a good thing for the consumer, the shareholder and the economy as a whole?

THE CONSUMER

On the retail front, we have all heard about financial institutions wanting to capture all of our business as your “one stop” cradle to grave financial services shop. However, anecdotal evidence  suggests that customer loyalty at banks really does not pay and is there any evidence to show that the retail consumer benefits from pricing power from banking, borrowing, trading securities or buying insurance from one shop?

Granted, there are small discounts if you buy different types of product offerings under one umbrella (State Farm Insurance is known to give a discount but you have to move all your insurance to them) but why give up leverage of moving around from financial institution to financial institution if there is no corresponding monetary benefit to shopping under one roof?

More concerning, the dirty little secret of insurance sold by banks is that banks are actually selling other insurer’s products or white-labeled products. Scotiabank will be selling Sunlife products. My insurance broker once told me that, at that time, RBC insurance products were white-labeled Manulife policies. If the banks are acting as distribution channels for insurers, obviously, there are costs of sales and their margins to consider. For a business with such large over-heads as banks, the cost could be great and they will be downloaded to the consumer.

But, to defend the banks for a minute, this may also be a good move if, and only if, this starts a price war. Banks have been selling insurance for years but if they move in scale, this may trigger price movement downwards. The key, as a smart consumer, is to obtain multiple insurance quotes from the banks, insurance brokers, on-line insurance quotes using the same assumptions and determine if different distribution channels have different price structures. If they don’t, I would still purchase insurance from someone other than the banks to avoid giving up all your leverage as a consumer; rarely is the lazy consumer, the smart one.

THE SHAREHOLDER

Increasing revenue sources means increasing revenue which, hopefully, means increased earnings. However, if the banks engage in a pricing war with the insurance companies (assuming the banks underwrite their own products) and vice versa (remember that some insurance companies are beginning to build out their banking divisions as well), what’s good for the consumer is bad for the shareholder. The recent supermarket price wars are a good example of happy consumers and unhappy shareholders.

On the downside, insurance is also a tricky risk management product. Actuarial calculations on probability of payout are really educated guesses into the future. Already juggling fallout from the credit crisis, if a bank dramatically increases its insurance exposure, it may have to build greater capital ratios (both for deposits and insurance exposure) which is a drag on earnings. Once again, the question becomes how well can a bank manage risk?

THE ECONOMY

There’s a rather deafening silence in the dialogue about financial services reform- the reinstitution of the Glass-Steagall Act. This Act, passed at the height of the Great Depression in the U.S., separated banks, investment banks and insurance companies from owning one another. One justification was that traders should be barred from using bank deposits to trade; banks are supposed to limit risk on deposits and they should not allow traders to have access to deposits given their relatively riskier functionality.

The act was repealed in 1999 under intense lobbying by financial institutions. Citigroup was the most well-known institution to consolidate deposit-taking, trading and insurance functions under one financial services holding company after the repeal of the act. Citigroup also became the poster-child for the credit crisis as its large derivatives exposure and imprudent trading practices put depositers’ money at risk.

Many countries continue to prohibit the consolidation of banking and investment trading functions. The U.S. sits on the other extreme of non-regulation. Canada occupies the grey zone. A financial institution can do a bit of everything- as long as its not under the same roof (a rule only a bureaucrat could convincedly think would work in real life).

If banks become insurance juggernauts, are we exposing our deposits and insurance premiums again to traders with much higher risk tolerance than the retail consumer? Perhaps the practical regulatory solution is to mandate higher capital ratio levels on both the deposit taking and insurance side once exposures reach certain levels and limit the use of revenue derived from safer divisions by riskier functions. Certainly,  risk-taking and innovation are opposite  sides of the same coin but one wonders if such risk taking should be done with grandma’s money.

The price of gold and its perception as an investment by bloggers seems to have an inverse relationship. As the price of gold rises, bloggers seem less enthusiastic about gold as an investment. Why such a negative attitude about something going up in price?

Gold, unlike silver or copper, has no industrial usage. In fact, other than for purely cosmetic purposes,  it has no utility which could at least justify an inherent floor price of the commodity. Having said that, gold is the closet thing to a universal currency. If you were in the Republic of Benin, you would most likely get room and board with physical gold; I am not as sure if you tried to pay with USD you would have the same success (especially lately). Obviously, there is also a huge market for gold in the jewellery industry and it is a highly desired luxury for most cultures.

However, it is the concept that gold is a universal currency that makes it, in some respects, better than a money market fund as an investment. When paper currencies that the developing world recognize as the standard falters (i.e. the USD), the markets rush to gold since its underlying value is not dependent on policy decisions of governments or their relative solvency.  As confidence wanes in paper currencies, governments typically resort to printing more of it which only accerlerates gold’s demand since you now have inflationary pressures on paper currency as well and gold is a good hedge against inflation (see below).

The end result is that, in bad times, gold serves as an able substitute for cash. As Jeremy Siegel found, a $1 invested in gold in 1802 would yield $32. 84 in 2006. It serves to protect the value of the $1 invested which, if kept in cash would be worth considerably less than $1.00 due to inflation. But as Siegel also points out that is all gold is: a good protection against inflation.  But, the opportunity costs of investing in gold long-term in lieu of other investment classes is enormous.

Like everything else in investing, gold has its time and place. I would not dismiss the fact it has no utility as a reason not to invest in it. Whether most of us like it or not, I call gold the irrationality hedge. The more irrational the markets get, the better gold is a hedge against such irrationality. The extreme example being times of war. What are governments doing in war? Most are stock-piling or stealing gold from where-ever they can get it.

Does this defy some well-reasoned argument why anyone would want to invest in a commodity that really does nothing other than look pretty? Of course it does but is the market that rational? I suspect the last 9-12 months is a walking argument that the market is not rational.

However, when such irrationality ends (and it always does), one should move out of gold. It is, and should be used, as nothing more than a short-term cash substitute and a hedge against inflation.

The argument that anyone should have substantial portions of their portfolio in gold defies any type of long-term prudent portfolio management. If the world is so bad that gold prices are astronomical, does the size of your portfolio really matter compared to, say, imminent threat of physical harm to one’s self and their family? Investing vast percentages of your net worth in gold long-term due to impending economic armageddon misses the practical point that a net worth calculation probably doesn’t matter anymore when your primary need is survival and self-preservation.

At the end of the day, substitute cash for gold. You would only hold cash/gold in your portfolio in the short-term and during times of uncertainity. Holding a large portion of it or holding it in the medium and long term will generally not serve a prudent long-term investor well.

For many months, investors have debated whether stocks are still a good investment. After all, at the nadir of the credit crisis, an investor who invested in the S &P 500 10 years ago would have received negative return. For some, it appeared that the Siegel-esque belief that investing in stocks for the long run was dead.

Although the economy has slowed its decent since then, some believe that the better empirical data to predict future performance of stock is to look at stock market returns for mature economies (for some reason, Germany is used as an example) since the period of time analyzed by Siegel (1802-2006) coincided with America’s ascendancy as an economic super-power and now it is levelling off or declining into a multi-polar economic framework.

The debate has slipped into the main-stream media as Time Magazine asks “Are Stocks Still Good for the Long Run?” and considers whether one would be ahead investing in fixed income instruments.

How the question is answered takes a puritanical “either or approach.” When this topic has been broached, the basis of comparison is typically 100% equity vs. 100% bonds. While there are people who have this type of asset allocation (see Let’s Bond as an example from the bond side), most retail investors do not invest fully in either 100% equities or 100% fixed income. In fact, many who are either pure equity or fixed income investors are professionals, or DIYer who understand their niche well. It is improable that these investors would invest only in the S & P 500 or buy a 10/30 year treasury and wait for it to mature.

Thus, the examples used to measure performance comparisons tends to be in the extremes and not reflective of the reality of the daily investing lives of most investors.

More to the point, there are some practical things to remember about looking at any asset class:

1. One of the points of an ideal  asset allocation is to reduce risk. A proper mixture of stocks, fixed income, cash and real estate should ideally be hedges against the short and medium term risks of the other asset classes. An under-performing asset class in a portfolio with proper asset allocation should not destroy an investing strategy.
2. As the Time article indicated, long term means different things to different people. The debate about whether stocks are still good investments is contextual. For those with long investing horizons (20 years plus to retirement), an ideal portfolio should contain some element of risk.
3. To quote the Time article, regardless of asset class, “…The main message… to John and Mary investor is, Pay attention to the price you pay for an asset.” In other words, its the classic, buy low, sell high advice.
4. Finally, moving from one investing extreme to the other is, in normal times, a sure way to lose money. In uncertain times such as this, one is only adding to their own stress.