Canadian Couch Potato recently responded to a reader’s comment that her investing strategy based on purchasing exchange traded funds did not seem to be working. There are some very insightful comments from readers but what struck me was the reader was already questioning her investment strategy a mere 3 years after starting it which is way too short of a period of time to start second-guessing yourself.

The best and worst thing to happen to the investing public is the internet. It was provided us with research and information we otherwise would have great difficulty obtaining but it has given us collective ADD and a sense we should all become day-traders to be successful investors.

However, if you read a recent interview with billionaire T. Boone Pickens, his traditional investing horizon is 5 years (it is now 2 years for him because he’s 82 years old). 5 years is, arguably, even a short period of time for an investor with a 15-20 year plus investing horizon, remembering Pickens made his reputation as a corporate raider (now known as private equity post Gordon Gekko) and hedge fund manager- occupations not exactly known for patience.

If you looked at the interval of time between recessions in the U.S. since the end of WW II, the results are (in years rounded up), 3, 4, 3, 2, 9, 3, 5, 1, 8, 10, 6. In other words, even a minimum of 5 year hold period in a product or investing strategy would have outlasted or equaled 7 of 11 economic cycles of one recession to another since WWII. By jumping in and out under 5 years, an investor risks missing the run-up in a recovery or investing at the start of a down-turn.

(as a side note, note how much larger the last 3 numbers are to the first 8- the 9 year figure notwithstanding. It tends to show how historically anomalous the period of 1982-2007 was and how “normal” a recession should be in the natural economic cycle of any nation. In other words, hyperbole of a possible 2nd recession tends to ignore historical realities)

The exception, as Pickens referred to, is if you have a short investing horizon a minimal 5 year period may be too long.

The long and the short of it is that it is not so much that a strategy is misguided but a poor investor does not give any strategy or product enough time to come to fruition. It is analogous to, short of a disaster, cutting a first date short halfway through dinner and deciding he/she is not worthy of a second date. How you know with such a small sample size?

Investing horizons also becomes a great litmus test for the quality of an investment advisor. If he/she cannot stick to a prudent strategy or product they recommended to you for 5 or more years, it may show they are merely salespeople churning through your portfolio for commission.

Despite the myriad of strategies and products on the market, one of the fundamental issues on why some investors do not reach their financial goals is lack of personal accountability.  As Michael James recently commented, the forces of inertia and fear of change can cripple an investor even when such an investor knows better than to maintain the course in the current and less than ideal strategy and/or products.

Part of problem is that we are impatient investors. The other problem is that we are dabblers as people. Just as many resolve to attend the gym/eat healthier/be better people on the turning of each calendar year, a large group of us also make half-attempts towards these goals and then give up due to resistance, hard work, unrealistic goals etc. As Napoleon Hill, author of Think & Grow Rich, wrote: “Spasmodic or occasional effort to apply the rule will be of no value to you. To get results, you must apply all the rules  until their application becomes a fixed habit to you.”

The issue becomes then, as well intentioned as someone may be towards self-improvement, how do we stick to it?  One method I have used recently is an accountability partner.

Very simply, pick someone who has the same drive and determination to reach a goal as you; their goal may be different or the same. Write down the goal(s) and how you intent to achieve this goal. For example, your goal could be to reduce your personal debt by an additional $5,000 in the next 12 months; in order to achieve this goal, you will have to make an additional $96.15 payment towards week towards paying down debt. The key though is to pick a reasonable goal. If you are unemployed, it would make little sense to agree to a goal to reduce debt by $5,000; perhaps a more realistic goal in this context would be to make 3 calls/meetings a day to find a job.

At an allotted time each week/month (or whatever interval is appropriate), have one of you call the other and report on your progress. Here’s the key- you have to be honest and your accountability partner cannot take your missing the goal with indifference. Just like a good coach, they have to make you feel uncomfortable and, quite frankly, bad that you missed your goal. Since your partner has a goal in mind too, there’s a certain embarrassment factor if your partner is well on their way to the goal while you are not.

To raise the stakes slightly, pick either a positive reinforcement reward or negative reinforcement punishment if you fail to meet your goal at the end of the period you set out. A positive reinforcement goal is you get something if you reach your goal. For example, you can take yourself and your significant other to a nice dinner if you meet your goal. A negative reinforcement is something is taken away or you are forced to do something you despise if you fail to reach the goal. For example, you have to engage in public speaking, a fear for most people, if you fail to meet your goal.

Sound like a lot of hard work and a lot of pain? That is exactly the point. It is hard to reach the next point in any aspects of life without some discomfort.

The goal is to pick a partner who will hold you accountable and to put an honest effort on the goal. One wonders if investment advisors could become accountability partners in order to prove that they provide value.

Good luck.

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.

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.

As I commented before, the exchange traded fund (ETF) industry is replicating the development of the mutual fund industry: fee creep, new players and increasingly exotic products. If history does repeat itself, and the industry engages in similar sales and marketing strategies as mutual funds, an uneducated investor may merely be going back to the future: a portfolio of numerous high fee ETFs that may overlap each other with no coherent or long-term strategy.

Thus, in an industry pushing more and more product, how many ETFs is too many ETFs in your portfolio?

Let’s look at the “why” question first. Why are you investing in an ETF based portfolio? Primarily, an ETF portfolio allows the investor low cost, diversification and an ability to re-balance from time to time. The question of “what” or “how many” should always be answered by referring back to the answers to the question why.

I am going to answer the “what” and “how many” without specifics to a product. Product is product. The primacy of strategy should always be top of mind rather than on product. More practically, Canadian Capitalist does a superior job commenting on ETF product and reference should be made to his blog.

Instead, my post addresses whether you may be committing mutual fund-itis by buying too many ETFs by analyzing each asset class.

CASH

An ideal ETF portfolio should not be a fully invested portfolio. After all, one of the reasons why you build an ETF portfolio is to re-balance periodically to capitalize on market weaknesses and to prevent a drift away from diversification. Always keep cash around to utilize this advantage fully (good advice no matter what your investing strategy). How much? This is subject to some debate. I like keeping 5-10% of my portfolio  in normal times and between 10-15% in volatile markets.

FIXED INCOME

One could achieve significant fix income diversity by 3 fixed income ETFs although 2 is probably a better number. If you want full coverage without too much duplication, consider: (i) a government bond ETF (short term for greater predictability); (iii) corporate bond ETF; and (iii) real return (aka TIPS) ETF for inflation protection.

If you opt for two fixed income ETFs, and assuming you want some margin of safety, consider looking at a short-term government ETF and real return ETF. If you want to be more aggressive, then substitute the government ETF with a laddered corporate bond ETF (bond laddering is a fixed income strategy where one purchases bonds that mature at regularly internals- for example, a portion of the portfolio matures every year) and a real return ETF.

What about preferred shares ETFs? As a hybrid debt-equity instrument, it can be classified as fixed income given it pays set distributions. However, preferred shares are typically issued by financials and utilities which constitute large portions of mature equity indexes. Thus, if a financial or utility hits a rough patch, it could adversely impact your equity and fixed income holdings if you hold both preferred share ETFs and a board based equity ETF. Since one of the advantages of an ideal ETF portfolio is diversification, it is arguable that loading up on preferred shares ETFs is defeating this purpose if there is a large equity holding in a ETF portfolio.

EQUITY

The portion of equity in your portfolio depends on your risk tolerance and investing horizon. The larger your risk tolerance and the longer your horizon, the larger portion of your portfolio should be in equities (typically, the formula is 120- your age should be your holdings in equities but a safer formula is 100- your age).

Depending on where you live, you may want to consider 3-4 EFTs: (i) and (ii) 2 ETF’s tracking the major North American equity index (typically S&P 500) and a major European/Asian equity index (typically the MSCI EAFE Index); (iii) an ETF tracking a LARGE emerging market index (as opposed to country specific); (iv) Canadians like purchasing ETFs tracking the TSX (which is really a financials, energy, materials index) OR, if you do not like the TSX, an ETF tracking a mid-cap or small-cap index (if you have the stomach for it).

It is in this portion of a ETF portfolio that mutual fund-itis usually occurs. People buy dividend paying ETFs, BRIC ETFs, ETF’s tracking specific countries or industries (I am still giggling about the ETF that tracks airline stock; might as well buy a distressed debt ETF to hedge against your loss now). Since dividend-paying stocks constitute large portions of large equity indexes and stocks issued in BRIC countries may also constitute holdings an in emerging market indexes, duplication is occurring and, again, the goal of diversification is being defeated. Having said that…

FUN MONEY

ETF investing can arguable be boring: it is quite passive and you aren’t rooting for one company in general, you are rooting for the indexes. Thus, if one has a long investing horizon and wants some excitement, one could take 2-5% of their portfolio and basically take a risk on something high-risk, high reward ETF (bio-tech, wind power etc.) keeping in mind: (i) the ETF could lose a lot of its value; and (ii) fun money should be kept a very small portion of your portfolio.

In summary, one should consider:

1. Cash
2. 2-3 Fixed Income ETF’s
3. 3-4 equity ETF’s
4. Fun money ETF (if you can handle the downside risk).

But the key is that each of the ETFs are tracking broad based indexes rather than narrow indexes.

Anyone have any thoughts on how much is too much in ETF investing?

I have been asked several times in the last six to nine months about investing in some down and out company (Citigroup, GM, Nortel) on the thinking of  “what’s the worst thing that happens? I lose a few pennies/dollars a share. If the company turns around, I can double or triple my investment!” What scares me is that half the people who ask me this question are deadly serious.

I tend to think of this type of stock investing as being in the hail mary school of thinking- named after the hail mary pass in football where you heave the football into the end-zone in some low percentage, high reward play made in desperation.

It is, in many respect, the flip side of penny stock investing. Put your money in a business who’s salad days are in the rear view mirror in the hopes that there is still enough goodwill in the market to effect a turnaround with smart management. Think of Apple. Nissan. Puma.

But is this an effective way to invest?

First and foremost, remember Buffet’s first rule of investing: never lose money. As much as we all want to cheer the underdog (and it is weird thinking of GM as an underdog), these are long shot bets and the chances of losing money are greater than the chances of a turn-around.

Second, another Buffetism is that “cheap is not good.” There is a reason why these once large businesses are trading at such a discount. Management ruined them. The market moved past them (Nortel). They got arrogant (GM). They engaged in illegal conduct (Enron). The market tends to be efficient over long periods of time and there is a reason the stock price is so low. You can only be mediocre for so long before everyone notices.  Buffet always believes you invest in good businesses that have moderately higher valuations than bad businesses on discount.

Third, many down and out businesses have a de-listing and restructuring risk attached to it.  How do you exit if the stock gets de-listed? In most restructurings, the shareholders get crammed down as well (typically, they are greatly diluted- see most airline restructurings). Thus, even if the business re-emerges from restructuring, an investor may not be in the same position as it was when you invested.

Apple is one of the few great turnaround stories in business history but it was never in such dire straits as some companies now and, as Job’s illness has proven, it is a business partially built on a cult of personality so it remains to be seen whether Apple can be a longer term success story (anyone find it odd that Manulife is taken to task for tardy disclosure but Apple is not for hiding the fact their CEO had major surgery? Last time I checked, Apple is not above the law- unless they made an app for that too).

In other words, successful hail marys are the exception rather than the rule so invest accordingly.

With high interest savings accounts paying below 2% and one year GIC rates at below 1.5%, one could be earning nominal or no after-tax return if your high interest savings account or GIC is held outside of a tax-deferred account. For those holding a large part of their retirement portfolios in cash or GIC, they may be opportunity costs to not shifting from cash or cash equivalent positions to higher yield fixed income instruments or equities.  Given these choices, what is one to do in an low interest investing environment?

Central banks across the world are maintaining low interest rates for a reason; to encourage investors to move out of cash and into higher yielding instruments particularly corporate bonds and equities as a means of recapitalizing private enterprise. The one flaw in the assumption is that people will act rationally to undertake the desired behavior modification.

Rationality is not a word I would use to describe the state of personal finance in 2009: “anything to survive” may be more of an adapt phrase. For this reason, some analysts believe that investment products that usually benefit in low interest environments are under-priced. What may some of these products be?

1. Corporate bond market. AAA rated corporate bonds yielding between 4-6%.  A yield higher than that typically implies higher risk of repayment.
2. Utility stocks. Typically quite sensitive to interest rates because of the highly leveraged nature of the business (not because of undue risk but because of the large amount of capital expenditures it must undertake to maintain the assets of the business). The lower the interest rate environment, the cheaper the cost of doing business.
3. Teleco stocks. Same reason as utilities.
4. Real Estate (under normal circumstances)- stocks and as investment properties. Another business which depends on leverage and thus fares better in low interest rate environments. Of course, if this was a “normal” recession, this analysis would hold true. But where a recession is caused, in part, by a large correction in real estate valuations, you have to pick and chose your spots.
5. Bank stocks (under normal circumstances)- banks usually lead recoveries because the typical economic stimulus in downturns (which we are seeing now) is to lower the cost of lending/return on cash in order to encourage lending-the traditional bread and butter of financial institutions- and encourage investors to stop hoarding cash. But no one is quite sure if banks are out of the woods yet;  some believe the other shoe has yet to drop on banks looking at  rising credit card delinquency rates and increased defaults on corporate loans.

One huge caveat though. Many observers expect that the government is solving one problem by creating another. Throw enough money at any issue and you will solve it. Thus, the fact that financial institutions are starting to get back on their feet is not startling news a trillion dollars later. The issue is that rapidly increasing money supply typically leads to inflation, meaning there may be more of a probability of a 1970′s hyper-inflation environment than a 1930′s style depression.

The typical monetary tool to fight inflation is to raise interest rates or choke off the money supply, both moves will have the same negative impact on the above stocks. Therefore, if inflation arrives sooner rather than later, the return on these products may be decreased.

Thus, caution should be exercised in deciding on any investment strategy based on short-term trends. Certainly, there are  better opportunities out there than high-interest savings account or a GIC but it would be imprudent for most retail investors to swing widely from one extreme to another in such uncertain times. A well-balance portfolio should be maintained at all times to weather all economic circumstances.

Finally, I would suggest the best investment of all- yourself. With just about every good or service to be had on the cheap, it may be a good opportunity to devote some resources to improving yourself whether through formal re-education, seminars or resources. Products come and go but there is only one of you in life.

Even though the market is beginning to pick up again, a lot of investors still have recent negative experiences with their investment advisor. Some members of the investment community counter that any relationship is not a one way street and some degree of personal responsibility needs to be taken by the client themselves.

Who is right?

Depends. I have been a legal advisor (an industry with its fair share of horror stories) and been a client of  investment advisors. Thus, I have sat on both sides of the advisor-client table and I would provide a few brief comments and tips.

HOW DID YOU CHOSE YOUR ADVISORS?

This is where I think the investor more often than not trips up. Like anything else in life, there are good, bad and indifferent advisors. It is your responsibility to find the one that is the best fit and not the most comfortable fit.

More often than not, I hear people pick investment advisors because of proximity, they saw an ad or they got what I call a throw-away referral (a referral given by someone who never used them or knows them casually). In other words, we act out of comfort and not accuracy. For example, my first non-bank account investment was to buy mutual funds through my bank branch because it was down the street- wow, was that a learning lesson!

I would also be remiss not to point out that not all advisors can sell mutual funds and stocks).  Conduct your due diligence of what they can buy and sell for you.

Start right. Even if it means taking longer to find a good advisor, take that time. The good ones often don’t advertise (don’t need to- their word of mouth referral networking is great) and the bad ones sometimes make the most noise. It is like dating- you have to sift through a lot of crap to find a good one.

WHAT IS YOUR INITIAL CONTACT WITH YOUR ADVISOR?

This responsibility is shouldered on both the client and investment advisor. If hiring an investment advisor is a long-term relationship, you just don’t propose to a girl on the first date do you? You enter cautiously and you establish some ground rules.

When I hired my investment advisor, I gave him a part of my portfolio and told him upfront that I was doing this and would transfer the rest if things worked out well. I also said that we needed to meet periodically- in other words, I set some ground rules. I find that clients who gave me reasonable boundaries to work with legally, even if I did not like them, gave a better form to the relationship.

On the flip side, it is really the advisors responsibility to be honest. Investor expectations can be unrealistic. A good advisor does not pour fuel on the fire of those expectations. If the client feels that he should be paid 18% on a guaranteed fixed income instrument, and if the advisor has told them this product may exist only in la-la land, then it is the investor’s responsibility when his result does not meet these unrealistic expectations.

HOW DO YOU DEAL WITH YOUR ADVISOR?

If you manage employees, unless you trust them 100%, you check in with them from time to time right? So why do some people hire an advisor and then never have periodic contact with them to see how things are going? Letting the advisor know you are around and want to talk is the investor’s responsibility. Ask “why?” a lot. Ask “what are all my options?” a lot. Ask “justify your advice” a lot.

The advisors responsibility should ideally: (i) keep in periodic contact (bonus points if you are actually not selling product but doing this to earn trust); (ii) lay out ALL options (not the ones that make the most sense for the advisor only); (iii) educate;  (iv) answer the “what” and “why” questions; and (v) avoid sales pressure tactics.

If you have a salesperson, fire them. If your advisor never calls back, fire them. If you had a terrible boy-friend, you would dump his sorry butt right?

FINALLY…

One final note, I have had very indecisive clients in my time who want me to make the decision. Here is the thing. A good advisor can give you options and tell you what they would do but clients always don’t disclose everything, they are emotionally attached to the issue, they get all sorts of other advice etc. etc. In other words, an advisor does not have perfect information about you.

Thus, at the end of the day, an advisor cannot decide for you. This is your life. You have to take responsibility for the final decision. Use your advisor to give you ALL options and information to arrive at that decision but you have to make it yourself. If you abdicate decision-making powers to your advisor, you are setting yourself up for failure because the decisions that will be made are from someone else’s perspective.

The United States Federal Reserve recently commented that it wants the amount of inflation conducive to a recovery. I would file the Fed wanting the “right” amount of inflation under the same category as bankers saying  circa 2002 that a little bit of above normal leveraging is acceptable (open Pandora’s box…now!). If, indeed, inflation is returning, does its return merely add another reason why the principal protected note is a bad investment choice?

To recall, a principal protected note (or guaranteed linked note) is a structured product which, theoretically, gives to the investor the upside of equity by linking a return to some basket of equities (an index, an industry etc.) while offering bond-like downside protection by guaranteeing 100% of the initial investment as long as the investment is held to maturity.

The issues of the principal protected note are well noted (high costs, investor is actually self-insuring, complexity etc. etc.- the best recent summary of the issues with principal protected notes is the Steady Hand’s blog on structured products). However, inflation risk was never highlighted as a plausible risk in a world of low inflation and inflation may yet undercut another pillar of the sales feature of principal protected notes.

Let’s step back 6 months. Many very complex principal protected notes have triggers known as “protection events.” In the event the performance of the equity side of the note was subject to a material adverse change (such as those seen in September 2008), the note, effectively, has an emergency brake and the entire portfolio converted into bonds and the investor is eligible to receive only the principal back upon maturity.

Is it that bad that one holds a principal protected note that will only return your principal? Better than losing your shirt right?

In the abstract, this is correct but the devil is in the details. Remember that you receive your principal back only if you hold the note to maturity (which, in many notes, is 3-5 years away). Assume the Fed cannot control inflation; a plausible scenario since the best way to control inflation is to choke off the money supply or raise interest rates- which are the last things you want to do when the credit markets begin to recover.

In 3-5 years,  every dollar of principal returned will be worth a lot less than when one invested it in a principal protected note. In other words, a principal protected note is giving you less than what you invested once you factor inflation. The longer to maturity the note and the greater the rate of inflation, the less one’s return. Given that most principal protected notes do not guarantee principal indexed for inflation, an investor is not even reaping the full effects of downside protection.

Many investors invested in these notes by re-allocating from a fixed income portfolio. In hindsight, they would have been better off leaving their money in fixed income which at least are interest rate sensitivity (or, in a real return bond, inflation sensitivity) and not stacked with fees.

One should never under-estimate the ability of the financial institution to adapt and sell bad products under new names. I do not doubt that we may see a new generation of principal protected notes with the principal indexed for inflation but why pay for this feature when you could buy a real return bond that accomplishes the same goal without the fees?

…and, as mentioned by many others, stocks, over the long run, are your best protection against inflation.

I received a cold call last Thursday from an investment advisor that went along the lines of the following (please speak slowly if you are cold calling me!): Hi I am Todd from XYZ brokerage house and I represent Mr. Big Time Trader. We are holding a seminar on March 16 on trading strategies now. We believe that the buy and hold strategy is a mantra of the buy and hold strategy that no longer works in current market conditions…”

The caller was basically reiterating one of the larger debates occurring about investment strategies. Mainly, is the buy and hold strategy dead? With once steady stocks like GE on the ropes, can you really hold any stock forever?

Fundamentally, if you are going to abandon one strategy, you need a land on a strategy that is as good, if not better, than the one you are leaving. The real life equivalent would be you don’t quit your job in anger without ideally knowing what you are going to be doing next.

What exactly is the landing spot if you abandon the buy and hold strategy? Most likely an active trading strategy (let’s assume even if you are in all cash, at some point, you will deploy it but shun the buy and hold strategy).

Practically speaking, an active trading strategy has the following implications:

1. You are become a stock picker OR you delegate that responsibility to a pro;
2. You are relying heavily on market timing;
3. Higher trading costs (although on some high MER mutual funds, you may end up ahead); and
4. Tax inefficiency from active trading (taxes are payable on sales; more sales = more potential taxes)

If you can master or handle the above then shifting from buy and hold to active trading may be a good move. However, most people I know do not have the time, skill, risk tolerance or a combination of all those factors to make active trading work.

What I often feel after these types of cold calls is that the investment industry is saying pick your poison: buy high MER mutual funds or let us soak up commission by actively trading for you. One way or another, we’ll find a way to make money off of you.

Of course, as Canadian Capitalist pointed out, a buy and hold strategy utilizing dollar cost averaging for a broad based index does not yield bad results over the long term.

Maybe that’s why the caller spoke so fast.