The stunning story of a patient investor who made good

Investment managers and professionals swear by two mantras. The one that gets the most buzz is to understand your risk tolerance. But it’s the other that I want to discuss today: have patience and conviction with your investments. This holds true whether you have hired an investment manager or investment advisor to manage your investments, or are a do-it-yourself investor.

I recently encountered a stunning example of the value of patience in investing. I was preparing a client’s tax return (note: the client has given me permission to discuss this example, without using their name). In preparing her return, I flagged that she may need a T1135 Foreign Income Verification form, which reports foreign holdings. My client had about 2500 shares of Apple stock, and I was unsure whether the shares has an adjusted cost base of more than C$100,000—the threshold to require that form.

The client said no, the original cost was far below the $100,000 threshold. It was just that she had held her Apple shares for around 14 years and not sold them. The client also provided me a summary of her stock purchase history. She had purchased 100 shares of Apple stock in 2008 for around C$16,000 and basically held onto them. She had only sold off a small portion once: in 2012, to help fund a house purchase.

The summary provided was startling. The 2,500 Apple shares that she owns had a fair market value of $375,000 (as of mid-April). Yet all she did was buy the original 100 shares 13 years ago for $16,000 and wait. Time and stock splits, and Apple’s overall strong performance, took care of the rest. What a textbook case of a patient investor (especially so given Apple’s stock price has been all over the place).

As someone who in shredding my tax returns a couple years ago realized how many flyers I had taken, how many disruptive stocks I had purchased looking for the big winner, I felt really ridiculous. I felt even worse when I realized that my first blog post on The Blunt Bean Counter in Sept 2010 was called Why Didn't You Buy Apple for $25?

In that post I discussed famed money manager Peter Lynch, who among many other suggestions noted that by just paying attention to what is going on around you and having some basic common awareness, both the novice and the sophisticated investor can find growth stocks in their day-to-day lives. I then commented in the 2010 post: “think of how much money any of us could have made paying attention to the iPod fad. Kids were suddenly walking around with white wires hanging out of their ears attached to these newfangled ‘Walkmans.’ In retrospect, how could we have missed this and not bought Apple?”

Why I did not buy Apple after writing that blog post is beyond me—and my clients’ timeline is fairly similar to that initial post.

Apple is just an example. You could have purchased most any Canadian bank in 2008 and had spectacular gains if you held the stock. Maybe not as large as Apple, but still substantial with significant less volatility.

So the moral of the story: Patience and conviction in your investing are especially important. That does not mean once you buy a stock you hold it for life; you still must review whether your original reasoning and thesis for purchasing the stock is still valid and whether the company is still growing. But good companies tend to stay good companies, and flipping from one to another or looking for the next disruptor is not necessarily the best strategy. Take it from me.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

What is your Wealth Advisor Thinking? One Professional Reveals Lessons Learned from her Clients

Getting professional wealth advice – or really any professional advice – can be frustrating. We are asked to open up our lives and disclose our thoughts to someone who is initially a stranger. Personally, I’d love to know what my professional advisors are thinking on a whole range of issues.

This week senior wealth advisor Carmen McHale of BDO Canada LLP takes a step from behind the desk to share her thoughts on the past five years of dispensing wealth advice. She also wanted to thank two colleagues – Indy Sebastian and Eric Wipf – for their help in reality-checking her thoughts.

___________

When asked to write about what I have learned from clients in the past five years, my initial thought was – everything. But that might take too long to cover. So instead I’ll focus on one area that I find fascinating: the emotional biases I first learned of in textbooks and now see in investing practice. Emotional biases arise from impulse, intuition and feelings and can result in irrational decision-making. Because they are all about how we feel and react – they are impulses, after all – they are harder to mitigate.

Knowing ourselves is something many of us take for granted, feeling that it comes naturally – but how well do most of us actually know ourselves? We may think that there is no one we know better, but the truth is, we are often blind to our deficiencies. Despite our attempts to stay impartial, our emotions sway us more than we care to admit.

Loss aversion

When a decision is made to invest, it is usually based on what we think we will gain. Although a good advisor will focus on communicating the downside risks associated with investing, it is very hard to know how we will feel about that downside until it actually happens.

When it does happen – because it will – are we going to fall prey to our emotions, or will logic prevail? If your portfolio is down 10% and your advisor is telling you to stay the course, are you going to take that advice? If an investment results in a loss, will you be able to swallow the loss as a sunk cost and sell the investment – or will you want to keep it until it bounces back? Will you want to sell an investment too soon because you are afraid your gains will turn into losses?

So what have I learned? That no two families or situations are the same, and while logical reasoning attempts to quantify risk in an investment policy statement, often when faced with a real investment loss – the experience of seeing it – revisiting the investment policy statement reveals the tolerance for losses is lower than originally thought. With honest communication about how the investment policy is there in part to reflect the tolerance for risk, advisors can help keep a client’s plans on track.

Overconfidence bias

Overconfidence bias is thinking you know more than you do about a certain topic, or thinking you have more control about an outcome than you do. I have worked in Calgary for my entire career, and often deal with professionals in the oil and gas industry – they know the industry and believe in it. This leads them to over-weigh their investments. Their current and future income is based on the price of oil; add to that a large concentration of oil and gas stocks in their portfolio and the risk is amplified.

Unfortunately, this compounded risk reared its ugly head in the last few years in Alberta, setting many oil and gas professionals’ best-laid plans off track. The markets can take down anyone, regardless of investors’ level of knowledge.

So what have I learned? To present alternative scenarios. One that over-weights investments in line with the overconfidence bias and one with a balanced portfolio. Canadians have become better versed in the extremes of markets, and whether it be the oil and gas professional or the real estate speculator I have learned to discuss the lows with clients and hope that the risk and volatility resonates.

Self-control bias

As a lover of chocolate, I am very familiar with this bias. Time after time, I buy a bag of chocolate raisins and think I can limit myself to a handful. We tend towards immediate gratification.

In an investing context, there is the inability to focus on the long-term goals – like not saving enough for retirement and only realizing when you are 55 that you are running out of time. This can lead people to take excessive risks when investing. Clients often think that the markets will solve the problem if their portfolio can just get them a 15% return.

So what have I learned? That for the most part clients really just want to know where they stand. Given a detailed action plan, they can focus on short-term goals while understanding the long-term focus. I have learned I need to be the practical voice and provide the client with the tools and knowledge to make the right decisions, and be there for them along the way.

Regret aversion

This is all about not taking action because you do not want to be wrong – you try to avert regret. When you have this emotional bias, you are more likely to do what everyone else is doing. This can cause investors to over-concentrate their investments in well-known companies. Then, if the position goes down, it is not your fault because you were simply following the herd. Regret aversion is about avoiding making true decisions and then rationalizing the poor decisions that were made.

In these situations, I try to educate clients on the various investment management options that exist in the marketplace. Most are familiar with bank representatives and investment brokers where the advisors assess your risk tolerance, time horizon and performance objectives to determine which asset classes are most suitable - but investors ultimately make the buy and sell decisions, and the advisor’s role is primarily to offer an informed opinion.

On the other hand, I am a big proponent of discretionary investing, which is a more hands-off approach for the client. In discretionary investing, advisors still collaborate with the client to assess their investment goals. But it removes the ultimate investment decisions from the client and transfers them to the advisor, who communicates the investment decisions and reports the results. Discretionary investing provides the necessary framework around investment decisions and helps to remove many of the emotional biases surrounding investment decisions.

So what have I learned? That many clients like to have a “play” portfolio – where they can invest a specified amount of money in less popular companies. Clients enjoy the opportunity to do their gambling here without having to worry about their nest egg.

Status quo bias

This is the urge to do nothing. As human beings we typically dislike change. Staying with the status quo is much easier. People feel greater regret for bad outcomes that result from a new action taken than for bad consequences that come from doing nothing.

Changes from the status quo will often involve both gains and losses, but the tendency to overemphasize the avoidance of losses – loss aversion – will favour keeping things the way they are. This leads to inaction when action may be called for.

So what have I learned? That most clients meet with me to challenge this bias, and most people when given small, quantifiable actions generally want to challenge this bias.

Lessons and the investment journey

What have I learned from clients over the years? That even the well versed in the irrationalities of the market fall prey to the reality of emotions. And of course, as humans we are creatures of nature – so even when we do know our weaknesses, we may shy away from hearing hard truths. The fear of needing to break detrimental habits built up over a lifetime, or the realization that our behaviors have prevented us from meeting our financial goals.

One of the major roles we fill as advisors is that of the voice of reason. We strive to be the objective practical eyes, guided by experience, assisting our clients in navigating these biases in the context of their overall goals. We strive to help our clients understand that these goals are not achieved by leaps and bounds but by well-considered small steps – that proverbial journey of a thousand miles.

Carmen McHale is a senior wealth advisor for BDO in Calgary. She can be reached at cmchale@bdo.ca, or by calling 403.956.0103.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

Your Investment Return - What Is It Telling You?

I find it shocking, how many people have no clue what their investment returns are for any given year let alone their historical returns. Some investment firms have been purposely opaque in respect of reporting investment returns for their clients. It is hoped that with the introduction of CRM2 (see this article) there will be far greater transparency in respect of the returns generated on your investments and the fees you pay your investment firm.

As of December 31, 2016, your investment statement should start reporting a personal rate of return. From what I understand, the reporting of your returns will only be mandated for 2016 and prior year investment returns do not have to be reported (some investment advisors/managers are very lucky; as 2016, the first year of reporting was a strong market year and this may allow them to hide poor past performance - thus, I would also request personal return information for the last three years, the last five years and since inception in addition to the 2016 return information). While your statements will not necessarily provide index benchmarks for you to compare your return against, at least you will have a return number!

If you have an investment advisor or investment manager and they have not reviewed your returns and strategy on a yearly basis before this required reporting, I would put them on notice you are disappointed and expect far more going forward. In addition, you should also review the investment fees you paid in 2016, which should also be provided on your statement. If you manage your own investments, you should be reviewing your performance on a yearly basis, or you are doing yourself a disservice.

Okay, enough with my rant. Today I actually intend to talk about what your investment returns are actually telling you about your investment strategy and investment policy and whether you are adhering to your strategy or chasing returns. (As an aside, if you are a good writer, you always tell your audience what your intended topic is within the first couple lines, you do not wait until the fourth paragraph. So do as I say, not as I do :).

Your Investment Strategy

When you engage an investment advisor or investment manager etc. the first thing that should be done is to create an investment policy statement and strategy based on your needs and risk. This will include a target allocation between fixed income and equities and target allocations between different asset classes and global diversification among other considerations. You should also be provided benchmark indices to compare your fixed income, Canadian, U.S. and World allocations against; unfortunately, this is often not provided.

For this post, let’s assume for simplicity sake that you want an asset mix of 30% fixed income and 70% equity which is allocated 30% Canadian, 30% World and 40% United States.

What Are Your Returns Telling You?

For purposes of illustration, I am going to use 2015 stock market returns since there were some of the larger variances within portfolios I have seen in years (I personally observed returns ranging from up 12% to down 17%). I will only briefly comment on 2016, since most statements are just being mailed.

So why the wide variance in returns in 2015? The reason was simple. The Canadian markets and resource stocks in particular were weak and preferred shares, especially rate reset preferred shares (due to low interest rates that were not contemplated when the shares were issued) were hammered. The TSX ended 2015 down around 11%. The U.S. market was down around 3% or so (but there was a huge foreign exchange gain where you held U.S. stocks because of the increase in the U.S. dollar relative to the Cdn dollar). World markets were also fairly weak.

So I ask you. If you had a 3-5% return in 2015, was that good or bad? This is a loaded question. If your allocation was the 30/70 mix I note above, that was probably somewhat expected and almost all due to the 30% or so increase in the U.S. dollar. Is that good investing or proper fund allocation? I would say a bit of both.

I noted that I saw people with losses as high as 17%. Was this bad? The answer surprisingly could be yes or no. If you had a large Canadian equity allocation with a resource bent (some people believe in investing most of their funds in the country they will live and retire in) then, the 17% loss may not have been as bad as your initial reaction and somewhat expected. That same portfolio will have exploded to the upside this year. Personally such a portfolio has too much volatility for me, but it may have been in adherence to that person’s investment strategy. Where you had a 17% loss because of rate reset preferred shares the investment industry sold and pushed (especially to seniors), but did not understand, that is another story.

For those people who had a 12% return in 2015, these returns were solely because they were over-exposed to U.S. stocks. I would say those returns, while excellent, were gained at the expense of risk (too much U.S. stock allocation) and you would have to understand the downside risk on a reversal in the dollar.

Some people told me their advisors did a great job over-allocating to the U.S. in 2015 and they were scaling back in 2016 (these conversations were in early 2016) to protect against a F/X reversal. When I hear comments such as the above, I cringe, since this says to me that their advisor has not created a disciplined strategy, but is stock picking, which more often than not, ends up badly.

2016 Returns

This year both the Canadian and U.S. markets have done very well. So if we look at the sample portfolio, one would expect a return somewhere between 8-11%. If you are this person and your returns are 18% I would want to understand why I outperformed far greater than my expected asset allocation. A better than expected return may indicate something amiss with your investment mandate. The same goes if your return was 6%, why were you below your expected return?

In conclusion I suggest the following:

1. Ensure your investment advisor/manager provides you with current and historical returns don’t just accept the 2016 returns that will be on your December, 2016 statement. Meet with them to discuss your returns and compare them to your intended strategy and investment policy and compare your returns to benchmark indices you agree upon. Ensure the returns you are provided with are net of management and investment fees and that the returns are not varying significantly from your expected returns. Variations both up and down may be cause for concern.

[BTW: If you are unhappy with your advisor and looking for a change, let me know. Depending upon your asset base, I or a colleague, may be able to assist you with financial planning and investment oversight and provide you access to several investment managers I work with directly (as an accountant I cannot provide specific investment advice, so I must work with an investment manager)].

2. If you manage your own investments, ensure you have created an investment strategy that it is written down and then compare your returns to what you expected and ensure you kept a disciplined approach in line with your strategy.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.