One of the classic human errors made when investing is to assume that what happened in the recent past is indicative of what will happen in the future.
The investment manufacturing sector knows this all too well, and will churn out new ETFs and mutual funds in the hottest sectors because they have the greatest chance of garnishing the most assets.
For those selling financial products, that means timing the market is crucial; for buyers on the other end, it poses a major risk.
This doesn’t mean that you should ignore the timing of when you invest, as it can have a material impact on returns. But when human emotion takes over the decision making process it can lead to disappointing results.
For example, 2017 was a great year for equity investors but was immediately followed by the worst year since the 2008 financial crisis. Those invested in the S&P/TSX saw gains of 9.1 per cent in 2017 but gave them all back and then some in 2018, for a 0.6 per net loss over the two years. A 60/40 Canadian balanced portfolio would have gained about 0.6 per cent over the same period.
That said, let’s assume you got excited about the market and increased your equity weighting to 75 per cent at the start of 2018. Instead of a 0.6 per cent gain, those investors would have recorded a 0.8 per cent loss over two years — suddenly a supposedly lower-risk, balanced portfolio would have posted worse results than an all-equity portfolio that simply bought and held over the two-year period.
Today’s situation is the opposite: The worst December since 1930 caused many to trim back their equity positions, including the pros. Over the past few weeks we’ve plowed through many investment-fund manager reports and the common theme was how defensively positioned they all were heading into 2019.
One of the best ways to ensure you don’t wind up overexposed is to rebalance at least yearly
Fast forward and here we are with one of the best starts to a year in more than three decades. The S&P/TSX is up nearly 6.9 per cent, while the S&P 500 and MSCI EAFE index are both up more than five per cent over the past four weeks. For those who trimmed back their equity positions to start the year, that is not good news.
One of the best ways to ensure you don’t wind up overexposed is to rebalance at least yearly, based on equity weightings determined by the personal objectives identified in a financial plan and recorded in an investment policy statement.
Take the aforementioned Canadian balanced portfolio. If it had been rebalanced back to a 60/40 split at the end of 2017, it would have posted a 0.74 per cent gain over the past two years.
The equity position would also have been increased by about two per cent at the end of 2018, the exact time many others were pulling back.
Having a plan and sticking to it can be one of the toughest things to do, especially when the majority of the investment industry in Canada is built on getting you to do otherwise. However, it can prove to be not only a liberating experience but also a less stressful one when trouble hits and you’re portfolio is separated from the crowd.
Martin Pelletier, CFA is a Portfolio Manager and OCIO at TriVest Wealth Counsel Ltd, a Calgary-based private client and institutional investment firm specializing in discretionary risk-managed portfolios as well as investment audit and oversight services.