Becoming a better investor

October 29 2007 by Ellen Roseman

So, how do you do a better job managing your investments, either on your own or with a financial adviser? About 70 people, keen to brush up their skills, have enrolled in the course I’m teaching at the University of Toronto’s school of continuing studies.

In the first week, we focused on the role of emotions. Behavioural finance shows that investors handicap their performance if they react impulsively to fear and greed or if they fall prey to overconfidence. I found interesting examples and useful lessons on reining in your emotions (or building in an overconfidence discount) in Jason Zweig’s new book, Your Money and Your Brain and an older book, Why Smart People Make Big Money Mistakes and How to Correct Them, by Gary Belsky and Thomas Gilovich.

In the second week, we looked at controlling costs. This is one area where investors have some degree of control. It’s hard to predict moves in the economy, interest rates and stock and bond markets. It’s hard to predict how fund managers will perform or how individual companies will perform. But if you can get a handle on your costs, you can improve your investment returns.

To keep costs low, you can avoid buying mutual funds with deferred sales charges and above-average management expense ratios. And instead of chasing hot fund managers, you can use passively-managed index funds or exchange-traded funds in your portfolio. Also, do-it-yourself investing with a discount brokerage account can reduce costs, as long as you don’t get addicted to trading online.

We also looked at the importance of marketing in the financial services industry. Companies can create demand for new products by manufacturing a crisis that needs the solution they offer. That’s all too common in selling retirement products and trendy new mutual funds.

An example of marketing hype is Manulife’s Income Plus, which talks about providing guaranteed income for life and all the upside of the markets. But at the website, you can barely find any mention of the high-priced guaranteed investment funds Manulife sells and the added cost of providing the guaranteed income for life. Maybe Manulife wants to leave “investor education” to commission-paid financial advisers, but too many of them push products without proper explanation. (Just look at Portus principal-protected notes linked to hedge funds. As the biggest seller of this product, Manulife had to pony up almost $240 million in refunds when the company collapsed.)

A low-key marketing campaign seems to be working for Steadyhand, a new fund company keen to differentiate itself from others (all too rare in a copycat industry). The president came from Phillips Hager & North, which has low fees, a limited product line and average performance, except in Canadian stocks and bonds where it outperforms. Here’s something I found at the company’s blog about its costs.

Providing top-notch money management at a reasonable price is what Steadyhand is all about. And our fee structure rewards clients that stick with us and grow their assets here. As their account grows, the fee is reduced and if they’re with us more than 5 years, it is reduced further.

I acknowledge that there are lower priced options out there, namely exchange-traded funds. But for truly active management, Steadyhand has few peers.

I’ve never had a formal contact with this new fund company, though I know their people are writing blogs and posting comments at other blogs (including mine). Blogs are a new marketing channel for many firms. There’s a trick to keeping them conversational and informative. You don’t want to read an ad masquerading as a blog.

15 comments

  1. Bylo

    Oct 30 2007

    “fees are covered off in training for advisors; are discussed at point of sale; and are disclosed in the usual manner in consumer materials made widely available online and to investors in the product.”

    Perhaps are discussed at point of sale, etc. but do advisors ever explain the egregious effect that 2% and 3% MERs have on investment returns over long periods?

  2. Brian Poncelet, CFP

    Oct 31 2007

    Hi Ellen,

    I think you may be missing the point about funds that charge “above average” fees and telling people to look at index funds. Remember August? When the market went down 10% or so, some in the media were getting nervous. Look at funds that do well in a down market. Index funds that are all stocks do not give that downside protection. You have to do some homework, yes, but there are funds that have good performance on the downside and upside.

    Your comments about people’s emotions are true. They should be able to handle last August’s 10% dip or the 28% fall in 2002 & 2003 in the TSX (which most people can’t handle). Instead, they should look for proven funds with good track records. The fees are a small price to pay.

    regards, Brian

  3. Brian Poncelet, CFP

    Oct 31 2007

    Hi Ellen,

    Your readers should read David Berman’s (National Post, Oct 31,2007) thoughts on RIM. The stock has a P/E ratio of 80. Without RIM in the index, the TSX would go down by 2.5%.

    Remember Nortel? The low-fee index funds do come with risk. Remember August? The markets were down 10% and the media were worried about the future! Think about people’s emotions (the first week’s lesson).

    A good start for people to look at is Morningstar.ca. They have lots of resources and look at the big picture (fees, risk, performance etc.).

    Hope this helps some readers.

  4. Bylo

    Oct 31 2007

    > Without RIM in the index, the TSX would go down by 2.5%.

    Suppose the investor has a reasonably balanced portfolio of 40% fixed, 20% Can equities, 20% US equities and 20% overseas equities. If RIM disappeared completely, the effect on the portfolio would be ½%. Portfolios fluctuate that much from day-to-day routinely.

    > Remember Nortel?
    Yup. Nevertheless, according to Globefund, the TSX60 index returned 9.1% over 10 years and 12.4% over 15 years. Knock off a generous 50bp for index fund MER (XIU’s is only 17bp) and the numbers are 8.6% and 11.9%, respectively. Now compare to the average actively-managed large cap Canadian fund which returned only 7.8% and 10.6% over the same periods. So, where’s this skill that fund managers are alleged to have? Even when the index was handicapped by Nortel it would seem that the active crowd still managed to underperform.

  5. Brian Poncelet, CFP

    Nov 1 2007

    Hello Bylo,

    You make some good points about fees and average funds not beating the index. Please read my comments carefully. Most clients cannot handle the downside. In the years of 2002 & 2003, the TSX composite was down over 28%!! If you look at mutual fund sales, the sales go up when the market goes up and money gets out of the market when the market goes down.

    Morningstar has some software to review mutual funds (PalTrak) and there is also Globe HySales. They show a number of factors, risk to reward scatter charts (fund vs. its peer group) and average P/E ratios (the lower the better, in general).

    When someone buys a fund, hopefully they are getting a financial plan. If there is no advice, then maybe they should buy some software, take some courses and do it themselves. But since only 50% get out and vote in this province, and maybe 10% buy a newspaper, don’t hold your breath!

    Rob Carrick (Globe & Mail) wrote an excellent column on June 16, 2007, “Time for a critical lookl at the S&P/TSX composite.” He talks about the benchmark Canadian stock index being three-quarters based on energy, materials and financials.

    When I look at the S&P/TSX 60 Index, the two recent bad years were 2002 (-16.30%) and 2003 (-15.68%), worse than the TSX composite! I repeat, most people can’t handle these down years! With Inco and Falconbridge bought in 2006 and other acquisitions, you are losing big names in the index. The high P/E of RIM is also a higher risk.

    regards, Brian

  6. Bylo

    Nov 1 2007

    > Most clients cannot handle the downside. In the years of 2002 & 2003, the TSX composite was down over 28%!!

    Which is why they should have a balanced portfolio rather than invest in just the TSX.

    > If you look at mutual fund sales, the sales go up when the market goes up and money gets out of the market when the market goes down.

    The vast majority of Canadians buy mutual funds through an advisor. So if there’s a significant increase in redemptions when markets go down, it’s not entirely because DIYers have panicked, but rather it’s because many advisor-led investors have panicked. Perhaps that’s an indication that advisors haven’t done as good a job of teaching their clients about the behavioural aspects of investing as they could. Perhaps then, the audience for Ellen’s article should be much wider than just DIY investors.

  7. Brian Poncelet, CFP

    Nov 1 2007

    Hello Bylo,

    Most Canadians right now buy their mutual funds through the big banks…not independent advisors. Look at IFIC’s website and see for yourself. When redemptions happen, the banks usually have the biggest hits. If you think people are getting lots of advice there, please let me know what bank and what kind of “plans” they are doing for their clients.

    Bylo, by looking at fees and not risk — like your index funds you are fond of — you are really not telling both sides of the story. I am glad you suggested that people should have a balanced portfolio, rather than just the TSX and in your case the TSX 60.

    If you look at pension managers, their main goals are safety of capital and reasonable growth. An index like the TSX 60 offers cheap fees, which is good, but the downside protection is limited. Wealthy people want these two goals met. If fees are reasonable, they have no problem. But they do not look for the cheapest, because like a good suit or car, cheapest may not be the best value.

    regards, Brian

  8. Bylo

    Nov 1 2007

    > Most Canadians right now buy their mutual funds through the big banks…not independent advisors.

    Whether or not that’s a fact, what does that have to do with the thrust of Ellen’s article? Advisors at banks are licensed, just as are the independents and most have professional credentials, e.g. PFP and CFP, just as do the independents. And just as the independents, most banks offer non-bank mutual funds. So why is the distinction relevant?

    > by looking at fees and not risk…

    According to GlobeFund the 3 year risk (presumably SD) of the TSX 60 was actually lower than the average actively-managed Canadian large cap fund. So in this instance, indexing wins on performance, risk and costs.

    > I am glad you suggested that people should have a balanced portfolio, rather than just the TSX

    The data providers seem only to show the risk (SD) of individual funds. I’d love so see data that compares the risk of a balanced portfolio of index funds to a similar portfolio of actively-managed funds, especially over relatively long periods like 10 or 15 years. Do you know if such data exists?

    > in your case the TSX 60.

    To be clear, you mentioned Nortel and RIM. Their weighting in the TSX 60 was/is much higher than in the broader TSX Comp. That’s why I used the TSX 60, i.e. to handicap the indexing side of the index vs. active comparison. Nevertheless, indexing still did better.

    > If you look at pension managers, their main goals are safety of capital and reasonable growth.

    And if you look at how most pension plans, including the largest like CPPIB and OTPP, invest you’ll see a heavy reliance on indexing.

  9. WhereDoesAllMyMoneyGo.Com

    Nov 1 2007

    >The data providers seem only to show the risk (SD) of individual funds. I’d love so see data that compares the risk of a balanced portfolio of index funds to a similar portfolio of actively-managed funds, especially over relatively long periods like 10 or 15 years. Do you know if such data exists?

    Hi Bylo – I think Globe Hysales will allow you to make such a comparison. It’s been a while since I’ve used such programs, but I have compared a portfolio of index funds versus a portfolio of actively-managed funds. Take all the advantages you’ve mentioned above and multiply them – the portfolio of index funds is a tough one to beat. Very tough. I mean, in many cases – it’s just not funny.

    Having said that, there are some fund managers that really add alpha and reduce beta – but they are soooo few and far between.

  10. Brian Poncelet, CFP

    Nov 1 2007

    Hi Ellen,

    When you go IFIC’s website, the numbers (sales) are in an Excel spreadsheet. I think you are looking in the first column “Net Assets”, but look under the column “Net Sales”. So for example in September 2007, the net sales were $969,819,000 (excluding money market funds) Yes, IG is the biggest fund company, but the biggest in net sales was RBC & TD ($332,739,000 & $317,223,000 respectively).

    If I look at other months like June, again RBC is the top seller of funds. The rest of the banks’ sales are also big. If I look at August, sales were in net redemptions… about $1.5 billion! RBC led with $-543 million and TD with $-349 million. If I include the other banks like BMO, another $-70 million and so on. Other months have a similar pattern.

    I think you made a fair comment about the banks knowing more today than in the past, but I don’t often see (never) people with hard copy financial plans from the banks. But maybe they are out there.

    regards,

    Brian

  11. Brian Poncelet, CFP

    Nov 1 2007

    Bylo,

    Yes Globe HySales will show you a comparison of say 40% S&P/TSX total return and 60% Scotia Bond Index so you can put in a fund which you would like to compare. Bylo, if you read my earlier comments I talk about fees (yes important) but also risk.

    regards,

    Brian

  12. WhereDoesAllMyMoneyGo.Com

    Nov 2 2007

    I forget what the exact number is, but doesn’t asset allocation factor in for 90% of risk mitigation, and the other 10% is security selection PLUS market timing?

    Let me dig up the numbers, but Harry Markowitz won a Nobel Prize in 1990 for his 1952 Journal of Finance publication entitled “Portfolio Selection” – but which we commonly know as Modern Portfolio Theory, correct?

    I think the debate should move from what is better (active versus passive) because it seems to have been answered. Rather, I think the issue of compensation should be addressed. Yes, without a doubt, there are many investors who are not comfortable picking their own investments. Does that mean they should rely on mutual funds? Perhaps not. Perhaps a better methodology would be to separate the cost of investment transactions from the advisor’s compensation in a more transparent manner…. i.e. fee based investing using indexed products. That way the cost of investing is known and the cost/value of the advice can be determined/quantified.

    Thoughts?

  13. Bylo

    Nov 3 2007

    > I think the debate should move from what is better (active versus passive) because it seems to have been answered. Rather, I think the issue of compensation should be addressed.

    Alas, the two seem to be intertwined. If the debate over active vs. passive is over, then why is it that so few advisors promote the winner? Could it be that the current commission compensation model influences advisors to favour active because it pays them and the fund companies they represent more?

    > Yes, without a doubt, there are many investors who are not comfortable picking their own investments. Does that mean they should rely on mutual funds?

    Not everyone, indeed the majority of people, lack the time, inclination, education, discipline, etc. to DIY. There’s nothing wrong with mutual funds per se— they’re a great mechanism for investors to participate in markets around the world— providing they’re low cost. Indeed, I’d argue that indexing works not because of MPT but because of low costs. (See Bogle’s Cost Matters Hypothesis e.g. at http://www.indexuniverse.com/index.php?option=com_content&view=article&Itemid=34&issue=17&id=1794 )

    > Perhaps a better methodology would be to separate the cost of investment transactions from the advisor’s compensation in a more transparent manner…. i.e. fee based investing using indexed products. That way the cost of investing is known and the cost/value of the advice can be determined/quantified.

    Absolutely! Investor advocates have been calling for greater transparency and unbundling of fees for many years. Why has the industry ignored their pleas?