1. Richard Vetter, BA, CFP, CLU, ChFC
Certified Financial Planner
Senior Financial Advisor
WealthSmart Financial Group
Manulife Securities Incorporated
3251 Chatham Street, Richmond, BC V7E 6B8
CRITICAL FACTORS IN THE PURSUIT Tel: 604-241-4357
OF A BETTER INVESTMENT EXPERIENCE Email: richard.vetter@manulifesecurities.ca
PREPARED FOR:
DATE:
2. KEY INVESTMENT PRINCIPLES
UNDERSTAND MARKETS KNOW YOURSELF
1. Let markets work for you. 7. Don’t confuse entertainment with advice.
2. Take risks worth taking. 8. Manage your emotions and biases.
3. Invest, don’t speculate.
HARNESS THEIR POWER WORK YOUR PLAN
4. Hold multiple asset classes. 9. Avoid common investment mistakes.
5. Practice smart diversification. 10. Plan for the long term—and stay the course!
6. Keep costs low.
4. 2 TAKE RISKS WORTH TAKING
SIZE AND VALUE EFFECTS AROUND THE WORLD
18.17
15.79 15.72 15.07
13.82 13.68
12.48
11.69 11.38 11.46 11.43
10.45
9.85
8.97 9.03
9.05
8.23
Annualized
Compound Returns (%)
US US US US Emg. Emg. Emg. Emg.
Large S&P Large Small CRSP Small Intl. Intl. MSCI Intl. Canada Canada Canada Markets Markets Markets Markets
Value 500 Growth Value 6-10 Growth Value Small EAFE Growth Value Market Growth Value Small “Market” Growth
US Large US Small Non-US Developed Markets Canadian Emerging
Capitalization Stocks Capitalization Stocks Stocks Market Stocks1 Markets Stocks
1927–2010 1927–2010 1975–2010 1977–2010 1989–2010
14.03 11.88 11.35 19.17 15.98 13.95 18.48 19.17 13.67 11.29 14.53 12.86 10.40 25.01 21.98 19.46 17.05
Average Return (%)
27.01 20.51 21.93 35.13 30.94 34.05 24.56 28.13 22.29 22.21 21.64 17.47 21.79 42.01 40.67 36.40 34.89
Standard Deviation (%)
1. In CAD.
All returns in USD except Canadian Market Stocks. Indices are not available for direct investment. Their performance does not reflect the expenses associated
with the management of an actual portfolio. Past performance is not a guarantee of future results. US value and growth index data (ex utilities) provided by
Fama/French. The S&P data are provided by Standard & Poor’s Index Services Group. CRSP data provided by the Center for Research in Security
Prices, University of Chicago. International Value data provided by Fama/French from Bloomberg and MSCI securities data. International Small data compiled
by Dimensional from Bloomberg, StyleResearch, London Business School, and Nomura Securities data. MSCI EAFE Index is net of foreign withholding taxes
on dividends; copyright MSCI 2011, all rights reserved. Emerging Markets index data simulated by Fama/French from countries in the IFC Investable
Universe; simulations are free-float weighted both within each country and across all countries.
5. No Point to Stock Picking
Investment Managers versus Chimpanzees
6. 3 INVEST, DON’T SPECULATE
PERCENT OF WINNING ACTIVE MANAGERS
July 2005–June 2010
1%
9% 12%
Canadian Equity
US Equity International Equity
Over time, only a very small fraction of money managers outperform the market after
fees, and it is difficult to identify them in advance.
Source: Standard & Poor’s Indices Versus Active (SPIVA) Funds Scorecard Canada, Second Quarter 2010.
9. Composite Asset Allocations
Canadian Pension Plans
1998–2009
Other: 23%
Equities: 44%
Fixed Income: 33%
Hurricane Subprime
Katrina Mortgage Crisis
Asian Flu Y2K Technology SARS Outbreak
Meltdown
Russian Debt Crisis 9/11 Terrorist Attacks US Invades Iraq Southeast Asian
Tsunami
CAD at USD 0.63 CAD at USD 1.10
Source: Pension Investment Association of Canada, ―Composite Asset Mix Reports,‖ in http://www.piacweb.org/publications, accessed March 15, 2011. S1390.3
10. 6 KEEP COSTS LOW
NET GROWTH OF $1 MILLION
Assumes 6.5% Annualized Return over 30 Years
1% Fee
$4,983,951
$5,000,000
Over long time periods, high
costs can drag down wealth
accumulation in a portfolio. $4,000,000
2% Fee
$3,745,318
Costs to consider include:
• Management fees 3% Fee
$3,000,000 $2,806,794
• Fund expenses
• Taxes
$2,000,000
$1,000,000
1 3 5 10 20 30
TIME (years)
In US dollars. For illustrative purposes only.
11. 7 DON’T CONFUSE
ENTERTAINMENT WITH ADVICE
• The television, print,
and online financial
media are in the business
of entertainment.
• The emphasis is often
on short-term, sensational,
and emotionally
charged headlines.
• These messages can
compromise long-term focus
and discipline, and lead to
poor investment decisions.
12. 8 MANAGE YOUR EMOTIONS
COMMON COGNITIVE ERRORS AND BIASES
• OVERCONFIDENCE • FAMILIARITY
• SELF ATTRIBUTION • MENTAL ACCOUNTING
• HINDSIGHT • REGRET AVOIDANCE
• EXTRAPOLATION • CONFIRMATION
13. 9 AVOID INVESTMENT MISTAKES
COMMON INVESTMENT PITFALLS
• NO INVESTMENT PLAN • MARKET TIMING
• LACK OF MANAGER SCRUTINY • WRONG TIME HORIZON
• CHASING PERFORMANCE • FORECASTING
• OVERCONCENTRATION • EXCESSIVE RISK TAKING
14. 10 KEEP A LONG-TERM PERSPECTIVE—
AND STAY THE COURSE!
9.14% 3.83%
S&P 500 ―Average‖ Equity
20-Year Annualized Return Fund Investor
(time weighted) 20-Year Annualized Return
(dollar weighted)
Comparing time-weighted index returns to dollar-weighted fund
returns suggests that the ―average‖ equity fund investor buys high
and sells low while owning a given fund for less than five years.
Source: DALBAR Quantitative Analysis of Investor Behavior (QAIB), 2011.
15. Disclaimers
Manulife Securities and the block design are registered service marks and trade marks of
The Manufacturers Life Insurance Company and are used by it and its affiliates including
Manulife Securities Incorporated. Manulife Securities Incorporated is a Member of the
Canadian Investor Protection Fund
The opinions expressed are those of the author and may not necessarily reflect those of
Manulife Securities Incorporated.
Notes de l'éditeur
Most people never achieve their financial dreams. Why? In many cases, they never understand how long-term wealth is created. They assume that investment success depends on picking a hot stock, finding an all-star investment manager, or avoiding market downturns. In reality, the blueprint for success is simple and straightforward. But you must rethink your notion of investing and take a different approach, which involves understanding markets and harnessing their power, then knowing yourself as an investor, and working your investment plan.Above are ten key investment principles or actions that can help you improve your odds of having a successful investment experience.
Markets throughout the world have a history of rewarding investors for the capital they supply. Their expected returns offer compensation for bearing systematic risk—or risk that cannot be diversified away.An efficient market or equilibrium view assumes that competition in the marketplace quickly drives securities prices to fair value, ensuring that investors can only expect greater average returns by taking greater systematic risk in their portfolios. This graph documents compounded performance of fixed income and equity asset classes from 1926 to 2009, based upon growth of a dollar. It shows that equities have offered higher compounded returns than fixed income investments. Within the equity asset classes, small cap stocks have outperformed large cap stocks, and value stocks have outperformed growth stocks, resulting in higher returns and greater wealth accumulation.Capital markets reward investors based on the risk they assume. Rather than trying to outguess the markets, investors should identify the risks they are willing to take, then position their portfolios to capture these risks through broad diversification.
To pursue higher expected returns, investors must take higher risks. But only certain risks offer an expected reward—and science has helped identify these risks. The two major equity risks are size and price (as measured by book-to-market ratio—or BtM). These appear in the Canadian, US, and international markets—strong evidence that the risk factors are systematic across the globe. This graph demonstrates the higher expected returns offered by small cap stocks and value (high-BtM) stocks in the US, non-US developed, Canadian, and emerging markets. Note that the international, Canadian, and emerging markets data are for shorter time frames. Small cap stocks are considered riskier than large cap stocks, and value stocks are deemed riskier than growth stocks. These higher returns reflect compensation for bearing higher risk. A multifactor approach incorporates both size and value measures—and exposure to markets around the world—in an effort to increase expected returns and reduce portfolio volatility. An effective way to capture these effects is through portfolio structure.
Story of room full of investment managers versus room full of chimpanzees and success in stock picking. Chimpanzees won, because they only work for bananas
In an efficient market, stock prices reflect all publicly available information—and only new information causes prices to change as market participants adjust their views of the future. Since new information is unknowable in advance, most fund managers who try to beat the market through stock selection and market timing fail to deliver long-term value.As shown above, few active fund managers can outperform their respective market indices. For the five-year period through 2009, only 9% of US Equity managers outperformed their respective benchmarks, compared with 10% for International Equity managers and 7% for Canadian Equity managers.Worse yet, many active funds failed to survive the entire five-year period. Active fund survival was only 39% for US Equity, 53% for International Equity, and 47% for Canadian Equity. Non-survivors either ceased doing business or were merged into other funds.
There is little predictability in asset class performance from one year to the next. The above slide features annual performance of major asset classes in the Canadian, US, and international markets between 1994 and 2009. The top chart ranks the annual returns (from highest to lowest) using the colours that correspond to the asset classes. The bottom chart displays annual performance by asset class. The data reveal no obvious pattern in annual returns that can be exploited for excess profits. The charts offer additional evidence of market efficiency and make a strong case for investors to hold multiple asset classes in their portfolios.
Talking Points:Professional investment managers are thought to have an advanced ability to anticipate and interpret financial events—and to use their insight to actively manage portfolios. This slide offers evidence to the contrary. The graph shows how a majority of institutional investors in Canada allocated their portfolios to major asset groups during a ten-year period ending in 2007. The data in this graph represent a composite asset allocation of over 130 Canadian pension plans totaling $890 billion. This amount reflects 81% of Canadian plans with assets greater than $1 billion. A timeline of selected events below the graph offers a contextual history for evaluating their investment decisions. The pension industry’s aggregate asset mix appears relatively stable in light of the stressful financial events occurring during these years. Perhaps more telling is the pension industry’s lack of response to the larger trends. Consider these examples:An evaporating US equity premium. Although average excess returns in US stocks had virtually disappeared, institutional weights in US stocks declined only slightly. Moreover, this decline reflects the lower relative performance of US stocks rather than the pension managers’ tactical move out of this asset class.A Canadian stock market boom. Although a commodity and resource rally was fueling strong returns in Canadian stocks, home market exposure declined among Canadian pension plans as managers developed innovative ways to circumvent the foreign content limitation and acquire more non-Canadian assets.Underperforming foreign equity markets. Despite lower performance in many non-Canadian stock markets, pension managers did not pursue more hedge fund exposure to offset lower returns of a long-only strategy in these foreign assets. Their “alternative investments” were mainly in private equity and real estate, with the recent addition of infrastructure. This time series provides no convincing evidence that professional managers apply special knowledge to outperform the financial markets. In fact, during this volatile ten-year period, many pension plans seem to have avoided market timing, as the group’s equity/fixed income split remained remarkably stable. Investment “experts” charge a fee to supposedly deliver value-added management in all market environments. Yet, recent history suggests that as a group, they employ a strategic asset allocation that is readily available through lower-cost, passively managed strategies.
Building wealth in the capital markets is a long-term endeavor that does not frequently capture media attention. The business and financial media look to more sensational news to attract readers and keep advertisers.The short-term focus is particularly obvious in articles that dispense investment advice and are framed to appeal to human emotion, especially fear and greed. Investors should view these messages as entertainment, not advice, and resist the temptation to act on them.
Behavioral finance examines the influence of social beliefs, psychology, and emotion on economic decision making. Research suggests that humans are not naturally wired for making good investment decisions, due to cognitive errors and behavioral biases. Investors who are aware of this tendency are better positioned to avoid:Overconfidence: People overestimate their ability to anticipate future investment results. Self attribution: Investors may take credit for their successful investment decisions, while blaming bad outcomes on outside influences.Hindsight: When viewing past outcomes, investors may apply selective recall and conclude that future movements were obvious at that time.Extrapolation: Investors may expect recent market results to continue in the future, and may place too much weight on certain factors or recent events.Familiarity: People may limit investing to areas in which they are familiar, resulting in a false sense of control.Mental accounting: People partition their wealth in categories, resulting in inconsistent and fragmented financial decisions.Regret avoidance: Investors who have experienced painful financial events tend to avoid those investments or markets in the future. Confirmation: Investors seek out or interpret information that confirms what they want to believe about an investment, markets, or their own skill.
In today’s sophisticated marketplace, investors have access to information, advice, and tools to help them grow wealth effectively. With these resources at hand, it would seem natural that people could pursue a successful investment experience. But lack of insight, emotions, and the temptation to speculate keep many investors from reaching their financial goals. Without a well-defined investment plan, they may pick money managers for the wrong reasons and make other decisions that increase risk in their portfolios. By understanding markets and the nature of risk, and by learning to manage their emotions, investors may avoid mistakes that can compromise returns.
Each year, Dalbar measures mutual fund investor performance using data from industry cash flows versus market indices. The research shows that the “average” equity fund investor significantly underperforms the market average, as represented by the S&P 500 Index. (In this study, the market average is considered a proxy for a “buy-and-hold” investor.)The main reason for this poor relative performance is lack of investment discipline. The short-term focus of many fund investors compels them to buy high and sell low, and to hold funds for less than five years, on average.So, investment returns depend on investor behavior. Those who invest for the long term and stay the course typically earn higher returns over time than investors who attempt to time market highs and lows.
