Our portfolios shrank in 2008, yet we're rich as investors.
Rich, that is, in the wisdom that comes from bitter experience. After confronting what will surely go down as one of the worst financial crises of all time, we should all be much smarter about matters of investing.
Let's review some of the key lessons of 2008. One of the most important is that your risk of losing money rises sharply when you venture away from safe but low-paying investments like government bonds and guaranteed investment certificates.
"The past year has really driven home the fact that the relationship between risk and return is alive and well," said Michael Mezei, president of Mawer Investment Management, a Calgary-based money management company that runs a well-regarded family of mutual funds. "Leading up to 2008, we saw a number of years of perceived easy money in you name it - in investing, in real estate, commodities, stocks. You can go on and on. What we learned, big time, in 2008 is that there's no such thing as easy money."
Long term, stocks still deliver returns that will beat GICs and bonds. Even after the carnage of the September-through-November period, investors who held Canada's most popular exchange-traded fund, the iShares Cdn LargeCap 60 Index Fund, had still made an average annual return of 7.6 per cent for the previous five years.
But as the events of the past fall showed, the stock market can pick your bones clean in the short term. John De Goey, an investment adviser with Burgeonvest Securities, learned that lesson well in the past year.
A client had sold his house and wanted to park the proceeds for a year or so while he waited for a planned move into a condo in 2009. Mr. De Goey considered a GIC or money market fund, but thought he could do better in an exchange-traded fund (an index tracking fund that trades like a stock) targeting blue-chip dividend stocks.
Several hundred thousand dollars went into the ETF in the fall, after the stock markets had fallen by an amount that now seems modest. "I said come on, we've got a year before we need the money, the markets are down 10 or 15 per cent and this ETF's holdings are all solid companies paying dividends," Mr. De Goey recalls thinking.
In mid-December, after steady losses, the client reached the limit of his tolerance and the ETF was sold at a loss of about 25 per cent.
"I don't take a lot of risk in my client portfolios - my assets under management are only down about 17 per cent from the peak in June," Mr. De Goey said. "But I'm chastened. We all learn our lessons from these things."
A basic principle of sound investing is that you can reduce the risk of investing in stocks by diversifying across various economic sectors and countries. But the panic conditions of 2008 proved that that there are limits to what diversification can do for you.
"Diversification works 99 per cent of the time," said David Baskin, president of Baskin Financial Services, a portfolio management firm. "But when there's a panic, it doesn't matter what you own very much. We never thought that could happen, at least to this extent."
The one diversifier that did work in 2008: government bonds or Treasury bills. Remember that if you want something in your portfolio that's crisis-proof.
Then again, demand for three-month U.S. government T-bills was so intense in late 2008 that the yield went to pretty well zero. In Canada, the three-month T-bill yields sank just below 0.8 per cent late in December.
Who's buying these almost safe but virtually return-free securities? Big institutional money managers like pension funds, insurance companies and endowments. Yes, another lesson of 2008 is that it's possible to rattle even the big boys - the investing world's soberest and smartest.
"Everybody has taken huge losses and basically they're gun shy right now, they don't know what the next shoe to drop is," said Mr. Baskin, who serves on the investment committee of a billion-dollar pension fund. "So they've stuck money in the only thing they know that won't go down."
