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Take full advantage of data when you return to playing the stock market, so you can ignore investments that show a tendency to fluctuate with a large upfront cost, as well as avoiding speculative funds. (Scott Eells/Bloomberg)
Take full advantage of data when you return to playing the stock market, so you can ignore investments that show a tendency to fluctuate with a large upfront cost, as well as avoiding speculative funds. (Scott Eells/Bloomberg)

PORTFOLIO STRATEGY

Petrified by the stock market? Here's a way to inch back in Add to ...

There are two kinds of investors now dodging the stock market – those who believe they’re not suited to stocks, and those who imagine they’ll get back in at some point.

This column is for the crowd who think they’ll come back to stocks. Two questions for you: When will you make this great return migration, and what investment vehicles will you use?

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And now for a suggestion. Begin your move back into stocks through regular monthly contributions to one of the mutual funds or exchange-traded funds captured in what we’ll call our Get Back Into Stocks screen. Here are the criteria built into the screen:

Volatility – Funds and ETFs had to have a beta of 0.8 or less; a fund’s benchmark index always has a beta of 1.0, and a lower reading suggests less of a tendency to fluctuate in price.

Cost – Only funds with management expense ratios of less than 2 per cent were considered; this is an arbitrary level set to include a variety of mutual funds while also weeding out high-cost products.

Five-year performance – Returns over the very difficult past five years must be in the first or second quartile; quartiles divide funds in a category into four groups by their returns over a set period, and first- and second-place rankings are best.

Category – Core funds only – no speculative stuff; specifically, the categories screened were Canadian equity, Canadian focused equity, Canadian large cap equity, Canadian dividend and income equity, Canadian equity balanced and U.S., international and global equity.

Minimum upfront investment – A cap of $10,000 was used, although most funds came in at $500.

The S&P/TSX composite index made 0.7 per cent on an annualized basis over the five years to Nov. 30 (including dividends), and Canadian equity funds lost an average 1.3 per cent. All the funds turned up by our screen did better than that. In fact, all but three of 17 made money over that same five-year period.

Funds in the Canadian dividend and income equity category dominate the list, which makes sense because many dividend-paying stocks have outperformed the broader stock market by a big margin in the past few years. Could dividend stocks be vulnerable to a downturn?

We’re starting to hear talk of a “dividend bubble,” which is a foolish term because it suggests ridiculous overvaluations and the potential for a sharp, painful correction. In fact, some dividend stocks have done very well in the up-and-down stock markets of the past couple of years. If the stock markets were to rally and more speculative stocks came into favour, dividend-paying blue chips could drift lower in price.

But for long-term investors, especially those who want income, dividend stocks as a group still make sense. The yield on the S&P/TSX Canadian Dividend Aristocrats Index was 4.3 per cent in late December, while the five-year Government of Canada bonds yielded 1.4 per cent and 10-year bonds 1.8 per cent. Both bond yields could double – that would be a huge move from today’s levels – and not match dividends. And that’s on a before-tax basis – dividends look even better in taxable accounts as a result of the dividend tax credit.

Quite a few balanced funds, one of the hottest mutual fund categories, make this list as well. I used to be a balanced-fund basher, mainly because of the way fund companies capitalize on strong demand by keeping fees excessively high. Today, there’s an ample selection of low-cost balanced mutual funds and ETFs for investors who want the instant stock-bond diversification of a balanced fund.

There are actually three types of balanced funds – one that emphasizes stocks over bonds, one that keeps both in roughly equal proportions and another that is mostly bonds. Given that the point of this column is to encourage people to reconsider stocks, only Canadian equity balanced funds are included in this screen. The lowest-cost option in our screen is the iShares Diversified Monthly Income Fund, an ETF with a management expense ratio of 0.57 per cent.

One flaw in the Get Back Into Stock screen is that it didn’t capture much in the way of U.S., international or global equity funds. In fact, just one global and one international fund made the cut. Two probable explanations for this dearth of non-Canadian content: Fees tend to be high in the U.S., global and international categories, as are volatility levels.

Don’t forgo non-Canadian content in your portfolio, though. The CNNMoney website published a chart of the world’s top-performing stock markets in 2012 recently and the TSX didn’t make the list. Unless the global economy picks up in 2013 and spurs demand for commodities, Canada could underperform again.

Where the Get Back Into Stocks screen excels is in offering investing options for all kinds of investors. For those with an adviser, there are mainstream funds from companies like CI, Dynamic and Invesco, which offers the Trimark Fund. For people who prefer to deal directly with a bank, there are funds from the BMO and RBC families. For doctors and their families, there’s a fund from the MD Management group.

And, for both self-directed investors and people who have fee-based advisory accounts (they pay 1 to 1.5 per cent of their account assets in fees and use low-cost investments), there are ETFs and fund companies like Beutel Goodman and Mawer.

Expecting more ETFs on this list? The classic ETF is designed to target the return of a particular stock or bond index, which means its beta should be 1.0. In this screen, we’re looking for funds with less volatility than the major indexes. Volatility can work both ways – sharper declines and higher highs. But if you’re thinking of getting back into stocks after bailing in the past, funds that walk on the mild side might suit you best.


For more personal finance coverage, follow me on Twitter (@rcarrick) and Facebook (Rob Carrick).

 

 

How To Get Back Into Stocks:
Here's a selection of mutual funds and exchange-traded funds that made it through a screen seeking funds that combined competitive returns and comparatively low volatility. The volatility measure used here is called beta; a fund's benchmark index has a beta of 1.0, and lower values for a fund suggest less tendency to jump around in price.

Fund 3-yr
Beta
1-yr
% rtn
3-yr
% rtn
5-yr
% rtn
Beutel Goodman Canadian Dividend-D 0.61 11.71 8.22 2.37
Beutel Goodman Canadian Intrinsic-D 0.69 12.91 6.66 1.52
BMO GDN Monthly Dividend Fd Classic 0.22 6.73 8.09 4.3
CI Signature Dividend 0.49 9.23 6.07 3.34
Dynamic Dividend 0.54 6.73 8.48 1.94
Integra International Equity 0.73 14.6 2.08 -4.86
iShares Diversified Monthly Income ETF 0.68 7.63 10.98 6.65
iShares S&P/TSX Cdn Div Arist Index ETF 0.59 6.86 10.95 4.49
iShares S&P/TSX Preferred Share Index ETF 0.08 5.31 5.94 4.3
Mackenzie Focus Canada-B 0.76 9.28 5.19 -1.24
Mawer Canadian Equity 0.73 11.87 9.97 3.16
MD Dividend Growth 0.61 11.23 11.07 4.43
PH&N Canadian Income-D 0.78 9.89 10.05 2.36
RBC Canadian Dividend 0.73 9.1 6.51 1.69
Steadyhand Equity 0.75 12.87 8.98 1.39
TD Monthly Income 0.68 8.95 7.5 3.96
Trimark Fund-SC 0.66 10.09 6.19 -1.83

Note: The minimum investment for PH&N applies to purchases from third-party dealers; if you buy directly from the company, there's a $25,000 minimum that can be spread over multiple funds in the family. Source: Globeinvestor Gold

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