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(Jacob Wackerhausen/Getty Images/iStockphoto)
(Jacob Wackerhausen/Getty Images/iStockphoto)

strategy

Three ways we let the power of compounding slip through our fingers Add to ...

Tom Bradley is president of Steadyhand Investment Funds Inc.

Set up a long-term investment plan and stick to it. It’s easy to say and difficult to do.

What makes it so hard are the inevitable market extremes, which range from “I can retire today” euphoria to “I hate the stock market” depression. At both ends of the spectrum, it’s hard to see how your plan is relevant. Needless to say, handling cyclical extremes is a big part of being a successful investor.

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But extremes aren’t the only challenge to wealth generation. There’s a long list of structural and behavioural obstacles that eat away at long-term returns. The little stuff can seriously diminish the power of compounding, which Albert Einstein called “the eighth wonder of the world.” I call the little stuff “slippage.”

I’ve organized the list into three categories:

 

Not getting what you pay for

In general, Canadians pay too much for investment services. Cost overruns come in many forms. Most investors need help and there’s a cost to that, but the fees have to match up with the service provided and have a positive effect on returns. Unfortunately, too many pay for advice they’re not getting. One call a year in late February is not advice.

Many fund investors pay to have their portfolio actively managed (as opposed to indexed), but don’t end up getting it. A significant number of funds in Canada, particularly the larger ones, are almost indistinguishable from the index they’re trying to beat. In other words, investors in these funds pay “active” fees for “passive” management.

 

Too many, too much

A wise client once told me, “A portfolio is like a bar of soap. The more you touch it, the smaller it gets.” This wonderful analogy has many applications.

It speaks to the fact that individual investors, in general, trade too much. They also have too many providers touching their money. They pay administration fees in multiple places and have less bargaining power when negotiating commissions and advice fees. Spreading assets around also guarantees investors don’t get the attention (i.e., advice) they need. In simple terms, an investor with $450,000 at one firm is going to get more advice and service (in total) than one who has $150,000 at three.

But in my experience, the most slippage from spreading assets too widely occurs because investors lose track of their asset mix. It’s a lot harder to figure out whether you’re on plan or not if you have to sort through four or five statements at quarter-end. Often investors don’t realize how much cash they have squirreled away, or how undiversified they are. Unknowingly, they might own RBC, Enbridge and Telus in eight places, but have little invested outside of Canada and no technology at all.

 

Procrastination

It’s not only structural factors that chip away at returns. A lack of investor discipline also plays a role. I’m talking about holding back on regular contributions because the market news is grim, or skipping them altogether.

Slippage occurs when investors only add to funds that have done well, pass over the laggards, and even worse, use their RRSP contribution each year to buy the latest flavour of the month.

Invariably, hesitation equals slippage. Delaying on the things that are critical to long-term success – regular contributions and a strategic asset mix – or only doing them when it feels good, eats away at returns.

Dealing with market extremes is a key to benefiting from the power of compounding, but investors ignore the little things at their peril. Don’t make a liar out of Mr. Einstein – avoid the slippage.

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