The stock market is where you go in order to make higher returns than you can get from virtually risk-free bonds and guaranteed investment certificates. On average, you can expect to make 6 to 8 per cent annually in stocks, and there will be years when you hit double digits.
Of course, there will be years when you lose in double digits, too (like I have to tell you that after the lovely year of 2008). Be humble when you invest in stocks, keep risk in mind at all times and understand that navigating the market is a learning process that never ends.
Three oversimplifications about stock market investing that you'll run into constantly
There's a common body of wisdom in the investing world that, for the most part, is built on decades of experience and observation.
The problem for people absorbing this wisdom is that it's often massaged to benefit those who sell investment advice or products. That's not to say that this wisdom is wrong. Oversimplified is probably a better way of putting it.
1. "Buy and hold" is the best approach for the average investor.
On the surface, buying and holding is an investing strategy that will serve you well. The problem is that some people take "buy and hold" as a call to remain passive when action is required to fix a troubled portfolio.
But let's be clear: left to their own devices, investors fiddle around with their portfolios way too much. They make the elementary error of buying funds coming off great years, and they sell after a year or two, as the fund falls back to earth. The net result is that they have bought high and sold low.
Buying and holding is based on the idea that stocks and funds go up and down over a long period of time - let's say 10 years, at least - but the highs will outweigh the lows and provide you with returns that, for stocks, should average about 6 to 8 per cent.
The bear market that took hold in the latter part of 2008 challenged the buy-and-hold theory of investing. Investors were told not to panic and sell, but in retrospect selling would have been the right move.
People who sold stocks at the beginning of October 2008 could have protected themselves against the ghastly double-digit losses of the next few months.
So, what's the best approach - buying and holding or trying to time market ups and downs?
The correct answer is something I'll call "intelligent buy-and-hold investing." Others call it rebalancing. You start by determining the correct mix of investments for your needs and risk tolerance, and you maintain it through market ups and downs by judiciously buying and selling to keep things in balance.
When the markets are soaring, you have to keep your exposure to stocks under strict control by selling some of your holdings. If your stocks or equity funds were 50 per cent of your portfolio and now they're 60 per cent, sell to get back to 50 per cent. If your stocks or equity funds fall to 40 per cent, it's time to buy.
The idea here is, first, to avoid the buy-and-hold passivity that leads investors to walk face-first into the bear market buzzsaw and, second, to avoid amateur-hour guessing about what the market is going to do. Have a plan, and follow it.
2. Asset allocation is what really matters in building a portfolio.
It's not unusual to hear investment industry types go on and on about how asset allocation - the mix of stocks, bonds and cash in a portfolio - is the main driver of portfolio returns.
In fact, academic studies have shown that asset allocation is vitally important to determining portfolio returns, particularly for long-term investing. But choosing good stocks, mutual funds and exchange-traded funds is important, too.
One reason why the investment industry pushes the concept of asset allocation is to wise up investors so they understand that they need a mix of things in their portfolios, not just a grab bag of whatever types of assets seem to be working at the moment.
This is useful. But I have a sneaking feeling that the emphasis on asset allocation is also a way of blowing smoke over the rotten performance of so many mutual funds.
By going on and on about how the mix of investments is of primary importance, clients may pay less attention to individual funds that are devouring fees but producing little.
The truth of asset allocation is that it's a surprisingly nebulous concept. Try comparing the mixes recommended for your personal finance situation by various investing websites or software packages (investment advisers use these).
I tried this and received vastly different blueprints. Some recommended foreign bonds, others didn't. Some recommended having a lot of U.S. exposure, others didn't. Some stressed having significant exposure to small-cap stocks, others didn't.
The point is that there's no black-and-white correct answer to the question of how you should design a portfolio. So work in broad strokes.
Consider your age, risk, tolerance, investing goals and time until retirement. Then, research a few different options and choose one that you think you can live with.
Note that asset allocation is a matter an investment adviser should spend a fair amount of time on. If you're a self-directed investor, most online brokers now offer portfolio-planning tools that develop asset mixes based on client needs.
3. The smart way to invest is in partnership with an adviser.
It's quite possible that you would be best served by having an investment adviser. Maybe you don't know much about investing at all. Or maybe you know a fair bit but don't have the time or the interest to look after your portfolio.
Advisers, at their best, are great simplifiers. Think along the lines of having an accountant at tax time. Just as you take all your tax receipts to the accountant and expect a tidy tax return, so you can take all your investment issues to an adviser and expect a tidy investment portfolio to be created.
So why invest for yourself when experts who can do it for you are ubiquitous?
The main reason is the opportunity to design a portfolio that is at least as efficient and, quite probably, cheaper than an adviser. The background here is that advisers must be paid for the work they do, and rightly so.
This payment is sometimes made directly by clients to advisers, but more often it's embedded in the cost of buying and owning investment products. Those costs cut into your returns and, if you eliminate them, you stand to make higher returns.
Let's remember that advisers can stop you from making any number of boneheaded moves that will undermine your returns. Then again, advisers aren't immune to these errors themselves. It's entirely possible that an adviser will collect fees from you that reduce returns that have been further undermined by bad decision-making.
The point here is that having an adviser is not a free pass to tip-top investment returns. If you can invest for yourself effectively, and you not only want to but have the time, give it some thought.
Excerpted from Rob Carrick's Guide to What's Good, Bad and Downright Awful in Canadian Investments Today . Copyright © 2009 by Rob Carrick. Published by Doubleday Canada. Reproduced by arrangement with the Publisher. All rights reserved.Report Typo/Error