It's usually just a matter of a few short minutes for Keith Matthews to determine the state of a prospective client's investment portfolio, and more often than not the prognosis is not good.
"If you open up someone's portfolio, it is typically a mishmash of individual stocks, bonds and mutual funds," the Montreal-based investment adviser said. "We call these 'storied portfolios;' every investment has a story behind it. That is not an investment philosophy."
Mr. Matthews, a partner and portfolio manager at Tulett, Matthews & Associates, has developed the analogy of the murky ocean and the blue ocean. Too many Canadians, he observes, are travelling across the murky ocean, an expanse characterized by chaos and confusion, without an investment plan or philosophy.
The murky ocean versus the blue ocean is a key theme of his book, The Empowered Investor: A Canadian Guide to Building a Better Investment Experience, recently released in a third edition. It outlines common investor pitfalls and how people can avoid or, more realistically, at least minimize them.
It's a long list, and his book details eight of them.
"Conventional wisdom says I need to trade the market, I need to buy IPOs, I need to place bets on predictions of markets because that is what the strategists tell me to do. I need a collection of mutual funds, I need a collection of stocks. I need to hire and fire managers because I am a bold investor and that is what I have been told do," he said.
"Unfortunately, all of these things, unbeknownst to the investor, are filled with risk."
Mr. Matthews's blue-ocean approach is based first upon creating an investment policy and then sticking to it. That investment policy outlines the asset mix strategy: from least aggressive (capital preservation) all the way up to aggressive growth. That investment policy should also serve as a guide for the investment adviser, not just the client.
Although every investment policy should be unique, Mr. Matthews writes that they all need to have some common elements: a process that spells out regular practices such as investment reporting; global diversification of equities; inclusion of value and small-cap companies; using passively managed (and typically low-cost) investment vehicles; regular portfolio rebalancing; no market timing and no speculation.
He contrasts that philosophy to the murky-ocean approach of "chasing things, trying to trade and trying to be tactical and move things around in your portfolio. That is not adding value."
The murky approach of attempting to beat the market through actively managed, sophisticated investment products or heavy trading is also the more expensive route for people when it comes to fees. That is no coincidence, Mr. Matthews said.
"Any time you are selling magic and you are selling some form of outperformance and secret sauce, the organization behind it feels that they can increase the fees. Every business does it." He advises investors to steer clear of "gimmicky" products that include the likes of hedge funds, alternative strategies, guaranteed products and tactical asset allocation funds.
While he promotes a lower-cost, passive versus active management approach, Mr. Matthews does see some investors in fact being too concerned about risk. Instead of swinging for the fences, they are afraid to swing at all.
"The amount of people taking risk off the table, selling equities in the low of 2008-2009, was huge in the last bear market. That is the kind of bad decision making that people have to stay away from."
In this third edition of his book, Mr. Matthews covers the period after the financial crisis, market crash and recession of five years ago. The investment principles are the same ones that were in the previous editions of the book.
"This blue ocean/murky ocean [concept] is a brand-new conclusion," Mr. Matthews said. "As I work as a practitioner you kind of get these light-bulb ideas once a decade sometimes. You sit back and say, 'How do I communicate these concepts?' "
1. Not having an investment policy statement. This should contain: long-term objectives, time horizon, saving and spending rates, diversification decisions for the portfolio, tax consequences, risks of the portfolio strategy and rules of engagement for dealing with investment professionals.
2. Lack of an investment philosophy. A set of guiding principles that shape and inform the individual's, adviser's and advisory firm's investment decision-making.
3. Being unaware of the mathematics of sustainable portfolios. Most Canadians are not setting aside enough money for retirement, Mr. Matthews writes in his book. How much do you have to save today and tomorrow to draw a certain percentage or assets in retirement?
4. Trying to time the market. "This is one of the biggest mistakes you can make, and it can easily lead to falling short of your investment objectives."
5. Chasing performance. Buying individual "superstar" stocks at their highs or chasing after hot fund managers or asset classes.
6. Lack of proper diversification. Many who believe they are well diversified actually have concentrated and risky portfolios. Lack of diversification (by asset class, industrial sector, geography and currency) "ranks as one of the most serious investment pitfalls."
7. Building portfolios based on 'expert' predictions. The investment industry is built upon predictions (stock tips, market analyses, mutual fund reports). In reality, no one can predict future asset prices.
8. Letting behavioural biases get in the way. Fear and greed prompt poor decision-making and the biases even have names such as herding behaviour, loss aversion, hindsight bias and confirmation bias.