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The best investing strategy? Ignore stock market predictions

Where do you think the market is going?

I get this question a lot.

My answer is always the same: I don't know. Nobody knows.

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Here are a few other things I don't know: who will win the Grey Cup on Sunday; whether it will snow on Christmas Day; what items No Frills will have on sale in its next flyer.

I do know one thing: In the long run – say over the next 10 or 20 years – the market will probably rise. After all, if you look at a historical stock chart, the general direction is up. That's what has made stocks such a great long-term investment.

But even though the broad trend is up, the market can remain in a funk for years at a time: from 2000 through 2002, for instance, the S&P 500 posted three consecutive double-digit declines, racking up a cumulative loss of 40 per cent over that period.

During the 2008 financial crisis, the U.S. stock market fell so hard that it took until this year to recoup all of its losses. Canada's benchmark index is still well below its 2008 peak.

So, predicting what the market will do in the short run is a mug's game.

That doesn't stop people from trying. Over the next few weeks, brokerage houses will start rolling out their forecasts for the stock market in 2014. My advice is to ignore these prognostications; they're really nothing more than informed guesses.

Rather than trying to time the market's cycles, here's a better idea: Build a portfolio that you can live with whether the market rises, falls or goes sideways.

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In his book, The Investor's Manifesto: Preparing for Prosperity, Armageddon and Everything in Between, investing author William Bernstein recommends seeking an "equipoise point." This involves choosing an allocation of stocks and fixed-income securities that suits your risk tolerance and will help to balance your emotions no matter what direction the market goes in the short run.

"Here is how it works: During a bull market you will derive pleasure from your stock gains and will regret that you were not more heavily invested; your equipoise point is that allocation at which this pleasure and regret exactly counterbalance each other," he wrote.

"Similarly, during substantial market declines, the equipoise point is that allocation where the pain of loss in stocks exactly counterbalances the warm, fuzzy feeling provided by your bonds and the capacity they provide to buy more stocks at low prices."

I know people who are 100-per-cent invested in equities. They have learned to live with market volatility and can keep their eyes focused on the long run. In many cases, they also have defined benefit pensions and other sources of income that allow them to take on the additional risk of an all-stock portfolio.

But most people would probably benefit from having at least some exposure to bonds or guaranteed investment certificates. When markets are rising, it's easy to dismiss the importance of fixed-income securities; it's only when markets are falling that people are glad to own them.

And make no mistake, the markets will fall.

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I just don't know when.

Can you recommend books on investing?

Following last week's Yield Hog column, several readers asked me to recommend a few books on dividends. Lowell Miller's The Single Best Investment: Creating Wealth with Dividend Growth is an excellent introduction. (You can read excerpts at Charles Carlson's The Little Book of Big Dividends: A Safe Formula for Guaranteed Returns is also good. Both are U.S. books, but the lessons apply equally to Canada.

Finally, you can find an archive of my dividend columns and a link to my model dividend portfolio here.

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