The markets are chilling investors this month. If you’re worried about a deep freeze this winter, you might want to bundle up.
In this case, bundling allows investors to shield themselves from the emotional pain of losses while still being able to profit from the market’s upside. Sort of like having your hot cocoa and drinking it too.
While some investors can hold a portfolio of individual stocks without worry, most would be hard pressed not peek at how their stocks are progressing, only to become alarmed at the stinkers. If you’re part of the majority, you should think about buying portfolios rather than individual stocks. Funds provide just such a package and fund investors naturally focus on the performance of their funds rather than on the securities their funds own.
For instance, you can invest in the Canadian stock market by buying the iShares Core S&P/TSX Capped Composite Index ETF (XIC). The exchange-traded fund has a low annual fee (management expense ratio) of 0.06 per cent. It is a good proxy for the S&P/TSX Composite Index, which follows about 250 of the largest stocks in Canada.
The Canadian stock market provides a timely example because it isn’t doing well this year. The iShares ETF fell 2.9 per cent from the start of January to the close of Nov. 8, according to Morningstar.ca.
But the performance of most of the stocks in the index was more alarming. Half of the stocks in the index saw their prices fall by more than 9 per cent over the same period, 14 stocks fell by more than 40 per cent and five fell by more than 50 per cent. Holding them would have been torture for some investors.
But if you own the index fund, you probably didn’t know about the poor individual stock returns until I mentioned them. I don’t blame you for not knowing. In this case, it is a positive. After all, it’s more sensible to track the performance of the ETF rather than each of the hundreds of stocks the ETF owns.
Investors can shield themselves from knowing about the extreme swings of individual stocks and bonds by owning low-fee funds that cover each asset class they require. But doing so might not be enough for some skittish investors who should bundle up even more.
For instance, the crash of 2008 frightened some investors so badly that they exited the stock market only to miss out on the subsequent bull run. The accompanying table shows why they fled. The S&P/TSX Composite fell 33 per cent in 2008, the S&P 500 declined 23 per cent, the MSCI EAFE index tumbled 30 per cent and the MSCI emerging markets index plunged 43 per cent. While it was a bad year for almost everything, Canadian bonds did relatively well with the FTSE TMX Canada Universe Bond Index climbing 6 per cent. (These returns are presented in Canadian-dollar terms and include reinvested distributions).
Skittish index investors might do well to bundle up their whole portfolio by putting it into a good low-fee balanced fund. Vanguard Canada recently launched a series of balanced ETFs that appear to fit the bill.
The Vanguard Balanced ETF (VBAL) sports a modest management fee of 0.22 per cent and puts roughly 40 per cent of its portfolio into bonds (Canadian bonds and hedged international bonds) with the remaining 60 per cent split between Canadian, United States and international stocks.
The ETF wasn’t around in 2008, but a little back-of-the-envelope modelling (using indexes similar to the ones it follows) indicates it might have fallen about 15 per cent that year. (The model’s annual returns are shown in the accompanying table.) The loss in 2008 wasn’t great, but it wasn’t nearly as bad as those seen by the individual stock indexes.
Investors who are more loss-averse can opt for the Vanguard Conservative ETF (VCNS), which puts about 60 per cent of its assets into bonds and the rest into stocks. The model indicates it might have suffered a decline of about 8 per cent in 2008.
(Mind you, the future isn’t entirely predictable. The ETFs and indexes may experience larger losses in the future.)
If you’re alarmed by losses, you might want to bundle up before winter comes for the market. That way you’ll be ready for a deep freeze while still being prepared for a mild winter and the spring that follows.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.
Norman Rothery