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rob carrick

Admit it, you’ve wondered whether you could own nothing but bank stocks and do great as an investor.

The answer: Probably, but don’t try it.

Readers have asked this question many times over the years, most recently in the past week. “Would owning nothing but Canadian banks and lifecos long term be harmful?” someone asked in an e-mail.

I have been known to be critical of the banks and the way they do business, but they are arguably Canada’s most reliable long-term wealth builders for shareholders on a total-return basis (dividends plus changes in share price). Consider the following stock indexes, which invest, respectively, in the Big Six banks; banks, insurers and investment firms; and the broader Canadian market:

The Solactive Equity Weight Canada Banks Index – basically shares of the Big Six – produced average annual total returns of 13.3 per cent for the five years to Feb. 28. The S&P/TSX Capped Financials Index (banks plus insurance companies and investment firms) averaged 12.2 per cent over that period, while the S&P/TSX Composite Index averaged 6.9 per cent.

This level of outperformance for banks happens periodically and can be counted on to get investors wondering why they should bother holding other stocks. The answer is that banks tank every now and then. In 2008-09, they were absolutely hammered. The interactive charts on show Bank of Montreal shares trading around $71 in May of 2007, and then falling to around $28 in February, 2009. Royal Bank of Canada shares over that same period went from $58 or so to around $31.

Banks rebounded and then picked up momentum in the ensuring years. Flush with years of strong share-price gains and dividend growth, investors may have forgotten the sheer terror of watching bank stocks in free fall. If you plan to hold bank stocks for decades, you can be pretty confident the ups will more than offset even the worst declines. But living through a crash like 2008-09 isn’t easy. Unless you’re a steely investing veteran, you’re going to have regrets that might lead you to sell at a market low just to avoid the risk of further losses.

In short, the vast majority of investors aren’t psychologically equipped to own bank stocks alone and would be better off with a diversified portfolio. And keep in mind, the Canadian market isn’t known for optimum diversification. Financials, mainly banks, account for a full 35 per cent of the index.

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