Can You Tilt the Odds in Your Favour?

It can be difficult not to jump into these high-flying stocks that we see day to day in the media. But Warren Buffett, the most famous value investor of our time, says it best, “the worst reason to buy a stock is simply because it is going up.” If buying a stock only because it’s going up isn’t sage portfolio advice, then what is? 

At RGF, we believe there are five significant factors that we can influence over time to support you in getting from point A to point B, while optimizing portfolio value. These five drivers of equity performance are simple. However, when market mania, emotions, and inaccurate media influences take over they are more than often overlooked.

Hold the right asset mix

Most of us understand that stocks outperform bonds over time. If your portfolio holds these two asset classes, then each percentage portion will have an average expected return over one to two market cycles. A common asset allocation is 50% equity assets, or ownership in stocks, and 50% fixed income assets, or lending money to companies. If the 10-year average return for the equity component is 7% and the 10-year average return for the fixed income assets is 4%, then the expected long-term weighted average return is 5.5%. Seems simple right? (50% of the 7% + 50% of the 4%)

But the most overlooked area in average-weighted returns isn’t in the math, it’s in the timing. You may have started your investment at a market high, or by chance, at a market low, or somewhere in the middle. Therefore, one needs one to two market cycles to fully reap the rewards of a portfolio’s maximum return.

Choose wisely

If owning stocks can maximize return, then what kind of stocks should you own? Should you focus on financials? Tech? Resources? Materials? Once you determine the sectors, then one must decide in what geographic area do you hold these sectors? US, Canada? China? Japan? Europe? Emerging markets? The answer is: You need to invest in all these sectors and all these countries to have a globally diversified investment portfolio. To tilt the equity returns in your favour one can overweight a specific type of equity. Value stocks are lower-cost assets compared to more expensive assets in their sector. These assets, historically, have the highest expected returns over time. Value-based equities tend to   be purchased at discounted rates, as the overall market has not recognized their future growth prospects. They have been broadly overlooked, giving them an entry price that offers attractive future returns. Data covering nearly a century backs up the notion that value stocks – those with lower relative prices in their category – have higher expected returns. On average, value stocks have outperformed growth stocks by 4.54% annually since 1928. Growth stocks have recently outperformed value stocks in the short term, however that outperformance has been a stark departure from long‑term averages.

Don’t try to time the market

It’s not possible to only be invested on the good days in the market and be out of the market on the bad days. Staying invested throughout the whole market cycle is the only way to ensure you take part in all the returns. This approach captures maximum return because you do not miss out on positive return days, which occur 86% of the time. In February 2020 the Western world was preparing for the coronavirus, and stocks markets, which dislike uncertainty, fell off a cliff!

The drop was the sharpest and fastest in stock market history. However, the following next two months set historic records in the upswing. No one could have predicted this bounce back. Using the S&P 500 index as a proxy, if you missed out on the top two months in 2020 because you decided to move to assets such as bonds, GICs, or cash, your annual return in 2020 would have been -2%. However, if you stayed the course throughout all of 2020 your annual return would have been +21%. Said differently, April and November 2020 created most investors’ positive returns for the year. Due to the inherent randomness of stock market returns, specifically in the short term, one must take part in all the trading days to reap the long-term benefits of investing in global equity markets.

Make a plan

Your portfolio is like soap, the more you play with it, the less you have when you’re done. Without a financial plan it is to easy to tinker with a portfolio. The only way to determine if you are on track for your portfolio and net worth goals is to track them. Having your plans documented is scientifically proven to help you reach your goals in the most efficient manner.

Having a respectable rate of return is only part of the wealth accumulation equation. One must also ensure their savings capacity, tax deferral, and tax savings are all optimized. Remember, it’s not how much you make that matters, it is how much you keep.

Stay balanced

The big lesson of behavioural finance is that people tend to do exactly the wrong thing at the wrong time. Investors flocked into the stock market in the first quarter of 2000 because high tech was hot. The money came out in the third quarter of 2008 because the world was falling apart. Rebalancing forces you to do just the opposite. Maintaining a similar risk ratio overall in your equity to fixed income assets requires you to sell when equities are up and use the proceeds to allocate to the fixed income side of your portfolio. Seems logical, right? Selling high and buying low. However, this strategy takes discipline, as you are parting ways with some or all of your best performers. Rebalancing manages risk, reduces volatility, and can improve your risk-adjusted returns over the long term.

No one of these portfolio performance drivers will get you where you need to go on their own, they are all equally as important as the other. The key to long-term wealth creation is not making one big bet, it’s about making many small and smart decisions over time to tilt the odds in your favour.

Understand your appetite for risk, do not just own any stock – choose the ones with the highest probability of the highest returns – stay the course when faced with volatile markets, rebalance when needed, and have a plan that you can review on an ongoing basis. ■