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Investing- 4 Tips To See The Forest Through The Trees

January 21, 2014

Data can be a girl’s best friend! Call me crazy but I enjoy the challenge of making sense of data.  2010097_i_see_the_light

Inspiration for my post came from the Silver Maple Leaf blog and the sharing of a rather complicated (but incredibly meaningful) graph on the history of investing from 1935-2012 (see link below).

Data (from a reputable source) doesn’t lie- it’s the interpretation that can stray in many directions. For those of you that are “analytically challenged”, you’ll be happy to know that I”m going to tell you what you really need to know from this graph.

Whether you’re are a novice or experienced investor, here are some lessons learned. Not that history ever repeats itself, but having this knowledge will help you make informed decisions for your own financial future.

1) Stocks have produced the best compounded returns over the long run- Since 1935Canadian, US and International stocks have outperformed bonds, tbills and Canadian real estate by a wide margin. Interestingly, compounded annual returns in Canadian real estate surpassed Canadian equities until the late 1960’s. After that, stocks outperformed real estate and by the end of 2012, there was still a big performance gap in stocks over real estate. It’s anyone’s guess as to whether this trend will continue or reverse. Remember that these statistics are averages so performance, especially real estate, could vary by region. What’s the take away? If your investment time frame is quite long, stocks can provide the best hedge against inflation.

2) The longer you hold stocks, the lower your risk of poor returns- Annual returns can be like throwing darts- you’re never quite sure where you’re going to land. But holding stocks for at least a five year period dramatically reduces your risk. Good to know for your retirement savings. For example, between 1935-2011, Canadian stocks had a positive return in 74% of 1 year periods, 96% of rolling 5 year periods and 100% of rolling 7 year periods. If you expect to need your money within 5 years, reevaluate what type of investments are right for you and how much risk you’re willing to take.

3) It’s important to stay invested during all market conditions– Even the smartest professionals cannot time the market on a consistent basis. Missing the single best year of growth in stock markets can do huge damage to your long term returns. Again, this is because annual returns vary so widely. For example, missing the single best year in each of the last ten year periods lowers your overall return by 26%(2002-2011) and 44%(1992-2011) respectively. So, next time the market drops, don’t panic, ignore the urge to sell and stay invested for the long run.

4) The power of compounding and diversification– Holding a balanced portfolio of stocks, bonds and cash will significantly reduce your risk with only a minor decrease to your  return. For example, a balanced portfolio (mix as defined in the graph) produced an 8.7% return (compared with a 9.8% return from Canadian stocks alone) but the risk was far less (9.1% vs. 16.7%) . This large decrease in risk can be a great comfort to investors looking to smooth fluctuations in their wealth over time.

Ok, if you’re curious about the graph, here it is for your review. I could go on and on about the data but I’m sure that’s not helpful. I live and breathe these 4 investing principles and they have served me well over many years. Knowing these tips has helped me avoid emotional reactions that can be hazardous to investment performance.

Another good learning source (for the analytically inclined) is BMO’s investing handbook. Skim it or read it cover to cover and you’ll see more great ideas to improve your investing success.

If you’ve learned anything new, be sure to speak to your advisor or revisit your investing strategy. Here’s hoping your investment returns grow even brighter!

  1. Cathy Clark permalink

    Fascinating chart Pat. Well written article too.

  2. Thanks Cathy! Glad you enjoyed it.

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