May 14, 2008--Timeless truth about investing

Here's my perspective on a timeless truth about achieving long-term investment success. But first, some quotes--

"Despite the recent record jump in oil prices, the outlook suggests that oil prices will continue to rise steadily over the next five years, almost doubling from current levels." --Jeff Rubin, chief economist at CIBC World Markets, predicting in April this year, that the price of oil will go to >$US200 by 2012

"It (the future price of oil) is all speculation. We might as well be talking about the future price of broccoli or TV sets." --Bruce Orr, spokesperson for the Canadian Petroleum Institute, commenting on Rubin's prediction

Many people love to predict and to read the predictions of others. You can't help noticing, though, that people who predict rarely agree on their predictions. Makes me glad I'm not an economist.

Is the ability to predict the future a key to being a successful investor?

It depends on what kind of investor you are and how you define success. Every investor has to wrestle with the fundamental fact that the higher the rate of return you target, the higher is the risk that you will not achieve your target. This is known as the law of the risk/return relationship. "Speculators" are investors who want big rates of return, the bigger the better, and sooner than later. This requires the investor to make the right prediction AND to sell before any gains become loses.

Speculation is inherently risky because pursuing big potential returns puts you at higher risk of losing your money. Speculation, therefore, puts your capital at risk and leads to unreliable rates of return. I have been told by professional speculators/investors that for every 10 stocks chosen, they expect--on average over the long term--7 of those stocks to lose money. They hope that the remaining 3 stocks will go up enough to cover those losses and leave them with a profit. Speculation, when it works, can be exhilarating, even intoxicating. And the toughest things about being a speculator? Knowing when to sell and tolerating loses.

I have nothing against speculators but it's not what I do for clients. I'm another kind of investor that is best described as a "pension manager."

How does a pension manager differ from a speculator?

1. Pension managers avoid losing money. A 50% loss requires a 100% gain just to get your capital back. Yes, there may be paper loses over short time frames, but you certainly do not want loses in the long run. That brings us to the second point.

2. Pension managers aim first, over 5-plus years or more of investing, to preserve capital. The second goal is a "reasonable and reliable" rate of return.** In other words, pension managers will not chase big returns because preservation of capital comes first.

3. Pension managers don't believe that consistently predicting the future is possible, and don't speculate with other people's money.

4. Pension managers balance risk and return to maximize the possibility of reaching your target rate of return with the minimum amount of risk possible. This is key.

5. Pension managers rely on a patient, disciplined system of investment analysis developed over years of testing. And they do this in an effort to provide a reasonable and reliable rate of return in the long term. **

**Note "reasonable" means a rate of return that aims to be higher than what a "no-risk" bank account will pay. "Reliable" means a rate of return we can be confident--but not certain--about achieving over the long term. [Not certain because past returns do not guaranteed future returns.]

If someone asked me, 'what's the most important thing you try to do for clients?' my answer would be that I help clients achieve their long term financial goals. Now, "achieving financial goals" may sound like nothing more than a slogan. But consider this. My typical clients come to me long before they retire and we work out a plan, including projections for rates of return, to allow them to look forward to their retirement goal. And, not surprisingly, it really matters that those projections be reasonable and reliable.

I started in this business 14 years ago in April 1994 which is long enough ago that some of my first clients are now entering retirement. And what started out as a projection into the future is becoming a reality and they and I see, right now, whether their retirement goal was achieved. In other words, the retirement plan we designed years ago is now, in effect, being "graded"--does it get an "A' or an "F" grade? I'm proud to tell you that it's an "A." And that brings me to why I'm a pension manager--my clients rely on me to try to protect their capital and provide a reasonable and reliable rate of return over a period of many years. Without these things, we can't plan and they can't hope to achieve their goals.

Cheers!

Tom

Tom Buck, M. Ed. CFP
Assante Financial Management Inc.
email: tom.buck@ethicalfootprint.ca