I had the pleasure of being challenged by a client the other day about the whole notion of putting money into stocks.
I say it was a pleasure because, first, it gave me the opportunity to clarify my own thinking about a question I suspect many people are struggling with these days. Second, the client is a person of goodwill, who I know was only sharing his genuine concern and fears with me.
The question the client asked was whether I thought the strategy of investing in stocks, since 2005, could be deemed successful.
To put this into context, since 2005, the world stock markets have produced, on average, a negative rate of return. The question was clearly meant to be rhetorical, under the assumption that the answer was a given - namely, since stocks were down over the past six years, investing in them must have been an unsuccessful strategy.
As part of my response, I asked the client if he could give me a definition of what "success" meant to him when it came to investments. He thought the answer was, once again, obvious: that success is measured by a steady gain or return.
As I get a little older (and slightly greyer), however, I have become increasingly cautious of things that are "obvious." Let me give you a few examples why.
In the 1990s, it was obvious to most investors that investing in Nortel was a successful long-term strategy. In fact, in 1999, I had a conversation with a client who was working as an engineer at Nortel, about diversifying his $6 million in company shares into a broader stock portfolio.
This client, who was 64 years old at the time, had everything invested in Nortel - his retirement plan, his stock purchase plan and all his savings. His response was: "Mr. MacDonald, I've been told by people like you to diversify ever since I started putting all my money in Nortel. If I had followed their advice, today, I'd have less than $600,000."
At the time, he was absolutely right. Had he invested his money in a broad portfolio instead of a single stock, his net worth would've been only a fraction of where it stood that day. So far, his strategy of investing in this "obviously" successful stock was paying off in spades.
Within a year, the value of Nortel shares dropped by half. I called my client to tell him that he was still independently wealthy, and that it wasn't too late to cash out his remaining $3 million in value, and invest it in a more balanced way.
His response was that he had no intention of selling. In fact, if he could, he would be buying even more Nortel shares at these "low" prices.
We all know what happened next.
At around the same time, I had a similar conversation with an engineer at JDS Uniphase. This fellow was even more confident in his company's future success than the Nortel engineer had been. So when shares in JDS dropped, he used a leveraged margin account at a discount broker to buy even more of them. This strategy was extremely successful - right up until the moment when it suddenly wasn't.
Fast-forward back to the present. When I met with the client who had asked me about the wisdom of investing in stocks over the past six years, I told him that it all depends on how you define a successful investment.
My definition of investment success is a portfolio that delivers the results you require, over the specific timeframe you set for that investment.
If your timeframe is a year (meaning you'll need to have access to that money within the next 12 months), then you should invest it in something that's guaranteed not to lose money.
If your timeframe is rather longer - like, say, a retirement plan that needs to span more than 30 years - then you will need a portfolio that can deliver a return substantially in excess of inflation, over the course of a 30-year period or longer, without your money running out of time before you do.
Let's take everyone's current favourite investment as an example: gold.
Last month, gold briefly topped $1,900 an ounce. When this happened, the value of the SPYDER Gold Trust ETF (the most heavily-traded gold Exchange Traded Fund in the U.S.) briefly exceeded the value of the SPYDER S&P 500 ETF (the most heavily-traded stock Exchange Traded Fund in America).
All summer long, investors have been piling into gold despite the fact that, as an asset class, it has no earnings and no chance of income. In fact, over the last 30 years, gold has barely kept up with the rate of inflation - and that's including this latest, frenzied run-up.
These investors have likely been selling stocks (which are arguably currently under-valued) to buy this asset (which is sitting at an all-time price high). Moreover, the stocks they're selling to buy gold represent ownership in companies that have earnings, pay dividends, and which are steadily growing their earnings year after year.
As for gold - already, a third of the money that's sitting in the SPYDER Gold Trust ETF was put there at prices higher than the price of the fund today.*
I don't know if gold will keep going up from here, or for how long. But it strikes me that all these investors who are chasing after this one asset class may not have thought carefully enough about their definition of success, their timeframe, or the likelihood that their investment choices today will be able to deliver on their long-term goals.
There's no doubt about it - we're living in unusual times. Flat 10-year returns and global debt crises have driven markets down. Today, stocks are relatively inexpensive, and in many cases, their dividend yields exceed those of 10-year Treasury Bills.
Given all that's happened over the past few years, investors can certainly be forgiven for their frustration and impatience with stock market fluctuations. But putting frustration in the driver's seat of your long-term goals is a good way to end up in the financial ditch.
When you're picking a portfolio that will meet your goals over the long term - make sure it's one that can get you there from here.
*Source: Nick Murray newsletter - Issue 9, Vol 11.
Alan MacDonald an Investment Advisor with Richardson GMP Limited, helps investors with over $500,000 of assets make smart decisions about money. Alan is the co-author of "The Copperjar System, Your Blueprint for Financial Fitness" available on Amazon.
All material by Alan MacDonald, Investment Advisor at Richardson GMP Limited. The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP or its affiliates.
Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.