Familiar is Not the Same as Safe

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I was having a chat with an investor the other day, and he told me about a strategy he and his wife had hit on, to guide their investments between now and retirement.

First, they decided to invest all of their money exclusively in Canadian bank stocks. Second, whenever things looked like they were going to hit a rough spot, they planned to sell their holdings, sit on the sidelines for a few months or years, and wait for the right moment to get back in.

They felt comfortable with this approach for a number of reasons. For one, they’re reasonably confident that Canadian banks will be a safe investment, with little to no likelihood of anything going seriously wrong. They also felt very familiar with the banks they’re investing in. Every day on their drive to work, all they have to do is look out the car window, and they’ll see all the different branches of those same banks on every corner of their city, often occupying some of the most impressive real estate in town.

So far, they’ve done okay with this approach, and I certainly wish them well. But before deciding to park your entire life savings in a single investment, it’s worth taking a step or two back, and thinking a bit more critically about our biases when it comes to investing.

Canada represents about 3% of the global economy. That’s a very small part of the investment world. But despite all of the options available in the other 97% of the world, Canadians tend to invest in Canada because, well, they’re Canadians! They live here, they can see and deal with the businesses they’re investing in, and mostly, it just feels like it makes more sense to invest in Canadian companies than to send your hard-earned dollars to some business you’ve never even heard of overseas.

This is an entirely normal reaction. And it isn’t just a Canadian thing. In France, the vast majority of investors invest in French stocks. Same thing in Germany, the U.S., Hong Kong – you name it.

Plus, the average Canadian investor could probably come up with a host of reasons why they wouldn’t want to put 80% of their assets into a country like France, or Italy, or Japan. But what they tend to overlook is that they can only come up with those reasons because their distance gives them the ability to be more critical and objective than someone who actually lives there.

It would be much harder for most of us to come up with the same number of reasons for why we shouldn’t put 80% of our capital in our own country. We’re too close to our own economy to be able to see the forest for the investment trees. But I bet that if you asked someone from France what might scare them away from investing in Canada, it wouldn’t take them long to come up with a pretty long list.

When it comes to Canadian banks, for example, there’s no question that they performed comparatively well throughout the credit crisis of 2008 and 2009. For those investors who were heavily exposed to Canadian banks, it was indeed fortunate that our banks didn’t fall for the same high-risk ventures that captured so many of the big international banks. That conservative approach allowed Canadian bank share prices to stay robust, while most bank shares in the rest of the world took 80% haircuts or worse.

But I suspect not many Canadian investors realized that the resilience of their bank shares had as much to do with the luck of their geography, as it did with anything more far-reaching. If we had been born in the U.K., we probably would have bought those U.K. bank shares with the same enthusiasm that we showed for our homegrown Canadian banks – and then been just as shocked as British investors were when it turned out their balance sheets were little more than a deck of cards.

On top of our geographic biases, we also have a bias towards big, strong companies that we’re already familiar with. Banks, utility companies, large retail conglomerates and so on all tend to be more attractive to investors, because we’ve heard of them and we know (more or less) what it is they do.

It might shock investors, however, to learn that the stocks that pay the most over the long haul are generally small cap value stocks. These little stocks carry low valuations precisely because there’s nothing familiar or sexy about them. You probably haven’t heard of most Canadian small cap value stocks, and you almost certainly wouldn’t know the name of even a single one in Europe or Japan. Yet, over time, these are the stocks that have proven to be the biggest winners.

When designing your investment portfolio, it’s worth considering what price you may be paying for the comfort of familiarity. If you were going to play a game where you had to guess which number between one and 100 was going to be pulled at random out of a hat, and you had the option to either put your money on three of the 100 numbers, or the other 97 – which strategy do you think would be more likely to pay off over the long run?

Investing isn’t a game of chance. But it makes just as much sense that the best opportunities for growth are going to reside in the 97% of the world’s economy you aren’t familiar with, rather than the 3% you are.

The next time you’re looking for the “best” investment, take a moment to reflect on how much of “best” is really just a feeling of familiarity. In my experience, I’ve found that the best way to capture the most profitable, yet unfamiliar, opportunities for growth, is through broad-based passively managed funds that focus on a particular asset class.

This diversified approach helps take away the risk that you or your money might get caught in the wrong place at the wrong time. A place like, say, a bank – though not a Canadian one, of course!

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.

For more information please visit www.alanmacdonald.ca or email Alan at Alan.Macdonald@RichardsonGMP.com.

All material has been prepared 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.

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