The High Cost of Low-risk Investing

The Globe and Mail has yet another doozy of a weird finance article. I have previously used their articles for a game I play with my high school students called “Spot the Nonsense.” In their latest piece, they profile David Trahair, a chartered accountant, who owns his own accounting firm, who has authored 5 personal finance books, who gives advice on stocks and who apparently hires someone to give him financial advice. How does that work, exactly?

“Virtually Risk-free Portfolio”

A risk-free portfolio is not obvious nonsense to everyone, so we’ll break it down. What does Trahair do with his finances? He is an ultra-conservative, to the point of eccentricity--the financial equivalent of people who build fallout shelters, or buy zombie repellant. He invests completely in GICs (guaranteed investment certificates), on which he claims make more than 2% and a “high-interest savings account,” which appears to currently pay a paltry rate of either 0.75% or 1%. Given that he has allocated about 50% to each, his rate of return is likely to be close to 1.5%. That rate would have just beaten inflation last year, failed the year before, beat it in 2013 and failed in 2012. So this strategy has some risk of losing purchasing power, over time.

But more to the point, this strategy would have missed out on the stock market gains of the past. The Canadian stock market (TSX) has historically gained 6.1% per year, trouncing these returns. If you don’t own productive resources, you miss out on the gains they provide. When you buy a guaranteed investment certificate or put your money in a so-called “high-interest” blah, blah, blah, what happens to your money? The institutions that you lend to buy productive assets (stocks) or lend it out to businesses (bonds). The banks take the risk because they believe that they will earn more than they pay you. So employing this strategy has a high risk that you will be a sucker.

Not rejecting stocks

The claim of not rejecting stocks sounds alright. But what is written here seems really odd to me.

“Mr. Trahair does not categorically reject stocks. He is okay with gaining exposure when risk is low – that is, when optimism is at an ebb.”

I guess that makes sense in principle; but he isn’t invested in stocks, according to the earlier part of the article. He also says that “more than half of the portfolio” is cash, which seems a bit odd. Technically, 100% is more than half, but still, an odd way to express the fact.

The next part is a bit more troubling. He consults with his advisor (!) about buying more stocks if there is a market crash. There was a market crash! Canadian stocks dropped 30% relative to highs, at which point I wrote about the discount on stocks, as did others. I guess he and his advisor missed that. I don’t have a big readership just yet. I’m new.

But setting aside that oversight, there is a problem with the whole concept of buying stocks when risk is low. No one has any idea when such a time would be. It is true that I thought earlier this year to be a smart time to buy, because stock prices had gone down. But I would never call that low-risk. The market can always keep falling. It is very unclear what magnitude of financial catastrophe Trahair is waiting for.  

“His worst move”

“Critics may say staying out of the stock market is a bad move, Mr. Trahair notes. But he finds they often have an association with the financial industry and “make their living selling stocks and mutual funds.”

I believe a healthy dose of scepticism is important and investors should be vigilant. But it is truly bizarre that he, an advisor, would be critical of financial advisors. And particularly so, given that the article is there, in part, to advertise Manulife, where he gets his high-interest savings account. I have no qualm with Manulife but I find it very odd that they would be placed above scrutiny, unlike stock brokers. One should be very careful when making large financial decisions, such as how to handle a retirement portfolio. But that doesn’t imply that stocks are inappropriate.

The Sense

The end of the piece has a breath of fresh sanity. Trahair recommends that people keep their stock allocation to 100% minus their age. This is a well-know and sensible formula, if mildly conservative for some tastes. Many Bogleheads have a similar investing principle, and they maintain a fantastic resource on how to choose what kind of assets (stocks, bonds, GICs, cash) to invest in. They have a very data- and thought-based analysis of what your likely risks are as well as your likely returns, although they do focus on the US market. If you want to go a bit deeper, you can even consult their investment philosophy; again a very sober and sound account. Their sister site is the Financial Wisdom Forum which gets into the same information with a Canadian focus.