It seems fitting that as my two kids embark on another school year today (Ruby in grade 6 and Sam starting grade 7 at a new school), we set out to revisit the ABCs of investing as I see it from my lens which you will come to learn is a different lens from many offering investment advice. .
Class is in session. Take a seat, students, and refer to the chart on the board which represents the growth in principal and including reinvested dividends in one of our chosen investment strategies.
Source: Harbour Edge MIC
Absolute – referring to absolute returns. Investment strategies that are aiming for absolute returns are seeking positive returns each month, or quarter, or year, depending on the underlying strategy and objective. Absolute returns are attainable in investment strategies which possess one of the following characteristics – private market investments (including real estate, mortgages, private equity and/or debt) or stock and/or bond strategies in which risk is properly managed or ‘hedged’ in order to vastly reduce short and long-term declines using tools available as a measure of defence rather than offence.
The visual attached is a great example of a fund we include in our client portfolios which we believe will continue to produce absolute returns in the private lending markets. This compares very favourably against ‘relative’ benchmarks such as the TSX (the antonym of absolute returns are relative to the benchmark/index returns).
Benchmark – most investment strategies deem their success or failure when compared against a benchmark such as a broad stock or bond index. Applying the correct benchmark to an investment strategy is critical, and it is equally important to understand the array of return expectations when comparing strategies for potential inclusion in a diversified portfolio. Using our chart as a reference point – the appropriate benchmark may be the short-term bond return (as a measure of absolute capital stability) or it may be the Toronto stock exchange index (S&P/TSX Composite) as a measure of what may be higher returns over time, but with plenty of capital volatility.
Most importantly, when setting out to build an investment portfolio – investigate, understand and seek to attain results that are in line with your own personal benchmark and not what the past performance of the broad benchmarks have done because those are not a reliable indication of the future. Working with our clients as it relates to benchmarks – our role is to understand the acceptable limit of short-term declines, and build a portfolio around that in order to reach unique benchmark goals. We start with seeking returns that exceed inflation, taxes and costs, and go from there as is suitable.
Compounding – Albert Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.” Compounding interest or growth in asset value is a powerful force which means that you are growing your money at faster and more consistent rates than if you are spending time and mental angst recovering from portfolio declines. Recall that the deeper the decline, the more growth is required simply to get back to square and to start compounding positive returns again. In other words – compounding positive dollar returns is far more beneficial than compounding negative dollar returns.
Considering our chart – compounding interest at 9% per year for 8 years means that our investment has doubled in value in 8 years (the rule of 72). The TSX and the short-term bond index earned approximately 20% and 10% in total in that same time frame (since fund inception). This is due to incredible stock market volatility which induced steep and long-lasting declines, as well as low interest rates despite stability in capital. Reliable compounding return strategies can serve as a solid piece of the foundation of any portfolio, offering greater reliability in short and long-term success as it relates to the growth of money.
A fairly basic view to get things started today. See you again in the days to come where we will continue with the ABCs of successful investment management, as well as offering comment and insight on other current events, history and finance. Class dismissed!
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