“Here’s one of many Canadian myths, that, like many Canadian myths, just happens to be true.”
--(Gord Downie, introduction to Three Pistols, 1991)
This is a story about millions of dollars of losses. It is a story about investor psychology, behavioural finance, and abject failure to learn. It is a cautionary tale, and, like the fables of our youth, has a moral at the end, for you, the reader.
In early 2009, a family came to see us about becoming a client. Let’s call them the Greys. Despite having a finance background, post-graduate educations, substantial assets, and a long history of investing, they experienced tremendous investment losses during the 2008 crash, which caused them no shortage of trauma. The pain of having lost 40% of their wealth was unpalatable, and taught them that they could neither predict the market nor manage their own investments. Mr. and Mrs. Grey asked us to help them craft and manage a portfolio that could produce stable, consistent growth, and did not depend on strong markets to make money.
So we did.
Until 2011, when they told us they wanted to sell all their diversified equity (stock) positions, because “everyone knew” markets were going to drop. We reminded them that the Investment Policy we had built together mandated they maintain a certain exposure to stocks, and that we strongly advised against this move. They did it anyway, saying they wanted nothing to do with stocks. And they stayed almost entirely out of equities until mid-2015, by which time the S&P 500 had risen well over 60% (Source: Thomson Reuters). Having no diversified stock exposure during this period cost the Greys over $1MM in missed growth.
Now, I say almost entirely out of equities, because they did insist on continuing to hold two small-cap stocks through this period. The Greys thought they had an informational edge—i.e. they knew these companies, and that they would do well. At the time, these two positions were worth $4.5MM to this family. We told them many times that the stocks should be sold—either entirely, or in significant majority, because the positions were risky, outsized, and entirely inconsistent with their stated objectives. Instead, they held on to both until one position had dropped 95% and the other had dropped 75%, at which point they decided to sell them. So $4.5MM became $800K, a realized loss to the Grey family of $3.7MM.
Recently, that family told us that they had found an Advisor who had been in the business for a far shorter time than we, and did not have our depth of knowledge or expertise, but was prepared to charge them two-tenths of one-percent less than we. They said that for sophisticated people like them, who didn’t need advice, this was much better, and they would be switching to this new Advisor and managing their own investments. Quite literally, full circle.
It is rare that we have a client leave our practice, but this isn’t the first time. Around the turn of the century, Sean had a new client transfer in with 80% of his portfolio in the common stock of a company called Nortel, which was trading around $110/share. Sean explained to that gentleman that his position was far too large, and needed to be taken down. The client told him that Nortel was a stable, blue chip company that was safe, but agreed to sell a tiny fraction of his position—500 shares. The next day, Nortel stock was up $7. The client told Sean that selling those shares cost him $3500 (500 shares x $7), and he’d be moving his account out. You all know what became of those Nortel shares.
The moral here isn’t that we knew what would happen. The moral is that prudence and risk-management should rule the day. Whether the subject is Home Capital, Apple, Marijuana stocks, or any other investment, no matter what your view, opinion, or belief, manage your position sizes and exposures, and ensure that no investment can have a disproportionate impact. This is at the heart of every portfolio we construct for our clients. We endeavour to build portfolios comprised of investments that are uncorrelated to each other and to markets, and the factors that could negatively impact them. Manage the risk side of the risk/reward equation properly, and the rewards follow.
Contrary to what the popular media (which makes money by selling advertising space; not by helping you preserve and grow your wealth) would have you believe, investor success isn’t about fees. Of course, that is a component, and nobody wants to pay more than they should for anything. But the only thing more costly than a professional is an amateur, and getting good value for good advice is simply good practice. Money is an emotional business—not intrinsically, but because it makes people emotional. And emotions can get in the way of reason, as Plato described: there is an antagonistic relationship between reason and emotions, alike to two horses pulling us in opposite directions.
When markets are at all-time highs, no one seems particularly interested in hearing about prudence, portfolio and risk management. That’s why the single greatest barrier to investor success is investor behaviour. The fear after 2008 (which was overdone) has been replaced by FOMO, which is equally harmful. Investors need to balance the two extremes. It is very hard for us to watch as people repeat the same mistakes that hurt them so badly in the last crash and will hurt again in the next, because our instinct as fiduciaries and as stewards of our clients’ wealth is to protect them—but sometimes, we can’t protect them from themselves. We wrote about this very subject only one short month ago. If you haven’t read that piece yet, please do so; you can find it here. The lesson, it seems, sadly, was lost on the Greys, but it is our sincere hope that it won’t be lost on you.
If you would like to discuss how you can invest smarter, we’re here to help.
On behalf of Sean and Farialle,
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