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The Crash of ’08 – how investor behavior affects returns
In a number of articles about “the Crash”, I noted that the “boomer” investor, the majority of which are age 55 or so, certainly survived the crash mostly intact but had apparently reduced the amounts earmarked for savings including RRSPs.
The stock markets have made a remarkable “V” shaped recovery and depending on what index you use, we can now say that the Crash has been largely erased and according to famed analyst, Mark Hulbert, “back in the black.”[1]
As much as that DALBAR 2012 report uses quantitative research to indicate that average mutual fund investors underperform their own investments, the Crash of 2008 illustrates how underperformance can easily be achieved.
In the Crash of 2008 and the resulting bottoming out of the stock market in March 2009, if an investor did nothing (a good thing, in a way), their investments (if they were following the stock indexes) made 0%. Your $10 investment started at $10, dropped to $5 and then climbed back to $10.
The investor who bought at $10, sold at the bottom in despair at $5 lost one-half of his investment or 50%. The investor who bought at the bottom made out like a bandit. This investor bought at $5 and the recovery took the markets back up to $10. His rate of return is 100%.
So in the above we have three scenarios. Do nothing, sell at the bottom or continue to invest. The rates of return potentially vary from 0% to -50% to 100% .
Given the above, do we see how investor behavior affects investment performance? There is a big difference between a -50% return a 0% return and a 100% return.
Sadly, for many investors, savings stopped soon after the Crash of ’08. RRSP contributions were reduced to a mere trickle and the ultra low interest rates that followed the crash, seduced many of us to take on more debt. If we are taking on more debt, we are not likely saving much money.
More debt, less savings, not a good retirement formula for the aging boomer who should be building a retirement nest egg that has to last 30 to 40 years after we retire.
DALBAR’s real world data tells us that investors can be their own worst enemy. What we do with our investments after we bought them can determine if we are a successful investor or not.
The lessons learned from the Crash of 2008 are:
1. Do not stop saving during periods of increased market volatility.
2. Be prepared to invest amounts during market declines.
3. Allow markets time to recover.
[1] 2007-09 bear market now totally erased By Mark Hulbert, MarketWatch April 4, 2012, 12:01 a.m. EDT Wilshire 5000 Index: http://finance.yahoo.com/q?s=^W5000
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Bonds & Interest Rates – an Introduction
A number of investors have been asking me about bonds and bond mutual funds lately, so here is a bit of a primer.
Interestingly, in dollar terms, the bond market is far larger than the stock market.
Bonds are debt instruments, similar to a loan to be exact - a promise to pay back principal along with interest. Bonds can be issued by governments or corporations. Keep in mind that there is a big difference in credit worthiness between government bonds and corporate bonds issued by companies.
A government bond is backed by a government. In Canada for instance, federal and provincial bonds dominate most of the trading. A corporate bond is backed by the corporation who issued it. You should be aware that if the company goes bankrupt, your bond may be worthless. On the other hand, a Canadian federal government bond is backed by our own government and is not likely to ever default on its own bond. Even though Canada has a AAA (triple “A”) credit rating (the highest possible), there is another "risk" you should be aware of. This risk is related to the everyday fluctuation in interest rates which will affect the day-to-day pricing of your bond.
There is an inverse relationship between interest rates and the value of a bond:
If interest rates go up, bond prices go down.
If interest rates go down, bonds go up in price.
Bonds move in the opposite direction to interest rates.
Think of a teeter-totter in order to understand this basic bond concept.
A rising interest rate trend is generally bad news if you are holding a bond or bond portfolio. So, if you're holding a bond that's paying 5% and interest rates go up to 10% well, this means you are stuck with a bond that's only paying 5%. Who’s going to buy your 5% bond if rates are now 10%? Not anyone who knows how to count!
If you had to sell the bond well before maturity, you would have to sell it at a lower price than what you paid for it in order to compensate the buyer for the lower interest rate. There are fancy computer programs to figure out how much you would have to drop the price of your bond in order to give the buyer the equivalent yield of 10%
Because bonds trade like stocks and are priced daily, this price adjustment goes on constantly. Please note that bonds – even Government of Canada bonds can change in price significantly. In 1982, a long term Canada bond dropped about 50% in value due to the soaring interest rates at the time.
So indeed yes, you can lose your shirt on a presumably “safe” investment.
Although I am able to offer my clients Canada bonds and provincial bonds, please see me for specific advice regarding your current investment situation.
