Some tips and traps for investors

What's a great way to make a buck?

No, this is not a joke. And if it were, you wouldn't like the punch line.

Answer: start a mutual fund.

Here's the first startling factoid: mutual funds always get their commission, typically around 2.5 per cent for equities and around 1.5 per cent for bond funds, but positive returns for investors are not guaranteed.

"Mutual funds are dependent on people who don't know how the system works. The investment industry is about selling products. And the system is designed for maximum profitability for mutual fund companies, not individual investors," says Warren Mackenzie, CEO of Weigh House Investor Services (formerly Second Opinion Investor Services). Weigh House is not affiliated with companies selling investment products of any kind, and so is not compensated by them.

The second startling factoid is that, during a 10-year span, most mutual fund managers don't outperform the Standard & Poor's Indices Versus Active Funds (SPIVA).

"In fact, 97 per cent of mutual fund managers don't outperform the index," says Mackenzie. The rule of business – paying for performance – doesn't seem to apply to mutual funds. And, Mackenzie adds, Canada has some of the highest mutual fund MERs (management expense ratios) in the world.

So, if you've decided to become a do-it-yourself investor, here are some tips and traps from investment veteran Mackenzie:

Know who you're up against. "In online trading, there are too many factors that affect the markets. Plus, when you're trading, you're trading against professional traders – typically a roomful of PhDs – with very sophisticated software and mysterious black boxes," says Mackenzie. The odds are not in your favour that you're going to beat professional traders. Plus, DIY investing is not a shortcut to long-term success.

Understand that DIY investing is a trade-off. Determine how involved you want to be in your own investments. "Be honest about your skills and knowledge as an investor," says Mackenzie.

"Doing it yourself requires at least a few hours each month and you need the discipline to follow through with your investment strategy. Time is money, and what you save in fees might be more than offset by the amount of time you spend managing your own investments," says Mackenzie.

Are you emotionally equipped to handle the volatility of the markets? "Be aware that it is one thing to do-it-yourself, but it is another thing to do a good job. Not everyone is emotionally equipped for DIY investing. Don't try it unless you can follow an investment plan that minimizes the effect of emotional reactions," says Mackenzie.

"Know when to fire yourself," he adds. Are you taking on too much risk? Or, are you failing to track how you're doing, compared to your own goals?

Have a strategy. Have a well articulated, written investment strategy. Set realistic goals. Target asset allocation and target asset allocation ranges. "Diversification is the only free lunch in investing," says Mackenzie.

Keep it simple. "Complicated portfolios generally reduce performance–they hardly ever improve performance. Plus, the more complex the product, the higher the embedded fees," says Mackenzie. Don't buy what you don't understand.

Control your fees and commissions. "In many cases, the difference in performance can be attributed to fees. Understand all the costs you are incurring," says Mackenzie.

"Over a lifetime of investing, 2 per cent higher fees will amount to more than $500,000 for a typical investor," says Mackenzie.

Manage risk. Understand all your risks including: inflation, deflation, currency exchange, interest rates, and so on.

Don't try to beat the market. "Be sensibly diversified and buy low-cost ETFs instead," says Mackenzie.

"Being an average investor is very easy. Being an exceptional investor is very difficult. With investing, it's okay to be average," says Mackenzie.

Making the Case for traders Former Toronto police officer learns from his early mistakes and now wears his financial success like a badge of honour

As a Toronto Police officer, Mike Case was trained for almost any situation. Yet in 2007, the rookie online trader felt completely powerless after he failed to pull the trigger on his trades and he was struck with a $30,000 loss.

Driven by an initial profit, Case held onto his Apple stocks – which took a dive in 2007 – anticipating an increase in the market.

"I didn't know what I was doing," Case, 50, said. "This is the bad thing that happens to almost all traders. You add about $10,000 or $12,000 and it goes up over $30,000 in a space of a couple of weeks. But then it drops off – and I did not know what to do. Of course the obvious thing is to get out, but you do not know that. You think, `it's going to go up, it's going to go up.'"

Only two years from retirement, Case needed to better acquaint himself with changing market conditions.

Through Questrade, a small, independent online broker, he was introduced to the Online Trading Academy (OTA) – a program which uses hands-on live trading instruction to teach people how to trade stocks online.

Ron De Appolonia, general manager of the OTA, said people are taking control of their finances, relieving financial planners of their duties, and educating themselves with online trading.

"When you go through a loss that big, people start to question the people managing their money. `Do they really have my best interest in mind?' or at least, `do they regard the risk in the market the same way I would regard risk?'" De Appolonia said.

"They find themselves saying, `I wouldn't do that,' and they realize they should have a hand in planning their finances. No one cares more about your money than you, so you cannot be the guard dog that is asleep."

The OTA provides financial education for individuals in equities, options, futures, trading psychology, trading plan development, and more.

Mostly the accelerated courses, they offer free repeats of the program, teach traders to adapt to ever-changing markets with the academy's capital.

"They are really making money or they are really losing it," De Appolonia said.

"We teach them how to manage risks. We have some skin in the game. We are not just teaching them and sending them home to practise with their money. We are putting our butt on the line – if they lose, we lose; if they win, we win. What we are trying to do is teach them and hopefully make a little bit of money while they are learning.

"It's not a theoretical improvement, it is an actual practical trading opportunity."

De Appolonia said key elements to trading is managing risk, reducing the chance for error and the psychology involved with trading.

While there is no guaranteed method for an investor, the OTA teaches students to find high probability and low risk opportunities.

"It is hard to come back from a big mistake and it is easier to come back from three or four small mistakes. We would rather people put their egos aside and say `okay, I got it wrong so let's move on and look for another opportunity to make money,'" De Appolonia said.

And managing fear, greed and ego are crucial elements that help traders determine entry and exit strategies.

Greed quickly transforms into fear when something threatens to take gains away from an investor. These emotions, De Appolonia said, need to be combatted or it can cause the evaporation of an account.

The school teaches students to view the market systematically based on technical skills, which helps reduce emotional input into trading.

"It is this emotional roller coaster where you start trying to snap up money and wins instead of looking at relevant information you looked at when you first got you into that trade," De Appolonia said.

Case now knows to look beyond the psychology, and when to enter and when to exit.

"Everyone wants to make $10,000 in a day. Not that it is impossible but these guys (OTA) keep saying, `Go for small amounts. Make $200 or $300 and do that for a month, every day, and then you can start trading bigger numbers.'" Case said. "If you try to make that big score you're going to lose a lot and you'll actually be behind."

After 31 years with Toronto Police, Case retired.

He is now driving a new Infinity G37, has a beautiful house in Pickering and is waiting for his three-bedroom vacation home in Panama to be completed.

He is also taking a program at Durham College to be a paralegal.

Profits from investments cover tuition, living expenses and additional luxuries.

Carrigan asked four prominent market strategists for their take on the market's valuation

Last week, an investment reporter asked four prominent market strategists for their take on the market's valuation.

David Rosenberg of Gluskin Sheff and Associates said: "No matter which way you look at it – forward P/E, trailing P/E – the market is vastly overpriced, (and) so the strategy is to sit on the sidelines, be selective in our equity choices, and wait for the correction to come or for the fundamentals to catch up with this overvalued, overbought, overextended market."

Another said: "People who are raising the red flag about markets being overvalued are those who missed the rally."

While entertaining, the confrontation is simply a minor bull and bear scrum stimulated by a financial writer asking an irrelevant question. The market is never priced on what stocks are worth today, but rather what stocks will be worth several quarters from now. The markets are forward looking and that is why the "valuations" never catch up to rising prices in a bull market.

These are harmless bull and bear arguments that are, for the most part, just noise and quickly forgotten.

The real danger to the average investor are the professional fear mongers, who use fear to influence the opinions and actions of others towards some specific end. The feared object or subject is sometimes exaggerated, and the pattern of fear mongering is usually one of repetition, in order to continuously reinforce the intended effects of this tactic.

Inciting fear is also a technique to gain notoriety and influence. Some financial advisers and money managers use fear mongering as a means to attract investors to the safety of their enterprise and away from their current and supposedly dangerous adviser.

I recall a "Night with the Bears" held on April 7, a speaker's series organized by Sprott Asset Management. Guests include Eric Sprott, Meredith Whitney of Meredith Whitney Advisory Group, Nouriel Roubini of New York University and Ian Gordon, author of The Longwave Analyst newsletters.

A packed house gasped as "lunatic fringe" cycle expert Ian Gordon predicted the Dow Industrials would hit 1,000 before this downturn is over. Gordon's analysis is based on the Kondratiev long wave or K-wave which spans about 50-plus years as measured from trough to trough.

Fear mongering can sway many investors into avoiding any type of risk. Sit on cash and don't invest. Don't buy a house. Don't change jobs. Don't borrow. Don't start a business and don't trust anyone.

The following is a quote from the classic publication, Reminiscences of a Stock Operator by Edwin LeFevre: "Among the hazards of speculation the happening of the unexpected, I might even say of the unexpectable, ranks high. There are certain chances that the most prudent man is justified in taking – chances that he must take if he wishes to be more than a mercantile mollusc.

"Normal business hazards are no worse than the risks a man runs when he goes out of his house into the street or sets out on a railway journey.

"Life itself from the cradle to the grave is a gamble and what happens to me because I do not possess the gift of second sight I can bear undisturbed."

I recall a recent conversation with a good friend whose daughter had just bought a small house in a Hamilton suburb. "She's crazy," he said. "Paying that much and going into debt like that."

I responded; "Calm down, I have owned several homes over the past 40 years and I paid too much for every one of them. My first East York bungalow cost me $18,000."

Most of the financially independent people I have met acquired their wealth either by inheritance, real estate, stocks or a family business.

Although most of us will never inherit a fortune or own a successful business we should at least take on some risk in the form of home and/or common stock ownership.

Our chart this week is 25 years of monthly closes of our own TSX Composite stock index plotted above the average Greater Toronto resale home price. The longer term trend for both asset classes is upward with the TSX returning about 10 per cent annualized and the single family home returning about 5 per cent annualized.

The higher return of stocks is accompanied by higher volatility and lower return of the home is accompanied by tax-free gains and shelter.

All and all, both are worth the risk, so don't be a mercantile mollusc.

Bill Carrigan, CIM, is an independent stock-market analyst.

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