Remembering to Look Forward
Making decisions for your future is more rational when you base those decisions on the current and changing state of affairs, not what happened in the recent past and projecting it out indefinitely. Put another way, it is more sensible to analyze investment opportunities that are available to us today and to weigh them within a context of the here and now.
When we broadcasted our kickoff presentation in January 2022, people were still talking about COVID (which has now been replaced with inflation and interest rates as the topics du jour). We suggested that when the time came the Fed would either raise rates too slowly, too quickly, or neither, and would very likely not get it exactly right. This was not any attempt at a forecast, this was simply a reminder of what has happened in the past.
Unlike Goldilocks, who did get it just right, the Fed and the Bank of Canada rarely nail it, despite having all the data. To us, this means that it is a fruitless exercise to try to make short-term forecasts regarding interest rates, inflation, and the economy; accordingly, we feel that they are also unnecessary in developing a sensible long-term investment or wealth plan. On the other hand, we do think considering some basic long-term investment principles is much more practical and worthwhile:
- Corporate profits grow over the very long-term
- Innovation, most of which few of us can foresee or understand as it’s happening, alleviates or solves many economic quandaries
- Equities outperform bonds over the very long-term and fluctuate in the short-term
- Stock and bond markets fluctuate. Treat this as normal
- Lower current stock prices means higher future returns
- The crisis of the day always passes
Let's look forward: What is the rational investor to do when faced with rising interest rates, inflation, and higher gas and food prices? It all begins with understanding your circumstances and not falling for generalizations offered by the media or well-meaning friends who do not know your life or what you value most as intimately as you yourself do.
- Are you retired, or still working? Or put another way, are you a person who needs income from your portfolio, or are you still investing?
- If you are retired and your near-term spending needs are in cash, you should still consider yourself a long-term investor when it comes to most of the rest of your other capital and simply let those funds grow for your long-term future.
- If you are working and still accumulating, the recent market weakness is very conducive to helping you grow your capital over the next 10 to 20 years as you can invest today at lower (read: bargain) prices. This is the sale you have been waiting for so take advantage of it if you can - no one knows when the sale will end.
To be fair, market moves down like we’re seeing right now make it challenging to keep emotions in check and to stick to long-term plans. So let’s put some thought into what our current investment choices are, and who and what they are suitable for.
- A 2 year GIC pays about 4%a
- 5 year investment grade corporate bonds pay about 4%a
- 20 year US bonds yield just shy of 4%b
- The current dividend yield on US Dividend Income (USDI) is just above 3%c
- The current dividend yield on Canadian Dividend Income (CDI) is about 3%c
- Keep in mind that, all else being equal, capital gains and eligible dividends are taxed less than interest income so you end up with more in your pocket after tax - often up to 30% more
The stock strategies mentioned above have, year-to-date, behaved as expected, with share prices down, and yet they collectively own banks, pipelines, grocery stores, health care and retail companies that are of the highest quality. These companies are profitable, pay dividends, and have grown their profits and dividends over the last 5 to 10 years and are expected to continue to do so over the next 5 to 10 years.
Now, if as an investor I need money in 2 years for a fixed expenditure that I know is coming, a GIC is a great solution at 4% because I know I am getting my money back in 2 years while also accruing 4% per year of interest; in contrast the alternative stocks could be lower when I need the money. However, if I don’t need my money for 10 years or more, I should own equities. Furthermore, if I have cash that I do not need for 5 to 10 years or longer I should invest those funds in equities as well. Why? Those equities will generate dividends of 3%, which have historically grown by 8% per year, and growing dividends and growing earnings should equal growing share prices over time.
Over time, share prices and the value of your portfolio will reflect the dividend, the dividend growth, and the earnings or profit growth of those businesses owned over time. Of course this doesn’t mean that the value of those businesses won’t fluctuate on your statements from month to month - just like this year - we all know that the market reflects investor sentiment, and the emotions of fear and greed during heightened moves up or down, and that it assigns different prices to the same business throughout the year even though the long-term value of that business has not changed. These are stock market fluctuations and they are a completely normal part of the market’s breathing process.
In March 2020 most businesses had their stock market prices decline by 30 to 40%, although the actual value of most of these businesses on a long-term basis never changed; what changed was that investors started to fear that the world would shut down forever (see principle 6, above). Of course we all know what happened and how that story unfolded. That is the main trouble with the future, we do not know how the story unfolds, so we assume the worst. With the past, we know how the story unfolded and it seems so obvious, yet we still continue to harbour uncertain feelings about the future.
In closing, for the last 100 years, the story has unfolded like this: The world encounters a seemingly insurmountable problem, people get frightened, the stock market corrects, the world rights itself and the stock market recovers to new all-time highs. Things eventually just sort themselves out.
Randy and Ian
a. Source: Wealth Solutions Group | Fixed Income, rounded. Yields/rates are as of June 21, 2022 and are subject to availability and change without notification. Minimum investment amounts may apply.
b. Source: home.treasury.gov, rounded. As of June 21, 2022.
c. Source: R&R Investment Partners. Weighted sum yield of the portfolio model, rounded. As of June 21, 2022.