Is                           Investments and Investing 

New investment products are continually being brought to market. They are often complicated, risky, expensive, and, have limited or no performance history. They are simply 'PRODUCTs'.

The investment world consists of businesses focussed on making a profit by selling you products (investments) and services. The industry feeds on investor needs, greed, and ignorance. In many respects the less you know and the more you rely on the industry the better. Ignorance, fear and confusion work in the industry's favour. If you make a profit that's fine but it is not the main objective.

Investment advice is hard to come by and has potential legal risks for the person giving it.

Most of the 'advice' given is information (education) you could find on the internet. Investment and retirement advisors are NOT your 'friends': they are sales personnel, whose objective is to make fees and commissions.

The investment industry is rife with acronyms, terminology, and 'rules' that are often difficult to understand - "Investing" without understanding investment jargon is the same as playing poker with 'poker sharks' and not understanding the game and rules".  You are not likely to win!

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Explanations of terminology, old and new products, and the 'rules' are included in this section.

Topics

#1 Investment Terminology and Definitions 

#2 Passive low-cost 'risk-free' investing

#3 How to minimize “investment risk”   

#4 A ‘safe’ investment is a myth - one does not exist

#5 Inflation is intentional and facilitated by governments 

#6 Selecting and Monitoring an Advisor 

#7 Short Selling – not for the faint of heart 

#8 Passive Investments - Key to understanding the markets  

#9 A 'Black Swan' - a '6 Sigma' market events

#10 "Investor" or a "Gambler" which one are you?

#11 Is ‘technical analysis’ or "Voodoo"? Does it work? 

#12 The "Rule of 20"  Buy or sell signal?

#1 Investment Terminology and Definitions 

Investing and the investment industry uses many terms and acronyms that may not be understood by the average investor. Some terms are specific to investments and others are only related to taxation.

A key point - the terms Gains and Capital Gains are economic terminologies. Taxable Capital Gain and dividend tax credit are only applicable to regular investment accounts but NOT applicable to tax-deferred savings accounts like RRSPs, DC plans, LIRAs, LIF, RRIFs etc. 

 

All sources of earnings and gains in a tax-deferred account are taxed as income at the marginal tax rate when withdrawn from one of these types of accounts i.e., no special tax features.

Common tax, pension, and investment terms that lead to confusion

Tax terminology  

    1) Registered Accounts: accounts where tax is deferred until the money is taken out (100% is taxed when withdrawn). 

    2) Non-registered Accounts: an investment or savings account where earnings and gains are taxed in the year. 

          A person usually has both types of accounts which are taxed differently and can create confusion. 

    3) Taxable capital gain: 50% of the profit (proceeds- cost) when an investment or asset is sold outside a registered account.  

Industry terminology  

   1Investment Risk: specifically refers to the gap between an investment's return and its benchmark  (NOT a measure of 'loss').  

   2) Risk/loss: used interchangeably by investors referring to any type of loss of capital. 

   3) Capital Gain: profit (proceeds - cost) realized if an investment or asset is sold (only taxed if outside a registered account)  

   4) Capital Accumulation Plans (CAPs): includes RRSP's, RRIFs, LIRAs, TFSA, RESPs, etc -  are all Registered Accounts 

    5) 'Rule of 72': an estimate of the time it takes to double an investment at a fixed annual return e.g.-  72 / 6%  = 12 years

The investment industry, like all industries, uses numerous terms and acronyms that can be baffling but are important to understand if you have investments. 

Sites providing investment definitions and explanations: 

a) https://www.educatorsfinancialgroup.ca/learning-centre/glossary-investment-terms/

b) https://www.investor.gov/introduction-investing/investing-basics/glossary

c) https://www.investopedia.com/financial-term-dictionary-4769738

If you require assistance in understanding investment terminology etc. - email pensionadvisorywahl@gmail.com 

#2 Passive low-cost 'risk-free' investing

You can basically eliminate investment risk by investing in an index ('passive') fund  

Investing in funds that are similar to a particular Stock Market Index (passive investing) is an approach supported by academic research. Passive funds include indexed funds provided by Fund managers and ETFs (Exchange Traded Funds).

 

In finance, a stock market index is a specific suite of stocks held in a "virtual" fund called an index An index reflects the prices of the stock held in the index.  It measures the return performance of a large segment of the stock market or a subset of the stock market. It is used to compare current and past prices levels to calculate market performance. Indices are also used as benchmarks to assess fund managers or anyone's portfolio performance over time.

 

Exchange-Traded Funds (“ETF) or passive Balanced Funds are examples of passive investing. Many investors have adopted a passive investment approach using ETFs because of their performance, and low cost.  

 

Also, see   https://www.nerdwallet.com/article/investing/etf-vs-index-fund-compare

 

Investment risk

Investment risk has a very specific and limited meaning: it is a critical concept in the finance world.

 

Investment risk is defined as the difference between a benchmark's return and the return in a portfolio. The Canadian S&P/TSX Composite Index over the past 30 years has had an 8.1% return. " The “investment risk” i.e., the variance in a passive fund vs. specific Index (its benchmark), is, by definition, very low. i.e If you invested in stocks in an index in the same proportion as an index the returns would be the same - no investment risk.  

Passive funds are inexpensive because a manager does not have to research the investments- it's done for them. It is usually is not possible to invest in all the stocks in an index so a fund manager does have is to select which of the stocks in the index will be held and in what proportion.

Passive investing reduces the expertise and time requirement inherent in investing. It achieves "market' returns with very limited investment risk, however, it is not ideal in every situation.  If you are a sophisticated investor or simply want or need high returns you can invest in individual equities or, specific market segment index funds vs. a composite index. However, individual stocks and ‘segment specific’ funds often come with higher investment risk over the short term -

 

see  – “Passive Investing doesn’t solve every problem”.

 

(the alternative to passive investing is "active' investing. Active investing doing extensive research and searches for appropriate investment which time-consuming and expensive) 

Whatever you invest in, make sure you research the investment and understand the risks.

 

G.Wahl,Managing Director, The PensionAdvisor    

#3 How to minimize “investment risk”                        

No risk, no reward! Like many things in life investing inertia and fear are common but have a cost.  

In the investment world risk, ‘investment risk’ has a specific meaning: “the probability of losses relative to the expected return on an investment”. The key in this definition are the words “expected return”.

 

Risk Measurement

In the pension world, the concepts of returns and risk are inseparable: both are compared against a benchmark that provides an ‘expected return’. The benchmark may be an equity or bond index such as the S&P/TSX (Canada), the S&P (US), MSCI (foreign equities), or the DEX-universal Bond Index. An ‘absolute’ measure such as a specific interest rate may also be used as the benchmark in certain conservative portfolios.    

 

In assessing the performance of a mutual or pooled equity fund manager the returns and the difference or deviation of returns of the fund vs. the benchmark are religiously monitored. The standard deviation of these differences is calculated for each fund and is referred to as ‘tracking error’. Tracking error is important: it reflects how much ‘risk’ the fund manager is willing to take by using a different mix of investments vs. The composition of the benchmark.  
 

A low standard deviation suggests that the fund manager invests in the same investments as the benchmark and in the same proportion. If the tracking error is significantly greater than the benchmark it indicated the fund manages risk-taking on significant additional risk. Correspondingly, if there is higher risk vs. the benchmark a higher return is expected i.e. additional risk must result in an additional reward (higher return).

 

How to minimize ‘Investment Risk’

Investment risk, by definition, is directly related to the return performance of a benchmark. By investing in mutual or pooled funds or, constructing a portfolio that is very similar in composition to the benchmark (difficult), investment risk is minimized or eliminated.

 

This is a strong argument for the average investor to invest in passive or indexed funds. Exchange Traded Funds  (ETFs) and passive equity or balanced funds that have low fees are available.  Low fees are a significant factor in maximizing your retirement savings accumulation.

 

Minimizing investment risk, however, does not mean that losses will not occur in an investment portfolio: if the market and the benchmark are down the portfolio value will also be down.

 

For the average Canadian the key is to have a comprehensive financial (retirement) plan with clear objectives and an appropriate (simple) investment strategy. 

 

G. Wahl, Managing Director, The PensionAdvisor

#4 A ‘safe’ investment is a myth - one does not exist

Believing you can avoid losses is a myth.  

Many people worry about the possibility of losing money and go to great lengths to avoid it.

There are basically two types of investment risk: the risk of losing money and “investment’ risk. Both are known unknowns!  The risk of ‘losing’ money cannot be controlled and in practical terms is irrational while investment risk can be managed and perhaps minimized, but also cannot be eliminated.

 

The Risk of Losing Money   

The fear of losing money is particularly common amongst people who have r will have limited savings or other wealth to carry them through retirement. It is understandable why they are concerned!  

The financial industry accommodates this fear by offering products such as bank savings accounts, term deposits, GICs, money market funds, bonds and mortgages with high credit ratings, or other interest-based investments as a way to avoid losses. These types of investments do provide short-term protection but seldom eliminate losses over time. The financial institutions are profit-based: their objective is to make money therefore they offer the lowest possible rates which can be less than the rate of inflation.   

Inflation is a measure of the rate of rising prices of goods and services in an economy. It is a key economic concept and governments closely measure and monitor inflation. Inflation and the loss of purchasing power undermine interest-based investments. The loss of purchasing power occurs when the interest earned on investments is less than the rate of inflation.

 

Governments and central banks plan for and encourage inflation: they set inflation targets (commonly 2%) and interest rates. The Consumer Price Index (CPI) is used to measure inflation, but it does not reflect current price increases being experienced by consumers – it is a lagging indicator.

Inflation, over time, benefits governments, and long-term borrowers because it allows them to pay the long-term debt in devalued cheaper dollars in the future, but it usually hurts consumers. For example, government benefit programs (CPP, OAS etc.) are adjusted for inflation: lower inflation minimizes, and delays benefit increases and government cash outflows. Companies also benefit from short-term surges inflation because they can increase prices while their costs remain stable.

The risk of loss of purchasing power cannot be avoided because of inflation. Owning a home or property, over the long-term, appears to provide protection against inflation for the average person. However, prices have their ups and downs and can drop over the short term. Unfortunately, the value of the property does not translate into the regular source cash needed to buy goods and services.    

     

Investment Risk

No risk, no reward! Like many things in life investing inertia and fear are common but have a cost. In the investment world risk, ‘investment risk’ has a specific meaning: “the probability of losses relative to the expected return on an investment”. The key in this definition are the words “expected return”.

 

Risk Measurement

In the investment world, the concepts of returns and risk are inseparable: both are compared against a benchmark which provides an ‘expected return’. The benchmark may be an equity or bond index such as the S&P/TSX (Canada), the S&P (US), MSCI (foreign equities) or the DEX-universal Bond Index. An ‘absolute’ measure such as a specific interest rate may also be used as the benchmark in certain conservative portfolios.    

 

In assessing the performance of a mutual or pooled equity fund manager the returns and the difference or deviation of returns of the fund vs. the benchmark are closely monitored. The standard deviation of these differences is calculated for each fund and is referred to as ‘tracking error’. Tracking error is important: it reflects how much ‘risk’ the fund manager is willing to take by using a different mix of investments vs. The composition of the benchmark.  
 

A low standard deviation suggests that the fund manager invests in the same investments as the benchmark and in the same proportion. If the tracking error is significantly greater than the benchmark it indicated a fund manager is attempting to increase returns taking on additional risk. Accordingly, if there is higher risk vs. the benchmark a higher return is expected from the fund by investors .e. additional risk must result in an additional reward (higher return). Fund managers using an 'active' investment approach (vs. passive investing) are paid more on the basis that they will outperform their benchmarks. 

How to minimize ‘Investment Risk’

An awareness of the total combined level of ‘risk’ in a portfolio is important to the CAP sponsors, mutual fund investors, investors and CAP members.

 

Investment risk, by definition, is directly related to the return performance of a benchmark. By investing in mutual or pooled funds or, constructing a portfolio that is very similar in composition to the benchmark (difficult), investment risk is minimized or eliminated.

 

There is a strong argument for the average investor to invest in passive or indexed funds. Exchange Traded Funds (ETFs) and passive equity or balanced funds which have low fees, are available. Low investment fees and costs are key factors in maximizing retirement savings accumulation.

 

Summary

Minimizing investment risk does not mean that losses will not occur in an investment portfolio: if the market and the benchmark are down the portfolio value will also be down. For the average Canadian and retiree taking on an appropriate level of risk is critical. The key in doing this is to have a comprehensive financial (retirement) plan with clear objectives and an appropriate (simple) investment strategy. 

                                    In reality, there is no such thing as a totally safe investment!

 

G. Wahl, Managing Director, The PensionAdvisor

#5 Inflation is intentional and facilitated by governments 

                                 Believe it or not, inflation is intentional!

 

Governments and central banks plan for and encourage inflation: they set inflation targets (commonly 2%) and interest rates used to control inflation. While the Consumer Price Index (CPI) is used to measure inflation, but it does not reflect current price increases being experienced by consumers – it is a lagging indicator. For example, the value  of a  C$100 borrowed in prior years:

                          Year                    Current value - C$100                      Current Purchasing Power

                          1991                                    $172.07                                                            $0.58

                          2001                                    $142.18                                                            $0.70

                          2011                                    $117.01                                                            $0.85

                          2021                                    $100.00                                                            $0.95

              (If you invested in a 10 Canada Savings bond in 2011 the purchasing power when it expires is about 15% less)

ICPI, is an arbitrary metric prepared by Stats Canada. It is based on certain assumptions (convenient assumptions one could argue) where certain key cost increases are spread (amortized) over time which effectively understates current inflation. Other acceptable measures of inflation indicate it is actually higher than CPI  (an 'inconvenient' result one could argue). If 'real' inflation is higher than CPI it benefits the government and the average consumer is even worse off.

 

Inflation, over time, benefits governments, and long-term borrowers because it allows them to pay the long-term debt in devalued cheaper dollars in the future, but it usually hurts consumers. For example, government benefit programs (CPP, OAS etc.) are adjusted for inflation: lower inflation minimizes, and delays benefit increases and government cash outflows. Companies also benefit from short-term surges inflation because they can increase prices while their costs remain stable and if they issued long-term bonds effectively redeem them in today's dollars at a healthy discount. 

The risk of loss of purchasing power cannot be avoided because of inflation. Owning a home or property, over the long-term, appears to provide protection against inflation for the average person. However, prices have their ups and downs and can drop over the short term. Unfortunately, the value of the property does not translate into the regular source cash needed to buy goods and services.  

Defined Benefit plans are always looking for low-risk long-term fixed-income investments to match their liabilities. It would pay for the government to accommodate this by issuing a large number of '50 year' bonds. 

While inflation is insidious for the average person, it is intentionally encouraged by the government! It is entrenched as one of the tools used to facilitate long-term borrowing and current spending programs.   

GH.Wahl, Managing Director, The PensionAdvisor 

#6 Selecting and Monitoring an Advisor 

An 'advisor' is a paid professional - a good communicator and knowledgeable 

Many smaller plan sponsors use an advisor (an agent or broker of record) to assist their CAP members  (Members) without understanding what to consider in evaluating performance. Sponsors also need to ensure that the advisor is doing only what has been authorized.

Advisors provide four basic areas of service:

1) Member retirement planning,

2) assisting with financial education,

3) investment advice, and

4) sponsor governance assistance.

Retirement planning support is provided by the record keeper in the form of information and tools that help Members in understanding investment concepts, identifying their risk tolerance, and selecting an appropriate asset mix. However, sponsors recognize that many Members simply don’t have the time and prefer to use an advisor to ensure they have considered all the elements of retirement planning. Member education is critical and the sp[onors responsibility therefore, advisors should review education materials and tools as part of their services undertakings.  

Offering advice?

Advisors may go a step further and provide Members with investment advice in addition to asset mix recommendations such as which investment option to use and when. Investment advice may benefit some members. This results in additional potential legal and financial risks for the sponsor. 

 

A DB or CAP sponsor usually relies on an advisor to assist in governance and selecting investment options or provide reporting to assist in administering the plan, all of which should also be taken into account as part of an advisor evaluation.

Section 3.4 of the CAP Guidelines recommends that sponsors, in choosing or referring members to an investment advisor should ensure the advisor has an appropriate level of knowledge, expertise and should be independent of any other service providers. Section 6.2 of the CAP Guidelines also recommend that sponsors clearly establish the criteria used in selecting the advisor and periodically use it as information in reviewing an advisor’s performance.

 

Sponsors may not even be aware that an advisor is providing investment advice — a risk from a governance and a fiduciary perspective. While offering investment advice may appear to be a good idea, plan sponsors tend to shy away from it because of the added fiduciary responsibilities and legal risks.

The objective in monitoring and assessing the advisor’s performance is important for a number of reasons and should be done formally and on a regular basis to ensure all (and only) the services agreed to are being satisfactorily delivered and at a reasonable cost.

Advisor Fees

The fees for the advisor’s services are applied to all investment options (excluding Guaranteed Investments (GIs) and daily interest investment options) as a part of total composite paid members. Advisor fees of 0.3% to 0.9%, depending on the size of the plan, are not uncommon and often represent a substantial portion of the total cost paid by the members. Members with investments of $100,000 -$400,000 may pay $300 -$3,600 annually for advisory service over their working life.

The advisor fees are paid regardless of whether a Member is involved with or uses the advisory service. The amount the advisor receives from CAP Member also automatically increases as the value of the Member’s investments increase, through contributions, earnings, or increases in the market value.

Members who only or primarily invest in GIs or daily interest accounts but make use of the advisor services are getting these services at little or no cost. Conversely, members invested in equity and fixed income-type options may not use the services of the advisor but pay the cost.

Performance

Evaluating an advisor’s service and performance in both DB and CAPs can be a difficult qualitative exercise.

 

If the Advisor is available to Members information about usage and the type of service provided is limited or doesn’t exist. Direct feedback from Members, the administrator or surveys can be useful in assessing performance but may be costly and difficult to interpret. Assessing the quality of actual investment advice is also a challenging task, which will require specific information and member feedback.

In the case of a DB plan the plan adminstrator, Pension Committee Chair, and pension Committee members will be familiar with the advisor have an opinion about the quality of service and value-added. The advisor should be evaluated regularly and provided feedback as part of a pension governance program.    

In some cases, the advisor fees are not disclosed separately, and neither the sponsor nor Pension Committee members of the actual annual cost.

In the case of CAPs, the total amount paid by a Member at each year. A convenient omission for both the advisor and sponsor. Forcing Members to pay fees but not telling them how much is not logical or reasonable. It likely would not be considered an example of acting in the Members' best interests. 

  

A good starting point in evaluating advisors is to request the amount of fees the advisor actually receives each year and obtain information on the type and quality of services provided to the administrator a Pension Committee and AP Members. The sponsor should understand what services are being provided by the advisor and to whom as well as whether or not the costs are reasonable. Providing the advisor with a list of information needs and a reporting format is appropriate in order to assess their performance. Increases in the amount the advisor actually receives year-over-year should also be explained and justified  (i.e., is there more or better service?).

Summary 

The CEO and CFO of an organization are focused on profits and risk. Their involvement in a DB pension and on a DB Pension Committee likely ensures an advisor's performance and costs are acceptable. 

In CAP the sponsor is responsible for ensuring the fees, which may have an advisor component are reasonable. Because the Members pay the fees it is likely they will get less attention than in a DB plan. As part of the governance, process fees should be formally reviewed on a regular basis.

 

Providing CAP members with investment advice via an advisor is acceptable but, it’s important to for sponsors understand the additional fiduciary responsibilities, risks and to understand who is paying the cost. Sponsors should ensure that an advisor is not providing CAP members with investment advice unless this has specifically been authorized. it is advisable to have an experienced and impartial consultant (advisor) assist and an organization's auditors in evaluating their performance -for example, a CAP recordkeeper.  

In Part V of this series, I will discuss fees and performance issues relating to equal treatment of plan members and  fee issues to consider when converting from a DB to DC plans.

G.Wahl, Managing Director, The PensionAdvisor

#7  Short Selling – not for the faint of heart 

Short selling shares - a potential unlimited risk 

Before short-selling best to understand the basics and inherent risks: 

a) Short selling is making a ‘bearish’ investment when you expect the stock price to drop.

b) Some argue ‘shorting’ is unethical because it is a bet against growth however economists usually realize it is important as part of a liquid and efficient market.

c) To sell short, the security is first borrowed, on margin, and then sold, then bought at a later date.

d) A ‘shorted’ security is held in a margin account.

e) You have to maintain a margin or cushion of 150% of the value of the position in a margin account.

f) The 150% represents 100% of the value of the short plus an additional margin requirement of 50%.

g) More security is required (margin requirement increases) if the price of the shorted stock goes up (referred to as a short ‘squeeze’).

h) According to the CRA interpretation bulletin IT-479R Canadian security includes a security that is sold short.

i) Gains and losses from the sale of securities are usually capital gains and losses. i.e., only 50% is taxed vs. 100%.

j) Gains or losses from short sales however are considered income gains or losses unless an election is made.

k) A taxpayer can elect under s. 39(4) of the Income Tax Act to have their transactions in Canadian securities to be treated as capital transactions.

l) The election applies to all sales of Canadian securities in the year of the election is made and for future years,

m) An election cannot be rescinded. The risk in short selling is that the stock price goes up.

If the price of the stock falls below the price you sold it - you realize again but if the price goes up you lose. How high the price goes determines the loss.  

Taxation

The gain or loss on the short sale of shares is considered to be an income gain or loss unless an election has been made under s. 39(4) to treat them as capital transactions.  In Federal Court of Appeal Rezek v. Canada (2005 FCA 227), it is stated that any broker's fees, rental fees, and compensatory dividends paid by the short seller between the short sale and the closeout will reduce the profit or increase the loss.

                                              A short seller can face ‘unlimited risk’  -  Caveat Emptor!!

G.Wahl, Managing Director, The Pensionadvisor

#8 Passive Investments - Key to understanding the markets  

'Passive' investments have minimal investment risk and low costs - both are important features

Active Investing

The terms passive investing (mutual investment funds), index funds, or Exchange Traded Funds (ETFs) refer to a particular investment strategy. An index fund or ETF tracks the performance of a specific combination of investments - referred to as an "index". An index fund can only be a mutual fund or a corporate mutual fund. 

Don’t be confused by the word ‘index’. It simply refers to is the specific group of companies, selected using a pre-determined set of rules. Think of an index as a 'virtual' set of investments -- it does not hold actual investments. Each Index is unique and based on location (say, Canada vs the US), size of companies, industry, type of business, etc. 

Index funds invest in a bit of everything in major economic sectors and the companies in these sectors are based on their investment criteria laid out in their rules. The objective of index funds or an EFT is to match the combined returns and volatility of investments but not outperform the index.     

Instead of researching and selecting for investments, a passive fund manager simply buys a representative sample of the investments, in the same proportion, as a specific index. Hence the name index or passive funds (investing).

The most followed Canadian index is the ’S&P 500 Index’, which includes  ~250 large companies, and in the USA, the  S&P 500 includes ~ 500 of the largest US companies.

Passive mutual funds do not trade on a stock exchange and consist of units invested in different investments. The unit values reflect the valuation of the units on either the same day or next day after a dealer receives an order to buy or sell units. 

EFTs - a word of caution 

An index (passive) fund is similar to an Exchange Traded Fund (ETF): both mirror the performance of a particular market. However, it is important to know that not all index funds are ETFs nor are all ETFs indexed.

ETF’s are ‘open-ended funds’ that trade like stocks, on an exchange. Index ETFs are generally low-cost because they are in passively invested requiring minimum time or research resources on the part of the fund manager.

Benchmarking  - A critical investment concept 

The concept of 'investment risk' refers to the deviation of the returns of a fund or investor from a specific index. The deviation is referred to as a tracking error. In other words, a specific index is used as a benchmark against which investment and risk performance is evaluated.

Benchmarking is one of the most important tools used in the investment and pension industry to evaluate investments.

Passive Fund Advantages

Passive investing and index funds have several advantages.

1) Diversification - The investments are spread investments across more companies than many actively managed funds.

2) The performance of any one company makes little difference to returns or risk.

3) The index represents a sample of the investments held in an index.

4) A passive investment requires less time and effort and is focused on the long haul .

5) Passive investing minimizes the amount of buying and selling thus minimizing transaction costs

6) Passive fund investment fees are low because the amount of fund manager time and resources need is limited. 

7) Investment risk is negligible unless a fund manager deviates from a passive mandate and strategy.  

The strategy is a long-term buy-and-hold approach that involves not reacting to or anticipating the market’s every next move. 

 

Active vs. Passive Management 

Active investing is a hands-on approach to investing that means a fund manager or investor research, buy and sell investments and manage risk exposure and diversification. This is the role of a mutual fund portfolio manager or a do-it-yourself investor.

 

The objective of active investment management is to beat the stock market’s average returns (the indices) and take full advantage of short-term price fluctuations. It involves a much deeper analysis and the expertise to know when to pivot into or out of a particular stock, bond, or any asset. A portfolio manager usually oversees a team of analysts who look at qualitative and quantitative factors, then gaze into their crystal balls to try to determine where and when that price will change. 

Actively managed fund fees are much more expensive than passive fees because the managers try to outperform their respective benchmarks by rebalancing portfolios, selling and buying assets, and reinvesting assets. Historically buying, selling, and seeking out opportunities is not effective.

 

Passive investments outperform almost all actively managed funds over time often as a result of the lower passive fund fees. Active management requires being right more often than wrong.

Wiiliam Sharpe,a well known economist, stated "The simplest way of dealing with (market volatilty) is via a very broadly diversified, very low-cost index fund. You can do it in other ways that would be a lot more expensive." 

Summary

Passive investment strategies are usually recommended due to low fees while achieving market returns.  In periods of economic growth why pay extra fees for an actively managed fund when passive options perform just as well?  "My regular recommendation has been a low-cost S&P 500 index fund." Warren Buffett - 2016. 


Academic literature has traditionally found that the fees from actively managed funds offset are more than offset the value-added provided by managers. S&P found that for the 10 years ending December 31, 2019, 89% of domestic equity funds and 65% of institutional separate accounts underperformed their benchmarks, net-of-fees.

For the average unsophisticated, time-strapped person saving for retirement, either passive fund or ETFs may be something to consider.    

“Buy index funds. It might not seem like much action, but it’s the smartest thing to do.” Charles Schwab, founder -The Charles Schwab Corporation

G.Wahl, Managing Director, The PensionAdvisor

#9 A 'Black Swan' - a '6 Sigma' market events

Stock markets are volatile by nature but fear often drives an over-reaction and disasterous results  

Stock markets are often volatile, driven by unpredictable factors - 'known unknowns.  Two notorious unpredictable events are referred to as 'black swan' or '6 sigma' events.

Black swan events

A black swan event is a situation where there is unpredictably high volatility in a market - it is a very unusual and extreme case of a market selloff. Black swan events are rare but have a severe impact, and appear to be predictable after the fact.  

  • Black swan events can cause severe damage to an economy and negatively impact markets and investments,

  • Forecasting tools do not anticipate nor can they prevent a black swan event.

  • Modeling to predict black swans is a goal that is not likely to be achieved: models are more likely to increase black swan risk than reduce it 

The use of normal distributions forecasting models is a major part of the problem. The models fail to predict black swans because they rely on historical data and previous large sample sizes that don't apply in rare events: statistics from the past are not effective for unusual events (you have heard this many times before).

By definition, an attempt to use past black swan events to predict future black swans will fail.  

Examples of Past Black Swan Events

Examples of the causes of black swan events: wars, widespread and severe pandemics, the crash of the U.S. housing market in 2008, the dotcom bubble, hyperinflation, widely accepted but flawed investment and risk strategies (high-frequency trading), major debt defaults (e.g., 1998 - Long Term Capital failure ), credit rating distortions (The CFAs answer to diversifying risk) 

A 6 Sigma Event 

A  6 sigma market event is one where the markets (valuations) are greater than six standard deviations from normal - a rare event in theory. It is also referred to statistically as a "fat-tailed" event. The probability of a 6 sigma event is 2 in one billion. Based on the frequency of market crashes over the past 30 years it would appear that they do not qualify as classic black swan 6 sigma events - a better excuse is needed! 

"The" Problem

The problem, in a nutshell, is that the world of investing, retirement planning, and pensions is heavily dependent on the stock market and - TIMING!  Advisors encourage, and pension plan sponsors need to promote investments in the stock market, to increase and fund savings and pensions (and fees). A case of too many eggs in one basket. 

               The only way to predict the future is to have the power to shape the future.​ Eric Hoffer   (??) 

(Right!-- REALLY? Good Luck!! some people and CFSa unfortunately actually believe they can do this)

G.Wahl, Managing Director, The PensionAdvisor 

#11 Is ‘technical analysis’ a case "Voodoo" investing? Does it work? 

#12 The "Rule of 20"  A Buy or sell signal?

Many 'rules' have evolved over the years RE: buying and selling equities 

There are many theories, myths, incantations, and ‘spells’  associated with the black art of investing. One of these is the ‘rule of 20’ which states that for a U.S. bull market to start, the price to earnings (PE) ratio of the S&P 500 plus the inflation rate must add to less than 20. Right now, the trailing PE ratio is 20.2 and the inflation rate (CPI) is 8.5 – 28.7. Bad news for those that believe the recession is over, the markets have bottomed, and inflation is tamed.

Apparently, the rule has a perfect track record: the U.S. market has improved after the Rule of 20 PE ratio and consumer price index (CPI) totaled less than 20. Maybe this is useful information – maybe not.  (It is part of the witchcraft referred to as technical analysis.) 

#12 The "Rule of 20"  Buy or sell signal?

Many 'rules' have evolved over the years re: buying and selling