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New investors who began trading on their online brokerage platforms last year when stock indexes were soaring to record highs could be forgiven for wondering what happened. The New Year has not been particularly kind to investors – and downright ornery to stock market investors. Volatility is the current watchword, as stock markets retreat in the face of inflation, coming central bank rate hikes, disruptions brought on by the omicron variant, supply-chain bottlenecks, and growing geopolitical tensions in Eastern Europe and the Asia Pacific region. Opening an investment account is relatively easy. But suddenly, investment planning doesn’t seem so easy any longer. To avoid panicking, perhaps it’s time to revisit these basic investment principles.
This is biggest challenge for investors, regardless of the size of your portfolio. Capital has many enemies, but three of the biggest systemic ones are inflation, taxes, and macroeconomic forces. We’re seeing perfect storm of all three of these converging on investment portfolios right now. So that makes it all the more important that you attend to the next three basic principles.
It’s important to diversify assets over a number of classes (including fixed-income, equity, and alternative investments) instead of putting all your eggs into one basket. Investment diversification can be accomplished with a variety of strategies, including broad-based mutual funds and exchange-traded funds that bring ready-made internal diversification in their portfolios hedge funds.
Don’t jump into investing without fully understanding what you are doing. Many novice investors will do just this, acting on fad investments (some technology sectors over the past couple of years, for example), something they heard from a friend or relative, or at the office, or even worse, over social media like Twitter, Facebook, or Reddit. This is the surest road to investment failure. It’s easy to avoid this rookie mistake, given the vast amount of research, data, and financial and legal information on just about every publicly-traded financial asset in the world. It doesn’t even take that much effort to root it out, and much of it is absolutely free.
New investors tend to overestimate their risk-tolerance levels. It may be a symptom of early success in a bull market, leading to overconfidence as an investor. But as the old saying goes, “Everyone’s a genius in a bull market.” Investment volatility, and market losses, can come about rapidly and without warning – as they have early in 2022. It’s a tough way to learn about Warren Buffett’s dictum that “Only when the tide goes out do you discover who’s been swimming naked.”
Be realistic about your own tolerance for risk (and ignore what others say – it’s not their money). Then allocate your assets accordingly. If you you’re a conservative investor, for example, with more interest in capital preservation and income, you’ll want to tilt your investments towards a more defensive allocation, with perhaps 60% to cash and fixed income, and 40% to equity. More aggressive investors might consider reversing that ratio.
Investing according to your risk tolerance and diversifying assets accordingly is one part of the investment equation. To achieve optimal returns, it’s also important to allocate those assets in the most tax-efficient way possible. Remember that “risk-free” really isn’t. Low-yielding investments like GICs, savings accounts, and government bonds will be eroded by taxes and inflation to the extent that you’ll actually be losing money every year.
Inflation erodes your purchasing power, and can do so drastically, as the recent inflation number has demonstrated. At the very least, your portfolio return has to exceed the annual inflation rate to stay in the black. But taxes can really take a bite out of your return as well. Over the long haul a $500 monthly contribution compounded monthly at a relatively conservative annual rate of 6% will grow to $500,000 in 30 years. But that will shrink substantially if you pay tax on your investment income at your top rate every year. I always recommend opening a Registered Retirement Savings Plan and a Tax-Free Savings Account. The reason is simple. In these plans, your money will compound tax-free.
Because your life stages and circumstances are continually changing, your financial plan and investment portfolio should be constructed to adapt to your changing needs. If you’re in doubt about where to go next, and you have a sizeable investment portfolio and asset base, consult an independent financial planner, who will work with you to create an investment plan that you understand and that will meet your long-term financial goals.
Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at rthompson@castlemarkwealth.com for a confidential planning consultation.
Notes and Disclaimer
Content copyright © 2022 by Robyn K. Thompson. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.
The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.
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