#1Reasons Why To Make Your Own Decisions
Truths From The Experts That Aren’t
#2Let Your Winning Stocks Run : Don’t Hang Onto Losers … FALSE
#3Asset Allocation Determines 80% of Your Investment Returns … FALSE
#4Time In The Market Beats Timing The Market … FALSE
#5Options Are Risky … FALSE
#6The Upside of Shorting Stocks is Limited to The Stock Price … FALSE
#7Capital Gains Are Taxed At Half The Income Rate … FALSE
#8The Tax Paid on Stock Sales Stunts the Portfolio Growth … FALSE
#9The Canadian Banking Ombudsman Works For Clients Of The Banks … FALSE
#1Reasons Why To Make Your Own Decisions
  • No one cares about your money as much as you do. Why would anyone think otherwise?
  • The advice you get will always be slanted. It’s human nature.
    • Stockbrokers will recommend trades to generate commissions.
    • Financial Planners will recommend ETF’s to keep you away from brokers.
    • Income Trust promoters will lie about ‘return of capital’ and pretend that hard cash equals true income.
    • Friends won’t tell you until after they sell a stock they previously recommended. They want to get their own best price first.
    • Etc, etc.
  • There is no way to know in advance who is both trustworthy, and has technical training, and has application skills.
    • Accreditation measures only test-writing skills.
    • Church members are scam targets because they think trust is a good personal quality. One could better argue the importance of unremitting suspicion when dealing with money.
    • Inevitably, the decision to hire an advisor is based on whether you LIKE the person. How irrelevant! As J.K. Galbraith wrote, there is a tendency to confuse good manners and good tailoring with integrity and intelligence.
    • It is human nature to accept ‘as factually valid’ the ideas that agree with your own preconceptions, or the ideas that are simple to understand and repeat. You hire advisors who agree with you and don’t make you feel stupid.
  • The cost. You can’t offload your work without paying upwards of 2%. The beauty of compounding interest (when you earn it), is how that interest gets magnified over time. The corollary is that the 2% charge is NOT a yearly charge you can forget about once made. It will also be magnified over time by compounding.Upscale services and vehicles like hedge funds carry an even higher cost. The Banks have done a great job of marketing their advisory services by making them available only to ‘high net-worth individuals’. Because they are restricted, we want them more. We want to ‘mention’ them at cocktail parties (to brag about our wealth). These services are no better (or worse) than those offered to poor sods at lower prices.
  • You can do just as good a job as the professionals. They must earn an excess to the ‘market returns’ in order to cover their fees. Statistics show they don’t do it (except for small-cap funds). Their compensation is based on asset values, not performance. Given the choice between a guaranteed return equal to the market (using index ETFs), or a 50:50 chance of earning higher (OR LOWER) mutual fund returns, which would you chose?
  • But..it’s too much work. Well, no. How much time you spend depends on how much you enjoy stock picking. If you ‘have a life’ you can simply buy a few large-cap ETF’s and then walk away and forget it (see the Couch Potato portfolio). Or you can ground your portfolio with index ETFs for solid beta, and take a flyer with a smaller percentage of your assets for the fun of earning some alpha.

#2Let Your Winning Stocks Run : Don’t Hang Onto Losers … FALSE

While one expert says “let your winning stocks run”, another will say “no one ever lost money by selling at a profit.. . Another will say “you haven’t made a profit till you sell”. So which is it? Advisors choose which to trot out according to hindsight. All the following examples are of the same class, impossible to be useful in real-time, so very patronizing, and insultingly simplistic.

Some experts tell you to only trade after trends are confirmed. They say “wait until a bottom is confirmed by a 10% move up” and “use stop losses trailing at 10%”. According to this advice you would earn only 7% for every 30% price movement (see figure to right). You would earn nothing if the price moved ‘only’ 20%.

After a stock falls sharply one expert will say “you missed a beautiful buying opportunity” if you did NOT buy and the stock rebounded. Another expert will call you a “sucker for buying on a dead-cat-bounce”, if you bought and the stock continued down.

Some experts tell you to “protect your capital above all”. But the only way to do that is to buy risk-free government debt. Buying equities involves sitting through falling prices. If you sell every time the price falls you will only provide more data for the researchers who have shown that “no one can time the market”.

Some experts criticises investors for “buying high and selling low” … yet others advise “buy stocks on a break-out” and “never catch a falling knife”.

To criticise Retail Investors for not executing to this perfection.!!!. At each and every point in time, all investors ask themselves; “Is this price move a blip, or a trend?”; “Will this reverse, or just keep going?”. Neither we nor the experts can know for sure. There is not one piece of trading advice that does not have its exact opposite, to be trotted out in hindsight. Do your best and ignore the experts.

#3Asset Allocation Determines 80% of Your Investment Returns … FALSE

The advice industry needs a ‘service’ to sell. The asset allocation recommendation

  1. is a cheap product to offer. It is computer generated from simple data from a standard questionnaire.
  2. cannot be ‘proved’ right or wrong in hind-sight.
  3. fits into the parameters of good advertisements – a simple and easy to understand product.
  4. does not involve any other professional (like a stockbroker) who might take away your custom.
  5. purposefully creates the misunderstanding that your returns will increase after proper asset allocation.

So of course they think it is really important! It’s really important to their business model. But the asset allocation decision does not determine returns. Your investment returns are determined by the level of risk you assume. You will not increase your returns by going through the process of devising an asset allocation or rebalancing. You increase your returns by taking on more risk.

When comparing the returns of different portfolios, 80% of the difference can be attributed to the fact that one invested more in a high-risk, high-return asset class (like equity), while the other invested in safer, lower return assets (like debt). Asset allocation re-positions you along the risk-return continuum. It does not increase your risk-adjusted return.

You need not allocate between asset classes to adjust your risk. You need not change asset classes to adjust the risk of your portfolio. Within common stocks there are many that are very safe and stable with low returns. There are others that are volatile with potentially huge returns. Same for bonds. Government bonds are very safe on some parameters, but corporate debt can be very risky.

You can also move in and out of asset classes to avoid, or take on more risk. At different points in history, different asset classes have produced the highest returns. At different times the risk of an asset class has changed widely from its historical average risk. Averages are very dangerous. The argument against this point is “You cannot time the market”. In other words, investors cannot see the inflections points, at the time, for moving between asset classes. But ask yourself, “Was it so hard for investors to know to buy long-bonds in the 1980’s?” “Was it so hard for investors to know to buy common equity in the 1990’s?” “Was it so hard for investors to know to buy corporate debt when it was yielding over 10% in December 2008?”

Asset allocation will lower your returns. Not only does asset allocation not increase your returns, it will most probably decrease your returns. It is widely accepted that most retail investors have inflated opinions on their own ability to mentally handle price volatility. They heavily weight common stocks, believing they will generate the highest returns. The asset allocation service will almost always recommend more low-risk securities with lower returns.

The benefit of asset allocation: The asset allocation process attempts to measure your personal tolerance for risk (volatility of returns). Theoretically, to maximize returns you hold 100% high-risk/high-return equities. This does not work in practice because once the threshold of your tolerance for risk is passed, and you are tested by market losses, your decisions will become counter productive. You will not realize the long-term returns because in the short-term you commit the sin of selling at market lows. In real life your optimal asset allocation puts you just inside the far edge of your risk tolerance boundary.

The process always reduces the theoretically possible returns to account for your risk tolerance. It will never increase your returns. But it does optimize the returns that you personally can achieve.

The second benefit of the allocation process is to explicitly address your need for cash at specified times. The price volatility of an asset may expose you to the risk that its value is depressed at exactly the time you need to cash out. You must hold the type of asset that can guarantee that cash.

Problem 1: How accurately do the advisors measure your personal risk tolerance? They have a computer program and a series of factual questions, but your answers give no insight into your risk tolerance. None of the questions ask you to assess your possible reactions to loss. The computer lumps you into a cohort without any consideration for your own mental toughness.

The computer program spits out an allocation between equities, debt, real estate and commodities. But there is no way to back test how optimal that allocation really was. There is no way to test “how you would have reacted” given a different allocation: “what your returns would have been” if the allocation had been different.

Problem 2: The concept of asset allocation is grounded in presumptions of long-run returns and risks for different asset classes. In the long-run stocks outperform bonds, value stocks outperform growth stocks, small caps outperform large caps. But in the long-run we are all dead.

In the medium term: E.g. It took 14 years before the market got back to its starting point after the 1929 crash. Fourteen years of 0% returns for equities. E.g. From 1966 to 1982 (16 years) the Dow Jones returned a total 1.2% loss. In the mean time inflation increased 7%. History is full of these exceptions to the rules. No one knows what future markets will be like. Portfolio allocation between asset classes is not going to help predict it. Nor will it protect you from the exceptions.

Problem 3: If you accept that the point of asset allocation is to manage your risk tolerance, then rebalancing is necessary. The risky assets, with a higher theoretical return, will grow faster than the others. Their weighting in the portfolio will grow until your threshold for risk is exceeded.

Academic studies show that more frequent rebalancing decreases returns. Higher returns come from less frequent rebalancing, even to four year intervals. The conclusion generally accepted is that rebalancing should be done only when the risk profile gets seriously out of whack, because you pay for peace of mind with lower returns.

Similar to the misrepresentation that asset allocation increases returns, it is also said that rebalancing increases returns. You can see the actual results from Canadian data in the graphs on Sheets 14 and 15 of this spreadsheet. There is no income gain. Rather the costs involved reduce returns.

Problem 4: It is now common to hear people say “Oh, my returns were much lower than the market index this year … but that’s OK because my financial plan shows I don’t NEED to earn great returns in order to meet my objectives”. Wrong, wrong, wrong. Equity markets are unpredictable. You have to make money while markets are rising because they will be falling in the future. Accepting sub-standard returns today will not earn you higher returns when things get ugly. Your financial plan incorporates an ‘average’ return. You must make use of the better years to offset the lesser years.

Problem 5: The advisors’ emphasis on asset allocation detracts from the more important issue of removing emotions from the management of equity portfolios. The risks you can handle emotionally are hugely influenced by self-knowledge and self-control: by creating an investing ‘process’ that acknowledges your emotional vulnerability and controls it. See the discussion at Emotions Destroy Returns

Problem 6: The academic research on the best asset allocation for sustainable retirement funding has only been modelled for 30 year timeframes. In reality many people retiring at 55 will live to 100. That is a 45 year timeframe. For more on the retirement funding see Retirement – Got Enough?.

Problem 7: Asset allocation advice always comes in the form of “percent in asset class 1, percent in asset class 2, etc. But practically the very first allocation everyone must make is measured in dollars, not percentages. E.g. if you are investing the savings earmarked for your child’s university tuition, then you will need specific $$ on a specific date. This will predetermine the exact asset chosen. A recommendation to hold 10% bonds, without specifying the maturity or type or dollar value, is useless.

Problem 8: Nearly none of the asset allocation models incorporate the mortgage on your personal residence. Yet it makes no sense to purchase 4% Government Bonds while owing 5% on a mortgage. Both are risk-free. There would be an immediate gain from selling the bonds to pay down the mortgage. Recommendations on asset allocation almost always tell you to buy debt.

#4Time In The Market Beats Timing The Market … FALSE

Variations on this warning are heard from advisors, that “if you exit the market you will miss some big moves back upward”, “most of a year’s returns come from only a few up-days”, “timing the market requires you to make correctly two decisions, the sale price and the reentry price”. It is a perpetual refrain.

Clearly it is in the self-interest of advisors that we believe this. They know that once you exit the market you may not return TO THEM. Regardless, they lose their commissions in the interim. They want you to believe it cannot be done.

Maybe there are valid arguments to prove that market timing cannot be done. If so they should be used because the most common argument is false, the argument that missing out on certain market moves will reduce your returns. It is false because, if returns are REDUCED by missing the few biggest up-days, then returns must be INCREASED by missing the few biggest down-days. Advisors never tell you the potential gains from market timing.

It should be obvious that the market-timer’s objective is to avoid the down-days, not the up-days. Yet those arguing against market-timing assume you will accomplish the exact opposite of your intentions. An assumption of failure cannot be the starting point for any logical proof that market timing will not work. The assumption ensures the wanted (wrong) conclusion.

Consider also the period of time used in the argument. Most frequently a single day. Technically ‘market-timing’ could be applied to everyone except buy-and-hold indexers, but mostly it is used in reference to investors who adjust their asset allocation according to changing economics and broad market sentiment changes. These investors don’t exit and re-enter daily. They will exit the market for weeks and months, not days. The choice of ‘days’ in this argument ignores reality.

So what are the benefits from exiting the markets during the worst down-months? Robert Shiller’s monthly data on US markets has been used on the last three sheets of this spreadsheet. The percent returns were calculated and sorted. The most extreme (up-month and down-months) 5 and 10 percent were deleted as if the investor had exited the market. The resulting returns were calculated assuming three scenarios compared to a buy-and-hold investment.

40 Years’107 Years’
% Returns% Returns
Buy and Hold the Index7.45.2
Perfect Foresight: Miss down months
worst 5%13.1
worst 10%15.915.7
Unsuccessful: Miss down months and up months
5% each8.1
10% each7.56.5
Accomplish reverse of objective: Miss up months
best 5%2.7
best 10%neg 0.4neg 3.2

Financial advisors use only the bottom numbers in their argument, assuming you accomplish the opposite of your objective. It is no surprise the returns have been wiped out. But the objective was to miss the down-markets, and the data shows perfect foresight would have doubled your returns. What is surprising is the returns when investors exited the market on all the worst down-months but also missed the best up-months. The returns were better than the buy-and-hold strategy.

#5Options Are Risky … FALSE

Analogy #1:You bought insurance for your house. When it DIDN’T burn down, did you consider that you had lost 100% of your investment (the premium)? How would you feel about the industry deciding that the insurance was TOO RISKY; that prohibited you from buying any. Buying house insurance is directly analogous to buying a ‘PUT’ option on a stock. And yet your broker will not allow you to make the purchase without getting special permission, jumping through multiple hoops, and passing a test, if at all.

Analogy #2:You bought a lottery ticket. When it didn’t win, did you consider that you had lost 100% of your investment? NO. In your mind, you had expensed it when it was bought. Buying a lottery ticket is directly analogous to buying a ‘CALL’ option on a stock. And yet your broker will not allow you to make the purchase without getting special permission, jumping through multiple hoops, and passing a test, if at all.

The situation is discriminatory and unacceptable. REVOLT!

#6The Upside of Shorting Stocks is Limited to the Stock Price … FALSE

You hear portfolio managers of long-only mutual funds saying “The upside of shorting stocks is limited to the stock price”…. right after they say “Losses from shorting are unlimited”. They are hoping to convince you that you SHOULD NOT WANT to short stocks. Why? Because they are not ALLOWED to short within their portfolio’s mandate. So is shorting stocks a valid strategy?

What really matters to any investor is the percent return on his investment, not the dollar return. A percent return is calculated with the $$investment as the divisor. But there is no investment to short a stock. No capital needs to be drawn from another opportunity. The $$investment is zero. Every penny of gain (or loss) is a 100% profit (or loss). Yes the upside is limited to the dollar value of the stock. But each of those dollars in purely incremental to the returns being earned on long positions.

Yes the downside is unlimited in dollars. And a short position that goes wrong becomes a larger (not smaller) part of your portfolio. But only if you are silly enough to stick around for so long. Why assume such stupidity and present it as an argument? You must manage your losses whether you are long or short a stock.

Why say “no” to an additional return that costs you nothing?

#7Capital Gains Are Taxed At Half The Income Rate … FALSE

Canadian income tax on capital gains is levied on only half the gains. It is common to hear people interpret this in their conversations and calculations as being “taxed at half the normal rate”. This interpretation is correct when talking about the marginal tax rate, which is the tax rate on the next dollar of income. But for many decisions, it is not the marginal rate that should be considered. The average rate is the correct calculation.

The point being missed is the doubling of the width of the incremental tax brackets when income is capital gains. You may have to read that last sentence a second time. Canada’s progressive income tax means that the tax rate applied to the last dollar earned is higher than the tax rate on the first dollar earned. By taxing only half the capital gain, twice the actual gain can be earned in each tax bracket, before the next higher rate is applied. So not only is the income taxed at half the rate, more of it is taxed at lower tax brackets. This magnifies the benefits of capital gains, and makes after-tax comparisons of investment returns more complicated than simply applying half the tax.

Using the tax rates of 2006 (the point doesn’t change with different rates), the weighted average tax levied on the first $100,000 of income is 11% for capital gains and 29% for interest income. The marginal tax rate for capital gains, at that point, is still the 2nd tax bracket. It is the 3rd tax bracket for interest income.

Cap gainsTaxableTax rateTax pay
Tax rate 1$55,07827,53923%6,300
Tax rate 2$27,24413,62233%4,495
Sum Total$100,00011% avg10,795
InterestTax rateTax pay
Tax rate 1$27,53923%6,300
Tax rate 2$36,37833%12,005
Tax rate 3$27,24439%10,625
Sum Total$100,00029% avg28,929

While we are on this subject, look at the averge tax burden (6%) and after tax/inflation income of $43,568 resulting from the first $100,000 of dividend income. In this case, you are pushed into higher tax brackets because of the gross-up to the taxable income, but the tax credit for taxes already paid by the corporation leaves you in the best possible position.

DividendsTaxableTax rateTx debitTx creditTax pay
Rate 1$18,99227,53923%6,3007,8341,535
Rate 2$25,08836,37833%12,00510,3491,656
Rate 3$31,39945,52939%17,75612,9524,804
Rate 4$18,42426,71544%11,6217,6004,021
Sum Total$100,000145,0006% avg47,68241,2506,432

If you want to play with these numbers and input your own income, use this spreadsheet with curent taxrates.

#8The Tax Paid on Stock Sales Stunts the Portfolio Growth … FALSE

It is common to hear the argument that by selling a stock and triggering tax, you will only have the after-tax amount left to reinvest. This smaller investment generates a smaller return and portfolio growth is stunted. But how true is this? Does this qualify as “letting the tax tail wag the investment dog”?

There are two situations where it is undoubtedly true. First, when a stock is sold in order to buy another with the same expected return (e.g. for rebalancing), nothing is gained and tax is needlessly prepaid. Second, when the payment of tax can be deferred until after death, you will receive larger dividends from the original investment. You will not care about the eventual tax after death.

This leaves the majority of situations, where you want to sell because there is a better opportunity promising a higher return. Buying to hold blue chip monopolies for the long term is no longer an option because they no longer exist. Investors are forced to turn over stock positions because of macro-economic changes.

So look at a scenario that starts with a portfolio worth $200,000 and an unrealized capital gain of $100,000. Assume the top 45% tax rate applied to capital gains at 22.5%. Make the assumption that the replacement stock will return 1% more than old stock. Assume that the maximum deferral of tax will be ten years before you would be ‘forced’ to liquidate anyways, even if you don’t sell now. How will two portfolios compare when one triggers tax today in order to buy a new stock, and the other stays invested with a lower return.

Buy New Stock for 10%Keep Old Stock at 9%
Pay tax$22,500$0.00
Net Invested$177,500$200,000
Future Value in 10 Yrs$460,389$473,473
Tax Accrued at Yr10$63,650$84,031
Portfolio net Tax$396,739$389,442

The results will change with the assumptions you use, but the conclusions are the same. You should not let the payment of tax deter you from optimizing your stock choices. Even a 1% incrementally better return will justify switching stocks.

#9The Canadian Banking Ombudsman Works For Clients Of The Banks … FALSE

The CBO (later called OBSI Ombudsman for Banking Services and Investments) looks good on paper. The Federal Government supports and recommends it. The brochure says it offers “resolution services for clients of any firm”. It claims it “works on behalf of clients”. In fact:

  • The Ombudsman is a child of the Banks themselves … it is not an independent government entity.
  • Although it may work for clients once it STARTS work … it will not start work until told to do so by the Bank concerned.
  • It will not start work at the request of a client.
  • It has no power to force a Bank to respond to the client.
  • It cannot force the Bank to abide by the Bank’s own dispute process … which is a necessary pre-amble to the Bank asking the Ombudsman to take over.

For an How-To manual for using the OBSI read this PDF. The Ombudsman is a sham: a sham supported by Government. Complain to the

  • Secretary of State (International Financial Institutions)
  • Department of Finance (Financial Institutions & Markets)
  • Senate Committee on Banking, Trade and Commerce.



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