Transcript

Welcome to our webinar, my name is Navid Boostani and I’m co-founder and CEO of ModernAdvisor.

Today I want to talk about why it’s important for all of us to think about investing for our future selves and some of the principles we all need to know to become successful investors.

But before I get to the presentation just a little bit of background about myself. I was trained as an engineer and worked as an engineer for a few years before I decided to switch careers and become an investment advisor.

The reason I did that was I found finance was one thing I was more passionate about than engineering.

I’ve been managing my own investments for about 16 years and managing funds for other people since 2008.

In my time as an independent advisor from 2008 until the end 2013 when I founded ModernAdvisor I came across a few issues including high fees, lack of transparency, and lack of unbiased advice in the industry in Canada that I decided to tackle with ModernAdvisor.

So now on to the presentation.

Why should we invest?
There are many goals that people might have when it comes to investing: it could be saving for retirement, it could be just building wealth, it could be saving for a major purchase like house, or it could be saving for your kids education.

So there are many goals that people might have – but first and foremost for most of us it is saving for retirement.

There’s good reason for this. You might have heard the term retirement crisis in the media. The fact is back in the day back in the nineties and eighties more companies were covering their employees with a pension so employees would retire on a guaranteed income from the company.

But the trend has been for declining pension coverage: in 1992, forty-two percent of working population in Canada were covered by pensions and most of them guaranteed income pensions or as we call them in the industry defined benefit pensions.

in 2014 that number had dropped to thirty five percent of the working population; most of those pensions were what’s called the defined contribution pension – so you put in money or your employer puts some money in your pension. What do you take out when you retire really depends on how much money has been put in and how well those investments have done.

So there’s no guarantee.

A recent report from Statistics Canada shows 11% of seniors live below the poverty line.

And of people aged between 55 and 64 – so these are people that are just before the retirement age – barely 20% had enough in savings to have a comfortable retirement.

That is why it’s easy to understand why saving for retirement should be the main goal for most people.

And it’s not really about making sure you retire like this: on a yacht sailing into the sunset.

For many of us, it’s to make sure we don’t retire like this:

I may be exaggerating here a little bit but you get the point. You just want to make sure you have a roof over your head, and that you can maintain your lifestyle when you retire.

Now – what are some of the things you need to know to become a successful investor – regardless of what your investment goal is?

I’m going to go over a few definitions. Many of you may already know this, but I’ve come across quite a few people who have heard the terms but don’t know exactly what they mean.

So I’ll spend a couple of minutes explaining each one because they’re going to come up in my presentation today and in our future presentations.

Let’s get started:

Stocks: most people have heard of the stock market and stocks but what are stocks?
Stocks are simply a share of ownership in a company that will entitle you to participate in the profits of that company. So when you buy a stock you are buying a piece of a company

Bonds or fixed income investments:
When you buy a bond you are lending money to a company or a government with the promise of receiving that money back along with interest payments. So bonds in simple terms are loans that you give out to other entities.

Some of the other terms you come across:
Real Estate Investment Trusts – these are entities that invest in real estate or mortgages secured by real estate, and pass on rental income or interest income that’s earned to their investors.

Mutual Funds: they’re the most widely held investment product in Canada. Mutual funds pool the assets of different investors – so many investors can contribute money into the pool. The pool is managed by it by an investment manager, or a team of managers, who decide how to invest the funds in different stocks or bonds or whatever the case might be.

Exchange traded funds or ETFs are similar to mutual funds in the sense that they pull assets from many investors and place them in a basket of stocks or bonds or other securities.

But they’re also different in the way they trade and they are structured.
An ETF – as opposed to a mutual fund – trades on an exchange which means you can buy and sell them like a stock during the trading day.

And also most ETFs (and there are exceptions) but most ETFs don’t have active fund managers. Instead, they follow a rules-based methodology and because of this – because they don’t have to pay active fund managers really high salaries to decide where to place the money – ETFs for the most part are much much less expensive than mutual funds.

Ok now with the definitions out of the way let’s move on to some interesting stuff – and I know you cannot see my face right now – but I said that with a straight face. This is going to get really interesting.

Risk and return. That’s one of the first things you need to understand – that relationship between risk and return – to be successful as an investor. If you want to earn higher returns you have to take on more risk. But what does it mean to take on more risk?

It means you have to accept volatility in your investment portfolio – and accept you could lose money – especially in the short term.

If you cannot stomach risk – and you put your money in safer investments that means you get lower returns.

I’ll be honest with you – As a young investor when I was starting out – I didn’t want to buy into this relationship between risk and return. I didn’t think I needed to take on more risk to generate market-beating returns.

I thought, “you know, that’s just for the average investor – I understand where that concept comes from but I’m not an average investor. Quite arrogantly I thought you know what I graduated top of my class in engineering. I can outsmart the system. I can come up with a scheme that would generate really high returns without taking much risk.”

And I was doing that for a while – or at least I thought I was doing that for a while – generating returns much better than you would get in the stock market and my portfolio didn’t have that much volatility. It felt like I was a genius but it turned out that I was being a dumbass.

So in May of 2010 there was a flash crash – and if you haven’t heard that term before, it means things went south very very quickly! The stock market in the US dropped by about ten percent in a matter of minutes. Nobody saw that coming. I certainly didn’t see that coming and that hit me hard and made me realize you know all this time I was generating those high returns not because I was an investing genius but because i was taking more risk than I thought I was taking on. I didn’t think the stock market could drop ten percent in a matter of minutes but it did . And it cost me a lot of money. Thankfully I did manage to recover from that loss – it took me two years and I learned a lesson.

That lesson is, if you want to generate higher returns you need to take on more risk.

More important than understanding the relationship between risk and return is understanding the relationship between your investment time frame and the risk you can take in your portfolio.

Risky investments such as stocks are not suitable for your short-term goals.

If you need money in the next six months or a year you don’t want to put a lot of it in the stock market because the stock market goes up and down.

If it goes down and you lose some of your money there is not going to be enough time for you to recover your losses. so if your goals are short-term; if you want to put money aside to buy a house in a year or two don’t put it in the stock market.

To really demonstrate this point I looked at the return on Canadian stocks all the way back to 1970. The results would be similar for many other risky asset classes such as American stocks or International stocks. But to keep it simple I looked at Canadian stocks.

I looked at the returns over one month, one year, five-year, and ten-year rolling periods . So what would happen if you had bought Canadian stocks and held your investments for a month, a year, five years, or 10 years.

For one month holding periods about forty percent of the time the returns were negative. What was even more shocking is that the worst-case return for a one-month period was almost a negative twenty-three percent. So imagine you put your money in an investment account the beginning of the month – you buy a basket of Canadian stocks – and by the end of the month you lose almost a quarter of your investments.

That could happen! It’s not a very likely scenario but it certainly could happen again as it has happened in the past. So if your goals are short turn you don’t want to put a lot of your money and risky assets like stocks.

On a one-year basis what I found was about twenty five percent of the time the returns were negative and the worst-case return was a negative thirty nine percent! So you would have lost almost forty percent of your money in the Canadian stock market over 12 months.

But it is not all bad news. As your time frame gets longer and longer the probability of losing money becomes lower and lower and potential losses become smaller. On a five-year basis – going all the way back all the way back to 1970 there were only six periods where you would have lost money in Canadian stocks and the worst-case loss would have been a negative five percent so that’s not too bad.

On a 10-year basis there were actually no periods during which you would’ve lost money. The worst case return would have been a positive fifty-four percent! The best case return for a 10-year holding period is actually close to five hundred percent!

So that really goes to show you why risky assets are not suitable for short-term goals but they’re also very essential for your longer-term goals because those are the assets that are going to give you the growth you need to build wealth and build a portfolio that you can retire on.

Ok so hopefully now you understand the relationship between risk and return – and more importantly the relationship between your investment time frame and the amount of risk you can take in your portfolio.

Another really important principle for any investor to understand is diversification. What do we mean by diversification?

Diversification basically means putting your assets in different investments that behave differently to different economic conditions. The point is to reduce the risk in your portfolio – the volatility in your portfolio – without sacrificing long-term returns.

For diversification to really work – you need to find assets that don’t move in lockstep with one another. So for example if you said: you know I’m going to diversify my portfolio by putting fifty percent in Canadian oil stocks and fifty percent in American oil stocks you’re not really diversifying because your entire portfolio is going to drop when oil goes down.

A good example of a diversified portfolio would be a portfolio that includes stocks in different geographies and includes bonds or fixed income and maybe some real estate and sometimes depending on your stock holdings other assets such as commodities.

Now let’s look at the benefits of diversification with an example: as you can see in this chart there are two portfolios: the red line shows a portfolio that was invested entirely in Canadian stocks.

The blue line shows a portfolio that was invested in a diversified portfolio of Canadian stocks, US, International and emerging market stocks such as China and India as well some bonds and some real estate investment trusts.

As you can see both portfolios have performed in terms of return almost identically. They start from the same point in January 2006 and they end at the exact same point in December 2015. The difference is the portfolio that only includes Canadian stocks has much higher ups and downs sp has much higher risk.

Especially as you can see in the 2008-2009 period the distance between the peak and the trough for the chart in red is much greater than the chart in blue. So that really goes to show you the benefits of diversification.

Now you might be thinking – especially if you have a long time frame – what do you care about the interim ups and downs of your portfolio? I mean as long as you earn a positive return before you need to take money out you’re happy, right? You don’t care what happens before that.

That might be a valid point especially if you have nerves of steel and robot-like discipline and if you don’t let your emotions affect your decisions whatsoever. But the majority of us – we get very emotionally attached to our money and our investments especially when there’s a crisis and there’s a big drop in the market we are very likely to make an emotional decision. This usually means we get out at the wrong time. I’ve seen this happen to a lot of people; I’ve seen this happen to people have been investing for 30 years; I’ve seen this happen to investment advisors; I have seen investment advisors do this to their clients in 2008, 2009.

Now you might think – especially if your time frame is a few decades – that you’re not even going to keep track of your portfolio – so how can you get emotionally attached to something that you are not even keeping track?

The fact is when there is a crisis like that there was in 2008-2009 or early in the 2000’s, no matter what you turn to – when you turn on the TV they’re going to be talking about the end of the financial world as we know it; they’re going to be talking about retirees losing their life savings; you turn to a newspaper is the same thing; radio’s the same thing it’s very very difficult to stay disciplined in such an environment. The reports of doom and gloom might eventually get to you and you might say you know what I’m just going to get out save the money that I have left and just gradually get back in when the markets calm down. And that almost never works because recoveries in the stock market come as quickly as the drop happened and you cannot time it.

The investor in this example got out of the market at the beginning of 2009 and said he’ll get back in when things calm down. He got back in in 2011 but he’s significantly worse off than the person who stayed the course throughout. The person who did stay the course could do that because their portfolio was diversified and had fewer ups and downs and wasn’t as affected.

So the point is that diversification is not just for people investing over shorter time frames; even if you have a very long time frame you’d be prudent to diversify your portfolio to protect your investments from yourself and your emotions.

Ok so the last thing I want to talk about today before I open it up to questions are investment fees. As I mentioned in my opening remarks one of the reasons I started ModernAdvisor was that investment management fees in Canada are the highest in the developed world. In fact the average mutual fund charges 2.4% per year in fees and that’s regardless of whether they make money for their investors or lose money. A recent study done by the canadian centre for policy alternatives found that the high cost of mutual funds in Canada could force Canadians to retired 11 years later or have up to forty percent less in retirement.

Again retired 11 years later or have up to forty percent less in retirement.

So let’s look at the effects fees can have on your portfolio with an example.

The subject of our example is a woman named Nadia. She’s 35 years old. She’s just starting to save for her retirement so let’s say she’s had other priorities until now but she’s starting to save for her retirement and she’s going to put in ten thousand dollars in her retirement fund this year and she’s going to increase her contributions by about three percent.

Nadia wants to retire by the time she’s 65 and let’s assume she can earn six percent before fees in a diversified investment portfolio.

Nadia’s contributions are going to amount to five hundred thousand dollars over the next 30 years.

In a typical mutual fund portfolio she’s going to pay two hundred and thirteen thousand dollars in fees which is going to leave her with two hundred and thirty four thousand dollars in gains and a portfolio ending value of seven hundred and thirty four thousand dollars.

Now in a low cost option that would charge only 0.65% instead of 2.4% she would pay only seventy-two thousand dollars in fees over the next 30 years. Which is going to leave her with four hundred and eighty-four thousand dollars in gains and a portfolio ending value of nine hundred and eighty-four thousand dollars.

The difference between the low cost investing option and the mutual fund portfolio: 250 thousand dollars. 250 thousand dollars more in Nadia’s pocket or fifty percent of what she put in.

Now there are a lot of people in the industry that argue it is not all about fees – it’s also about returns. If you can pick out funds that would outperform the averages they’re worth the extra fee. And as a statement I i agree with that. if you can find funds that consistently beat the averages by five percent paying an extra two percent a year for them is a no-brainer.

The problem is you can’t really pick these out performers ahead of time. There is no reliable way for selecting these funds – all you can do is you can look at past performance of these funds but past performance is not indicative of future performance. So even though a fund has done really well in the past doesn’t mean it’s going to continue to do well.

I’ll give you a personal example: in 2006 I was working as an engineer at an engineering design firm. I had been there for about a year and i’d already started my education in investment management and was on my way to receive my CIM designation. So I was kind of the go-to guy when it came to investments.

One day my boss comes up to me and says, “Navid I have a bunch of money in a couple of mutual funds and they’re not doing anything. They’re terrible. Why don’t you just pick out a couple of funds that I can put my money in. And I said sure I can do that you know how to study mutual funds and I thought well this is a great great way to impress the boss; make him some money and hopefully that will result in a raise for me!

So I spend a few days, did loads of research I picked out a couple of funds and said, “hey listen I think these are great funds you should put your money in these” and I left it at that. About six months passed and i didn’t really hear anything about these new funds for my boss’s investment portfolio.

All I did notice was that I didn’t get a raise! so I knew there was something wrong.

So one day I i went up to my boss and said by the way did you ever put your portfolio in those funds that i recommended. He said yes and they’re terrible – just as bad as the old funds that I had! I was really surprised so I decided to take a look. I mean how could that be? These funds were in the top decile of the asset classes they were investing it!

So in one case the manager had retired just a couple of weeks after I made that recommendation – I mean what are the odds – but I guess that happens. Another manager had come in with a different skill set and the return of the funds had just gone back to being average or just below the average once you took the fees into account.

In the case of the other fund, I don’t know what had happened. It looked like the strategy that the manager was employing was not working any more – and the fund performance had started to suffer.

That goes to show you there’s no way you can really pick outperforming funds beforehand. Now whether it’s a manager leaving or a strategy not working different market conditions past performance is not indicative of future performance and that’s a fact.

There is a study done by Morningstar – looking at factors that can predict outperforming funds in advance. These are funds that would perform better than their peers in the future. What they found out was that the most reliable predictor of future performance was how low the fees were for that particular fund. The lower the fees the higher the chance of out performance in the future.

So next time you hear this argument about how high fees are worth it because they they could mean higher returns; be very very skeptical. More times than not that’s just one way for the financial industry to make sure they retire like this;

when you retire like this!

With that I thank you very much for your time and I’ll open it up to questions.