Question. Hi, I’ve been a ModernAdvisor client for about a year, and everything is great. I understand the investment philosophy and the rationale for using index funds in the portfolios, but I’m also very interested in investing in marijuana. I keep hearing about the big opportunities, and how it could be a chance to get in on the ground floor of a brand new industry. What do you think? Is now a good time to invest in marijuana?

Answer. That’s a very common question these days, as many investors are wondering about the potential new investment opportunities in Canada’s new marijuana industry.

On Wednesday, Oct. 17, 2018, Canada marked the end of criminal prohibition of marijuana. It is now perfectly legal for adults in Canada to purchase, possess, or grow marijuana for personal consumption and recreational use. In fact, it is perfectly legal to possess, in public, up to 30 grams of marijuana. It is also perfectly legal to share that amount with other adults.

So, does that translate to an investment opportunity?

Marijuana Stocks: Risks of “Going Green”

Many marijuana stocks have already risen dramatically in value, and many investors have already made handsome profits. Of course, those significant increases also mean that a lot of companies are probably overvalued at this point, which in itself presents heightened risk for investors. When hype and speculation lead to extremely high valuations, the situation inevitably becomes unsustainable, and some companies will simply not survive.

Some investors are comparing the marijuana stocks to the dot-com stocks in the 1990s. That is, while there are definitely opportunities, the tech boom, and subsequent bust, did not end well for many investors. Marijuana may simply not become the huge multi-billion dollar industry that some are predicting. Or, even if it does, how would you know in advance which companies will be winners and which will be losers? Not every company will become the next Amazon, and some will suffer the same fate as pets.com.

Furthermore, the fact that it’s a brand new industry is in itself a risk. What if a future government simply decides to change the rules? In fact, Conservative Party leader Andrew Scheer indicated that he would not commit to keeping marijuana legal, but rather, that “The Conservative Party will do our due diligence, examine the consequences of this decision, and we’ll examine the reality on the ground.”

As some may remember, back in 2006, income trusts were all the rage for Canadian investors. But that changed in a hurry when the Department of Finance announced that they were imposing a new tax on income trusts. Despite all the rigorous analysis and due diligence, countless investors lost millions and millions of dollars, literally overnight, simply because the government decided to change the rules. If you think government intervention is a far-fetched scenario, think again.

ModernAdvisor Investment Philosophy

At ModernAdvisor, our investment philosophy isn’t based on picking winners and losers. The first step in our investment management process is selecting a set of asset classes that can be used as building blocks of our client portfolios. When doing this, we look for asset classes that provide diversification benefits, have a meaningful (at least 10-years) investment track record, and are covered by at least one low-cost, high-quality exchange traded fund (ETF).

It doesn’t mean that you won’t be exposed to the marijuana industry in your portfolio – it just means that we aren’t actively making that decision any more than we’re making decisions on how much exposure you should have to any other industry sector.

For example, if financial companies (such as banks) constitute approximately one third of the Canadian stock market, then the Canadian equity component of your portfolio is also about one third invested in financial companies. Note, however, that’s not because we actively decided to put one third of our Canadian assets into financials. It’s simply because, by owning an index fund representative of the overall market, you end up with the representative weighting in each industry sector.

So, to the extent that the marijuana industry eventually becomes x% of the overall Canadian market, then x% of your Canadian holdings will be invested in marijuana companies. Again, this is not a decision on when it’s a good time to invest in marijuana, or how much you should have in your portfolio. Rather, it’s the outcome of owning an index fund that is representative of the overall market.

Bottom Line

Keep in mind that, a lot of hype and excitement about the legalization of marijuana doesn’t automatically translate to good investment opportunities. While there are no doubt investment opportunities in Canada’s new marijuana industry, there are also considerable risks.

For that reason, marijuana stocks are generally considered quite speculative in nature. If you’re thinking about investing in marijuana, ask yourself – Is this money you can afford to lose? It is generally advisable to limit your exposure to speculative investments to only a small amount of your overall portfolio. And for that reason, if you do decide to invest in marijuana stocks, we would suggest you do so with only a nominal amount, for example, no more than 5% of your portfolio.

If you have any other questions about ModernAdvisor’s investment philosophy and portfolios, or about any of our other products and services at ModernAdvisor, just ask us.