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Money Matters: November-December 2012

Why an Investment Plan is Essential to Protecting your Future

December 3, 2012  By Jim Sanderson

I have written about the importance of succession planning to maximize
the value of your business and ensure you receive a good return on your
efforts to build your business.

I have written about the importance of succession planning to maximize the value of your business and ensure you receive a good return on your efforts to build your business. Just as you follow a step-by-step plan to profitably complete any contract your business is awarded, so you need an investment plan to make sure things go smoothly on the financial front.

An investment plan will help ensure that you have enough money for a long retirement, to leave a legacy to your loved ones or to make a difference to your favourite charities.

Getting started
A discussion with your financial advisor will help you to set out your investment goals. Where do you and your partner see yourselves in one, five, 10 and 20 years? Where do you want to live? Do you want to travel or renovate your retirement home – or both? Is helping your children or grandchildren get established most important to you? Do you want to stay involved with your business or sell a portion and be a partner? These considerations all require planning. Once you have set your main goals, your advisor can help you put an investment plan in place to realize those financial goals.


Your investment portfolio is the foundation on which you protect and build your wealth through diversification outside your business. How do you go about building a portfolio that will generate the returns you need to enjoy a long and worry-free retirement? After determining your financial goals and investment horizon, your advisor will have an investment philosophy that will support either active or asset-class investing. The approach you want is the one that will produce the returns you need and the peace of mind that you are seeking.

Choosing between active and asset-class investing
There are both advantages and drawbacks to each investing style, which have been debated by market experts since the first index fund was introduced in 1976 (Vanguard 500 (VFINX). I have always been solidly in the asset-class investing camp. If you are an active investor, I don’t want to “knock you out” in this article but rather give you a corner to move toward.

Monkey business?
In 1999, a chimpanzee actor in L.A. named Raven posted a 79% gain in her portfolio, then swung a 213% gain the following year. Raven, whose picks were tracked by the now-extinct, amassed her fortune by throwing darts at a board containing 133 Internet-related stocks. As a result of pure luck or innate jungle instincts when it came to dart throwing, Raven would have ranked as the 22nd most popular money manager in the United States if she had actually been managing money in 2000. Then there was the Cebus (a type of New World monkey) from Chicago named Adam Monk (seriously!) who worked temporary investment magic by circling stocks in the newspaper with a red pen.1

Though no one I know has hired (or would considering hiring) a monkey to pick his or her stocks, recent market turmoil has caused some investors to re-evaluate all aspects of their portfolio as they grow tired of volatility and seek a successful investment experience.

The debate between asset-class and active management styles goes back as far as Adam Smith, the famous 18th-century Scottish social philosopher and pioneer of political economy. Yet, many years later the debate remains unresolved in many investors’ minds. This is the result of companies offering the investors incentives (the chance for substantial and quick investment returns) rather than evidence. After all, a lucrative and influential industry, which includes most of the mainstream media, has every reason to keep the debate going. Investors who place their trust in their advisor’s stock-picking skills are less likely to jump ship for lower-cost (and lower-margin) asset-class management –based, or passive solutions.

The following overview of the pluses and minuses of each investing style is based on historical returns generated by each style.

An active-style manager invests through a process of buying and selling assets, including stocks and bonds. His decisions are based on research and experience and he has only two arrows in his quiver – market timing and stock picking. He tries to predict the future and the end result after he makes an educated guess is “he is right or he guessed wrong.”

You may ask, “If an active manager can gather information and gain insight or knowledge through research into a company, shouldn’t he be able to beat the market?”

My answer: Not necessarily. You or I could have a different set of information or a different interpretation of the same information, while other investors may have no information at all. However, none of us is at an advantage or disadvantage because the aggregate of all information is already contained in stock prices. So, rather than gaining insight or knowledge, the manager is simply gathering and interpreting information the market has already digested.

One way to look at it is that in order to beat the market with skill rather than luck, you wouldn’t just need to have more information and insight than the “average” investor. Theoretically, you would need to have more information and insight than all investors combined, which of course, could never happen.

Active management advantages

  • Investors can benefit from expert analysis provided by professional portfolio managers. They are resolved to make informed decisions to maximize returns on behalf of investors based on judgment, research and prevailing market trends.
  • Annually, some mangers may generate returns significantly higher than those generated by the index.
  • Managers can be proactive in making portfolio changes in advance of a market upturn or downturn. They just have to make the right calls for their strategies to work.

Active management disadvantages

  • It involves higher fees and operating expenses, which cut into the value of the portfolio.  
  • Managers may make unsuitable portfolio selections, which could reduce returns.
  • Style issues may interfere with performance. A manager’s style may not accurately reflect or anticipate the trending or mood of the market, which could reduce returns.

The proof is in the numbers
Figure 1 demonstrates that beating the market is not that easy, but there are some managers who have been successful. You are really rolling the dice when you bet on the active style because it is impossible to identify which of these managers will be the one to make the right calls in any given year, or over a certain decade. Active managers can have great winning streaks that extend for a decade (or more). Then, they are suddenly blind-sided by external events they can’t control or anticipate. Their investing approach turns against them – they lose money and their track record suffers.

For the five years ending 12/31/2011, only 49.3% of all active U.S. equity funds both survived the period and maintained the same style. If you want to maintain consistent asset allocation, which is the leading factor in determining the portfolio’s performance, active management can be a poor choice.2

An asset-class style manager does not rely on a stock-picking approach to build an investment portfolio. Rather, he purchases the same stocks and bonds, in the same proportion, as an index. An index fund is a mutual fund that mirrors the movements of a financial market by proportionally holding every security in that market. For example, say you were to purchase the Vanguard S&P 500 index fund, one of the largest index funds in the world.

You would therefore hold a fund whose performance would reflect the performance of the S&P 500. So, if the S&P 500 increased 10% during 2012, then the Vanguard S&P 500 Index Fund should be up approximately 10% as well. Index funds aim to duplicate the performance of a given market.

The asset-class management style is often called passive because investment managers don’t make decisions about which assets to buy and sell; they simply invest in assets that mirror the indices. This is not to say passive managers don’t work hard to manage the portfolio. Many monitor it closely and rebalance as required so it does not become overexposed to one asset category, which can lead to missed opportunities and deep losses. And given the hundreds of indexes available, choosing the best index based on the portfolio goals also requires hard work and skill.

We build well-balanced diversified portfolios across different asset classes (Canadian, U.S. and International Equities along with Fixed Income). A typical balanced portfolio will have 20% in each of Canada, U.S. and International Equities along with 40% in fixed income (GICs, domestic bonds and global fixed income). As the balance between equities and fixed income changes we will rebalance the portfolios back to your original optimum mix. The asset allocation is what will drive the overall return.

This process allows you to sleep at night and not worry about the markets.

Asset-class management advantages

  • It involves low operating expenses.  
  • There is little decision-making required by the manager or the investor, aside from when to rebalance the asset mix within the portfolio.  
  • It is more tax efficient.
  • This style offers greater diversification.
  • Investors are free from worrying about short-term volatility and price fluctuations that can lead to impulsive buying and selling that may result in deep losses.

Asset-class management disadvantages

  • Performance is controlled by the market index the asset class mirrors. Generally, investors must be content with market returns because that is the best any index fund can do.  
  • Lack of control. The return for the investor mirrors the market return (minus any fees). There is no hope of outperformance (which can be an advantage when you refer to Figure 1 knowing that 97% of active managers in Canada did not outperform the index over the last five years).

Figure 1


How management fees can hurt your portfolio in the long term
Fees associated with active management can impact a portfolio’s long-term performance in varying degrees. Here are some calculations regarding the long-term cost of fees.

In Figure 2, we compare three fee structures on a $1,000,000 investment at 6.5% over 30 years. The $1,000,000 investment with a 3% fee will be $2.8M, the 2% fee will be $3.7M and the 1% fee will be $4.9M. Fees matter! The average industry fee for Canadian mutual funds is 2.56%.

On a $1,000,000 investment, a 1% decline in fees would be an extra $1,250,000 in your pocket instead of some company’s marketing budget or expenses.

Figure 2


Take a long-term view with your investment plan
Regardless of which side of the investment management debate you take, it is important to remember that active and asset-class style investment managers are drawing from the same assortment of equities.

As markets move through cycles driven by events no one can control, one approach may generate better returns than the other. In the long run, your return will probably equal the market returns minus the fees you pay.

Your financial advisor needs to keep your financial goals in mind while remembering the important roles asset allocation, portfolio diversification and the fees you pay are playing in securing your future. If you don’t know what these are, it is time to help yourself and get a second opinion.

Effective stock-picking monkeys in very short supply
Talk with your financial advisor today to get an investment plan in place, making sure your life and investment goals are clear from the start with a clear picture of the costs involved. If you need a second opinion, ask your friends for a referral or feel free to give us a call.

And remember that the Adam Monks, Ravens and other “wonder monkeys” are in very short supply.



Jim Sanderson is a wealth advisor with over 25 years of experience in the investment services industry. The Jim Sanderson Group of ScotiaMcLeod, specializes in helping successful individuals and companies in the aggregate and roadbuilding industries across Canada create and distribute wealth. or e-mail:

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