April 2016

Sticking to the long term plan and alternatives

Long Term Returns
The Cost of Fear
Diversifying Investments

A poster in our office shows the total returns of different asset classes if you started with $1,000 at the start of 1935 and held onto them until 2015. Over these last 80 years there were several shocks to the market including World War II, Korean War, Vietnam War, Black Monday, the dot-com bubble, 9/11, the recent financial crisis and too many other fear events to name.

Despite all of these events, US equity returns are quite impressive, $1,000 invested during this 80 year period it would be worth $5.75 million today verse the inflation adjusted amount of $17,600. Less impressive are bonds which come in at a value of $134,000. Quite a hefty price for safety!

Unfortunately for investors we don’t have an 80 year timeline to put down an investment and let it ride. The market is bumpy and emotions are very hard to overcome for long term investing success. We also have real needs for invested money whether it’s monthly income or a planned future purchase. This is why we buy safety assets like bonds and accept lower returns.

So how do we best invest for the long term, control the market bumps and generate income?

Using the beginning of 2008 which was one of the worst periods in financial history to enter the market as my starting point to the end of 2015 I tested a couple of scenarios. Assuming a $1 million portfolio invested in the S&P500 and the need of $50,000 income each year I came to the following conclusions.

Don’t panic. Withdrawing funds after a pullback and going to cash is extremely detrimental to your future success. If you had pulled your investments at the end of 2008 and held off reinvesting for 1 year you would have destroyed $240,000 in value verse waiting it out. The value destroyed jumps to $350,000 if you left the market for 2 years. To worsen the situation in order to continue withdrawing $50,000 per year in income you will need to take excess risk to earn higher rates of return or risk running out of money sooner than expected.

The need for cash and a short timeline creates the need for diversification, when the financial markets crash you need a parachute. The diversified selection above is a holding of 80% s&p500 and 20% uncorrelated asset class. When equities lose a large amount of value you take the $50,000 withdrawal from the uncorrelated assets that are indifferent to poor markets. When the market is thriving we take the $50,000 from the equity holdings. This method created a value of $143,000 verse just holding the index!

So what makes up the uncorrelated asset class? Traditionally it has been bonds. Bonds are great and need to be held. A well-diversified bond portfolio should be stable when equities underperform. The Pimco Total Return fund earned just close to 5% in 2008 verse a -38.5% loss in the S & P 500. Here is where the conversation generally ends.

However, bonds have become more risky due to the record low interest rates and the return on a government bond after taxes is lower than target inflation. In real purchasing power terms you are paying to hold high grade bonds. This is not an ideal scenario.

To combat this issue we are looking at a 3rd leg of diversification in alternatives. Some alternative investments can have bond type risk characteristics while having returns closer towards equity. (Remember above the 80 year return of equities verse bonds) They have low correlation to equities or bonds which creates a second parachute for security. Traditionally these have only been available to institutional money and high net worth individuals but we are using our strength as a collective office to negotiate access.

Alternative asset classes identified:
Private Mortgage Investment Corps (MICs)
Private Infrastructure direct investment (Toll roads / Airports / Private power generation)
Private equity funds
Private direct lending and/or real estate deals
Arbitrage funds (Earns returns by taking 2 sides of a trade and squeezing a small profit)
Catastrophe bond funds (Return is based on events like hurricanes)
Direct term-life insurance policy purchases (Return bases on mortality)

While it is not practical or possible to enter into all of these alternatives we are finalizing due diligence to invest in a private mortgage investment corporation so we can begin to add the 3rd leg of diversification to your accounts while maintaining a strong risk to return profile for our clients.

Having asset classes of diversification along with a long term steady plan to generate income and overcome the financial bumps in the road will allow us to help put you in the best position to realize your long term financial goals.

This newsletter was prepared solely by Bruce Morrison who is a registered representative of HollisWealth™ (a division of Scotia Capital Inc., a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada). The view and opinions, including any recommendations, expressed in newsletter are those of Bruce Morrison only and not those of HollisWealth. TM Trademark of The Bank of Nova Scotia, used under license. Morrison & Partners Wealth Strategies is a personal trade name of Bruce Morrison.