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Advisor Insights

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Active investing habits that pay off in the long term

First, set goals, personal timelines and risk tolerance; second, get the right asset mix and do homework on holdings; finally, review portfolio each year with advisor

By: SIMON AVERY

Date: February 12,2015

As the rout of oil prices tempts many investors to abandon the energy sector, it’s a good time to re-visit the adage that the market rewards patience over skill. Patience may indeed be a virtue, but a personalized strategy is golden.

Investing for the long term consistently delivers better results than trading for the short term, because even the most successful investors cannot repeatedly time the market to their advantage.

But the 33-per-cent drop in energy stock prices since September is enough to test the faith of any long-term investor. To begin with, the idea of long-term investing is not well defined. Does it mean holding assets for one year, or 10 years? Does it mean waiting out the collapse of energy prices, or moving money to another sector with upward momentum?

Unfortunately, there is no clear rule. Instead, the notion of long-term investing requires each investor to set a time horizon based on personal needs. The process must begin with an individual setting goals and determining when he or she will need the money, says Peter Drake, vice-president of retirement and economic research at Fidelity Investments.

“We are not talking about a general rule, but a specific rule about the financial needs of an individual,” he says.

The first step in the process is to know why you are investing. It might be for retirement, for a new home or for children’s education. Knowing your goal makes it much easier to set your time horizon.

If you have 30 years to build your retirement savings, you have the freedom to invest aggressively and let the decades smooth out the market ups and downs. If you have only five years before you will need the money for your child’s university fees, you will need to pay much closer attention to risk tolerance and adjust asset allocation to dampen the effect of market volatility. Of course, more conservative holdings, such as government bonds, usually mean smaller returns.

Over the past 45 years, the Toronto Stock Exchange has delivered a compound annual growth rate of 9.4 per cent (assuming dividends reinvested). But to get that average return, investors have had to stomach periods of decline with prices tumbling by one-quarter or one-third in a single year.

How you react in those bad times will shape the size of your returns. It’s important during market drops to avoid getting caught up in the emotional coverage of the moment, and to stay focused on personal timelines and goals, Mr. Drake says.

“I can’t specify how many years a long-term horizon is,” he says. “Long-term investing is a very good principle. But it doesn’t mean you buy a basket of stocks and never do anything. It doesn’t mean you don’t change your portfolio.”

Perhaps the decade between Jan. 1, 2000 and Jan. 1, 2010 illustrates this idea best. An investor who held a fund replicating the S&P 500 index, the main U.S. equity benchmark, during this period would have a 22-per-cent loss to show for their patience.

“Certainly, you can prove or disprove the theory of long-term investing by the period you select,” Mr. Drake says. The point is to have defined your goals, time horizon and tolerance for risk at the start, and then make your decisions about individual holdings within those parameters. Those “buy,” “hold” or “sell” calls come down to personal judgment, he adds.

Before the financial crisis of 2008 and 2009, it was common for investors to adopt a passive, buy-and-hold strategy. But the market meltdown that ensued has led to new thinking, says Barbara Garbens, a financial planner in Toronto who runs B L Garbens Associates Inc.

Good investing habits today include establishing risk tolerance, setting the right asset mix, doing one’s homework about particular holdings and reviewing portfolios each year, she says.

“Unfortunately, I don’t know how many people are actually doing this,” she adds.

If investors have chosen prudently in the energy sector, for example (i.e. the companies have good balance sheets, cash flow, profit and dividend records), then they should not worry about the short-term turmoil, as long as they don’t need to access those funds soon. Part of a good long-term strategy is making sure your cash requirements are covered in the near term, Ms. Garbens says.

An essential part of any long-term strategy is savings. When it comes to building wealth, people tend to put a lot of energy into their investing strategy but not nearly enough into their savings strategy. The reality is it’s very hard to produce big returns without a growing pile of savings, Mr. Drake says.

Regular savings become even more important in times of volatility, because you will need a bigger base to generate returns with more conservative holdings, he adds.

Before the financial crisis, many investors felt that if they stayed in equity markets long enough, they were almost guaranteed a good return. But building the right portfolio for the long term has become more complicated and requires more work. For those who don’t want to commit the time and effort, getting a financial advisor is a smart move, Mr. Drake says.

“Retail investors would really like to catch that lottery win and just get it over with,” he says. “But that’s just not very realistic.”

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