This article is a continuation of my previous column, and a summary of the themes of my 30- to 45-minute presentation. Most stock investing perceptions are actually misperceptions. I outlined five common misperceptions in the previous article. Here are another four.
1. You have to sell to make a profit
The three companies I have held the longest are Bank of Nova Scotia purchased for $5.59 per share in 1992, Royal Bank purchased for $16.01 in 1999, and TransCanada Corp. purchased for $10.95 in 2000. Today they are valued at about $70, $95 and $50 respectively. In BNS’s case, I have collected approximately seven times my original investment back in dividends. All three companies had four to five per cent dividends when I purchased them, and still have these dividends on their current price. Their dividend increases have matched their price increases. Have I not profited? If you have to sell to make a profit should I sell those original shares and purchase them back? That wouldn’t make sense.
2. Have a 60/40 equity/bond mix
When was this guideline first suggested? I found an article that said it began when interest rates were around eight per cent. Long-term stock returns are about 10 per cent. With an eight per cent interest yield, a 40 per cent allocation to bonds makes perfect sense. However, at today’s interest rates, bonds make very little sense at all.
An article from CNBC that said since 1928 a split of 60 per cent stocks (S&P 500) and 40 per cent 10-year US treasuries yielded 9.0 per cent, vs. an all-stock portfolio of 11.5 per cent. Those returns sound comparable until you recall the rule of 72. In about 28 years the all-stock portfolio would have twice the money. If you do the math, the fixed income portion of the 60/40 split averaged just 5.25 per cent, less than half the returns from stocks. And worse yet, if you calculate real after-inflation returns the bond portion was only 2.1 per cent real return. The stock portion had 8.4 per cent real rate of return, four times the bond portion. And that’s during a period that interest rates were significantly higher than today!
3. Bonds are safe and don’t fluctuate in value
Bonds values go down as interest rates go up, and vice versa. If bonds are held to maturity they can be cashed in at face value. However, if you sell bonds prior to maturity, their value can fluctuate significantly to reflect current interest rates. Say you buy a 2.5 per cent 30-year bond and interest rates rapidly escalate to 5.0 per cent. The value of that bond could drop by 25 to 35 per cent. If you sell before maturity, the value will be based on comparable bonds at new interest rates. Another risk with fixed-income investments is inflation outrunning after-tax returns, leading to diminishing purchasing power.
4. A house is your most important investment
This misperception may not pertain to farmers who often own homes as part of their farms. However, for non-farmers, I think this is the most dangerous misperception of them all, and a key reason why so many people struggle financially. I maintain that owning a home is a lifestyle choice rather than an investment. While this misperception may be controversial, I provide a thorough explanation of my rationale in the book.
Please get in touch if your group would like to hear my full presentation.