Weigh House Investment Principles

The following sections outline Weigh House’s 10 proven principles for a sound investment process. The principles are not ours alone; in fact, they have been widely adopted by investment managers, who believe as we do that:

  • Investing should be approached prudently and conservatively; and,
  • The investment process is more critical to long-term success than any individual security or investment product.

Principles one to four address investment policy and asset allocation, key considerations in designing an investment portfolio. Principles five through 10 focus on portfolio implementation, addressing issues that significantly impact long-term investment returns.

1. Set realistic expectations

Your investment portfolio should reflect your objectives, as well as expectations for future capital market returns. Your objectives and expectations should be realistic and internally consistent.

Expectations of returns and risk should not be based on recent history. A common mistake is to examine recent market trends and assume they will continue. A more useful approach is to look at price earnings relationships over the long term, and assume that these relationships will continue.

2. Aim for the right rate of return

A financial plan is the best way to determine the target rate of (investment) returns you require to achieve important financial objectives. Higher returns are associated with higher risk, and wise investors assume no more risk than is necessary to achieve their goals. The target rate of return should be documented in your investment policy statement (IPS).

It can be tempting to assume unnecessary risk in an attempt to generate higher investment returns. A high risk portfolio will devalue more in a typical bear market however, and recovery (i.e. return to current value) can take many years.

3. Choose an appropriate asset mix

Your target rate of return determines the asset allocation (i.e. the mix of stocks, bonds, cash, domestic and international investments) within your portfolio. The ‘right’ asset mix:

  • Is expected to earn the target return with the least amount of risk;
  • Does not exceed your risk tolerance; and,
  • Reflects the long-term outlook for capital markets.

As a general rule, broad geographic diversification in an equity portfolio reduces volatility (risk) and increase the average rate of return by taking advantage of investment opportunities outside of Canada. Investing outside of Canada further reduces risk by exposing you to a broader group of industries.

Foreign investment also provides protection should the Canadian dollar fall in value relative to foreign currencies. On the other hand, it introduces risk that the Canadian dollar appreciates relative to foreign exchange. Since it is difficult to predict how our dollar will move, diversification is the best strategy.

Asset allocation is a cornerstone of your investment policy and should be documented in your IPS. Your portfolio should be ‘rebalanced’ regularly to maintain your target asset allocation.

4. Understand investment risk

You should understand the potential capital loss inherent in your investment portfolio, and in particular, how severe your losses could be in a serious bear market. With this understanding, you can make an informed decision to reduce investment risk.

History suggests an investment portfolio, if left unchanged, will eventually recover from a fall in value. There are two important considerations however:

  • It may take a long time – it takes a 100% return to recover a 50% loss.
  • Fear of further losses cause many investors to sell when their portfolio is at (or near) its lowest point, and they miss out on the recovery.

5.  Define your investment strategy

Most investors fail to reach their investment objectives, or become dissatisfied with portfolio performance, because they fail to execute an overall investment strategy. Yet there are a number of different strategies that, if followed deliberately and consistently, are likely to produce reasonable rates of return with moderate risk, including:

  • Growth investing
  • Value investing
  • Small cap investing
  • Tactical asset allocation
  • Sector rotation
  • Momentum

A disciplined strategy has a further benefit – it helps you avoid knee-jerk 'fear and greed' responses in the face of market volatility.

Your investment strategy should be articulated in your investment policy statement.

6. Keep it simple

A simple investment portfolio is usually better than a complicated one. With a simple portfolio, it is easier to understand risks, monitor performance, and rebalance assets as the markets and personal circumstances change.

Multiple positions in different mutual funds generally increase portfolio complexity, particularly if the funds invest across different asset classes or different geographic regions. In most cases, the added complexity does not improve returns or reduce investment risk. As an investor, you should be aware of the benefit that exchange traded funds (ETFs) offer for diversification and simplicity.

7. Manage investment fees

Investors cannot control interest rates or capital markets, but they can control the fees and commissions they pay. The first step in minimizing fees and commissions is to clearly understand what they are – including hidden fees.

Excessive fees impact net investment returns significantly. For example, a $100,000 mutual fund portfolio with an average Management Expense Ratio (MER) of 2.5% incurs $2,500 per year in management fees. If the portfolio return 20% annually, the fee may be acceptable. For returns in the 6% to 8% range – perhaps a more realistic expectation – the fees are disproportionate. If a mutual fund portfolio earns 8% before fees, a 2.5% MER represents over 30% of the gross returns.

It is important to gauge the value received for fees paid. If you are investing in mutual funds that consistently outperform the market, then you probably are receiving good value. Alternatively, if your mutual funds consistently underperform, then the fees represent an unnecessary expense.

All fees should be disclosed in the investment policy statement.

8. Minimize income tax

Tactics that reduce taxes on investment income provide great opportunities increase your wealth. Simple steps include:

  • Hold interest-bearing investments inside tax sheltered accounts (e.g. Registered Retirement Savings accounts and Tax Free Savings Accounts) and equities in non sheltered accounts, and,
  • Have the higher income spouse pay expenses and the lower income spouse invest.

There are also more complicated strategies that involve insurance and estate planning. Further, investors should always look for tax-loss harvesting opportunities.

9.  Measure performance to a benchmark

Monitoring your overall portfolio performance (i.e. the overall returns earned from investments) is important. It allows you to determine if you are on track to reach your financial goals.

Comparing portfolio performance to an appropriate benchmark (typically a market index) provides additional insights – it indicates extraordinary performance, both good and bad. And while consistently good performance (‘overperformance’) is clearly desirable, consistent underperformance requires corrective action.

It is important not to confuse underperformance with losing money. Your portfolio could earn 8% this year, but if its overall benchmark increases 12% you are underperforming.

Establishing benchmarks for each asset class yields further perspective. It makes it possible to distinguish those assets classes that are performing well and those that are not, enabling you to determine where changes need to be made. In addition, it provides insights into the expected range of portfolio returns in both good years and bad. Most investors can live with a devaluation of their portfolio provided it is within their expectations of the ‘worst case’ scenario. Dissatisfaction occurs when devaluation is greater than worst case forecasts (and / or greater than the benchmark).

Benchmarks should be documented in your investment policy statement.

10. Use the right advice channel

Investment advice is available from a number of ‘channels’, including:

  • Books, periodicals and the Internet;
  • Discount brokers;
  • Mutual fund and insurance representatives;
  • Investment advisors;
  • Investment counsellors and managers; and,
  • Bank and trust company representatives.

Choosing the right advice channel is a key decision, predicated on a number of factors:

  • Your investment knowledge and experience;
  • Your willingness and availability to manage investments yourself;
  • The size and complexity of your portfolio as well as the types of securities you choose to invest in;
  • The breadth of services you require; and,
  • The fees you are prepared to pay for the advice you receive.

At a fundamental level, you must decide if you want someone to execute your instructions, suggest (and sell) securities and investment products, or provide knowledgeable advice. Further, since good advice comes at a price, you should ensure you are getting the level of support you require, but only what you require.