A trader looks up at a chart on his computer screen while working on the floor of the New York Stock Exchange shortly after the market opening in New York July 11, 2013. Global stock indexes rose sharply while the dollar tumbled on Thursday after Federal Reserve chief Ben Bernanke signalled the U.S. central bank may not be as close to winding down its stimulus policy as markets had begun to expect.LUCAS JACKSON/Reuters
Andrew Hallam is the index investor for Globe Investor's Strategy Lab. This is his first column. Follow his contributions here and view his model portfolio here.
This might sound crazy, but I don't want to see my indexes rise in value. My Vanguard U.S. stock market index has gained an irritating 22 per cent in Canadian dollars; Vanguard's FTSE Developed Market ETF has also misbehaved, gaining 15 per cent.
As a 43 year-old investor, I prefer to see falling prices. Before labelling me nuts, hear me out. Only retirees or near retirees should smile when stock markets rise. After all, such people will soon be spending their market proceeds to cover living expenses.
Younger investors play the opposing side of the trade. Instead of selling investments, they're accumulating them. As such, they should prefer falling or stagnating prices.
Index funds hold real businesses with genuine earnings. When businesses earn more money (on aggregate, this happens nearly every year) stocks should be worth more. But the stock market doesn't always agree – not immediately. When stocks don't rise, investors get a better deal. The longer prices procrastinate, the better.
Unlike an individual stock, broad based indexes don't run the risk of dropping to zero. So when they fall, celebrate the drops and buy more. They'll bounce back – often when you least expect. If your portfolio is diversified across a wide range of index funds, purchase the laggard each month. Such a strategy could maintain a balanced portfolio without having to sell.
Three of my Strategy Lab ETFs are similarly priced to where they were 10 months ago: Vanguard's Canadian Short Term Bond, Vanguard's FTSE Emerging Market, and Vanguard's FTSE Canadian Stock index. If this were my personal portfolio, I would have been adding fresh money to these indexes each month.
Most investors do the opposite. They chase winning markets or stocks instead of taking a contrarian approach. Those critical of chasing a falling index with fresh money might point to Japan. It still hasn't recovered from its 1989 peak. But Japan's average stock suffered PE ratios averaging 70-times earnings. That's five times higher than the developed market norm. Irrational prices coupled with a shaky economy hurt Japanese investors.
Fortunately, Canada's stocks and bonds are reasonably priced. And so are the emerging markets. Vanguard's FTSE Emerging Market index trades at 12-times earnings. Vanguard's FTSE Canadian Stock index trades at 16-times earnings.
Some index investors split their equities evenly between Canadian and foreign stocks. Others place greater emphasis on home-grown companies. Long term, it shouldn't matter. Global stock markets (whether Canadian, American or emerging) have recorded similar returns over the past 30 years.
That doesn't mean they rose in unison. Some years, the Canadian market lagged. Other years, the U.S. market disappointed.
Rather than overweighting an index you think might outperform, it's better to stick to your goal allocation. By doing so, you'll buy the underperformers, sowing seeds to grow.
This is what I need to do with the Strategy Lab portfolio. With two of my indexes running away from the rest, gaining 22 per cent and 15 per cent respectively, it's time to rebalance. I don't have the luxury of adding fresh money to the laggards, so I'll skim off my winners to buy more of the stagnating markets.
I'm selling 30 shares each of the U.S. and International indexes. Coupling the proceeds with dividend-derived cash, I'll split the money evenly, adding to my Canadian index, emerging market index and my short-term government bond index.
My portfolio wasn't built to win a one-year contest. Instead, I wanted a diversified model. It's less volatile than a full equity portfolio, and with bonds in the mix, I'll have something to sell when stocks, once again, offer mouth-watering bargains.