Three Questions for Bill Richardson Part 14
Question 1: The end of the year is a time at which I like to look at my portfolio to see how it performed. I know there are many ways to do this. What do you suggest?
To begin, you are definitely on the right track in your thinking that the end of the year is a good time to review your portfolio’s performance and there are many ways to do this. The key to doing this effectively is to understand what you are measuring your performance against.
Most portfolios are what we call balanced. That is, there is a combination of stocks and bonds (fixed Income). A typical portfolio has a 60/40 split. That is, 60% stocks and 40% bonds. This is determined by your tolerance for risk. If you are more risk averse, you will have more bonds or all bonds, for that matter.
The next thing to look at is your geographic asset allocation. That is, are you mostly invested in Canada, the US or Internationally?
Don’t get caught in the trap of comparing your performance to major indices, like the TSX Composite or S&P 500 Index if you hold a 60/40 portfolio. You will always under perform in strong markets and you should outperform in weak markets. If your portfolio is mostly invested in Canadian stocks, don’t compare your performance to the S&P 500 but choose the TSX Composite Index instead.
It is fairly simple for us to create a standardized benchmark as we utilize software that most advisors do not have access to. So, we could create a benchmark with 30% US Stocks, 30% Canadian Stocks and 40% Bonds.
Another trap to avoid is judging performance on too short a period of time. Many investors make longer-term commitments to a strategy but look at performance on a monthly basis. These investors set a goal of a 5% return over time but get upset when they have performance over the previous three-months of -5%. During short periods of time, things happen, and performance may excite or disappoint you. Avoid getting caught in this trap as it will negatively affect long-term performance.
One thing that we do is track against peers. As most of you know, I have been managing the Willoughby portfolio and we will have a 5-year track record in April 2021. Willoughby is a balanced fund, so we constantly measure its performance against other Canadian Balanced Funds. For the past two years, Willoughby ranked number one at the end of November.
There are many ways to track performance against benchmarks or a return necessary for you to achieve your financial goals and it is a very good thing to track. Just make sure you are comparing apples with apples.
Question 2: Normally, we keep a pretty close eye on the Canadian Dollar as we spend a lot of time in Florida during the winter but with COVID-19, it looks like the Canadian Dollar has risen quite a bit. Is this a good time to convert some money to US Dollars?
It has been quite a volatile year for the Canadian Dollar. It started the year at 77 cents and dropped almost immediately down to 69 cents as COVID-19 news began to emerge. It bottomed on March 19th, a few days before equity market bottomed and since then it has been straight up for our Dollar ever since. Right now, it sits at 78.5 cents.
If you follow stock markets, that is a good way to judge the Canadian Dollar, at least currently. During 2020, when the S&P 500 goes up, the Canadian Dollar goes up and when it goes down the Canadian Dollar goes down. The same can be said for the relationship between oil prices and the Canadian Dollar. In March oil prices dropped to almost zero. If you look at a chart, they actually went negative or they were literally giving oil away. More reasonably it traded down to $10 per barrel. Prices have since recovered to almost $47 per barrel, which like the stock market is not quite back to where it was before COVID-19. The median price for 2019 was more like $58 per barrel.
Stocks, oil prices and the Canadian Dollar have all been trading in the same direction for a while now so if stocks remain strong, the Canadian Dollar may continue to rise. At current levels, your Canadian Dollar will go further in the US but keep an eye on the US stock market for better timing.
Question 3: What is the best way to judge if stock markets are expensive or inexpensive?
There are a number of ways to judge whether stocks are expensive or inexpensive but for the purpose of 3 Questions for Bill, let’s keep it relatively simple.
Before I begin, please let me remind you that the key factor that you always want to look at is earnings growth. Earnings growth plays a more prominent role in the performance of stock prices than buying them at expensive or inexpensive prices.
Using a stock like Adobe, the price has risen from $30 in December 2010 to $477 currently. Earnings per share has risen from $1.70 to $7.94. See the correlation? During that period, the PE Ratio, which is a good judge of expensive/inexpensive has risen from 34 to 60 times earnings.
So, a value investor might have avoided Adobe because he didn’t want to buy it after the PE rose to 56 in early 2016 with the stock trading at $85. In hindsight that was a big mistake.
Price Earnings ratios, or price to book values or price to sales or cashflow are good ways to judge whether a stock is expensive or cheap but try to avoid value traps. You are always best to buy companies with consistent and predictable earnings growth that is expected to continue into the future, and buy them at reasonable prices and diversify by sector, of course. Then use factors, like PE Ratios to determine if, in the short-term, they are trading at reasonable prices.
Until next time, have a great day!