My father always taught me that there are three ways to do things in life: the Easy Way, the Hard Way and the Smart Way.
Investing based on this principle has provided me with more consistent success than I would expect if I had strictly stuck to the traditional two ways of doing something. Whenever I encountered failure early in my life my father would repeat these three methods and often later in reflection the best path to correcting my mistake would become evident. Often the Smart Way was a combination of the Easy Way and Hard Way found through collaboration, teamwork and looking at the bigger picture of interpreting my surroundings differently.
The Smart Way is a different interpretation of how things come together to make better sense and achieve higher efficiencies. My investment motto of “allow money and debt to work for you instead of against you” is based on this principle. When you invest you want to do things that make sense, are fundamentally sound and require very little effort or energy to maintain.
My interpretation of value investing is much more than simply looking at a stock’s quantitative value, underlying fundamentals and financial position. To me it’s about assessing all aspects of a business and asking myself if the intrinsic value of that company is more or less than the market price. Often there are times when I don’t need a massive stack of financial statements, insights into global operations or a tour of a manufacturing plant to get a sense within the first hour or two whether an investment is something that fits my style or requirements to own.
Based on the Smart Way principle I want to highlight some introductory areas that many individuals get caught up in when investing. A De-Value Investor is an individual investor who de-values their investments and opportunities for creating wealth by ignoring basic fundamentals and avoiding the bigger picture or Smart Way.
After each quote and explanation ask yourself if you are a Value Investor or De-Value Investor in each situation based on what you might do or already do. Each of the following statements I have heard in person within the last year.
“I’m going to borrow money this year to invest in my RSP.”
Any money you borrow to invest in your RSP will not be tax deductible in comparison to borrowing to invest in a non-registered account. While this may appear to be a great idea proposed by your bank or financial advisor any loan taken to borrow money to invest in your RSP will have no tax savings on the interest. Receiving a tax rebate for your RSP contribution to pay down onto the loan may make sense, but ask yourself how far ahead you might be if you are in the highest marginal tax bracket and paying full interest on your loan. Examining this situation the Smart Way could show you how you might save almost half your interest cost.
“An extra mortgage payment? I’ve got 25 years to pay off my mortgage. I need a new TV instead.”
On a $250,000 mortgage at 6.5% interest amortized over 25 years the total interest paid will be almost $252,400 – that’s only interest!
You’ve essentially paid for two homes: one in principal and one in interest. Pre-paying one additional payment of $1600 each year would decrease your interest to $203,500. You could save nearly $49,000 in interest and have your mortgage paid off in 21 years just adding an extra payment each year. Have you ever used a mortgage calculator to see how you can meaningfully decrease your interest?
“Why would I need to diversify? I don’t need to diversify! I hold only as much stock as I can hold in one hand.”
While being over diversified can negatively impact returns, not being diversified at all can leave an investor exposed and vulnerable to unexpected events in one sector, industry, country or investment. Effective diversification is ensuring you have exposure to investments that behave differently in various market conditions and buffer your overall portfolio against extremes of volatility and risk.
“They don’t need profit…the company is going to the moon! I have to invest in this stock…just look at that chart!”
Trees never grow to the sky and the fundamentals of gravity dictate that what goes up must come down. Speculation has high rewards, but also a high potential for losses. Companies without profits are dangerous because they’re burning through more cash than they can generate and this eventually catches up to a company.
“Oh…that’s what that company does?”
Do you understand what you’re buying? Do you know what factors can influence changes within the market a company operates? Is there sustainable demand for products or services? Are their operations complex? Can you explain what they do in a single sentence? What are the risks?
“I can’t sell…there’s still potential…plus I’m only down 40%.”
Knowing when to buy is always easy; knowing when to sell can be painful and difficult to ascertain. Do you have a rule, guideline or minimum loss (percentage or dollar amount) that you can tolerate on your investments? How important is capital preservation to you? Do you have as much confidence in yourself to sell as you do to buy?
“I’ve procrastinated for years with saving and investing. Now I feel I need to catch up.”
There are a lot of investors in this boat and the sea can be rough and unforgiving. Do you have a tolerance for risk? What is your definition of risk? How much risk can you tolerate? Have you ever asked yourself these questions?
“This stock has gone nowhere in 4 months! I need to sell. The analyst said that this stock should have doubled by now!”
Adequate patience and realistic expectations are hallmarks of successful long-term investing. Analysts have two knocks against them: they are paid for an opinion and view the business from external sources. What you need to do, in any situation, when receiving advice is ask yourself who stands to benefit most from the advice being given. If the quick answer is not “you” than you have to question if there’s a conflict of interest that is impacting the opinion you are receiving.
“I haven’t met with my advisor for almost two years. I like them because they send me chocolates at Christmas each year.”
When you pay for a product or service you should expect to receive something tangible in return. If you’re paying a premium to receive advice and no advice is being given than you should be asking why you’re paying that premium in the first place. How much is a 3% MER on your portfolio worth to you? 3% over ten years is 30% of your potential returns that you’ve paid for a service – are you getting a value-added service or performance? Whose interests are being served as a priority?