Published by CastleMoore Inc., 1 First Canadian Place, Suite 3700, Toronto, Ont. M5X 1C9

January - February 2007

The irascible De Gaulle

Heartaches

Valentine’s Day is upon us: the season for human beings to celebrate our emotional nature. For jaded participants like me, this “Day of Love” has become a day of hollow ritual, a day of cards and chocolates and flowers; a day of tokens of love, not real love. What has happened to my real emotions? Have I  forgotten how to feel?

Ken can be reached at:

ken@castlemoore.com
1.416.306.5770 or toll free 1.877.289.5673

Robert Sneddon, FCSI email

The True Story About Loss

You may have seen the typical illustration used to highlight the impact of loss upon your investment portfolio. But, have you seen the real impact of that loss, shown in the proper light? The typical illustration used to show the impact of loss upon a portfolio goes something like this:

If you suffer a 10% loss in Year 1, you must directly follow that by an 11.11% gain to get back to square one by the end of Year 2. We have all suffered some type of investment loss over the years; it’s no big deal. It goes with the territory. But, if we suffer two consecutive years of loss, it gets even harder to achieve the return required to break even. Occasional losses are a normal or expected outcome of investing. No one wins every time. The critical element is to reduce your losses as quickly as possible. I’ll talk more about that later.

Here is what the typical illustration often overlooks: what it forgets to factor into the equation. What return were the general markets were providing at the time you suffered your loss? If the markets were delivering   8% returns, the true impact of the loss calculation is quite different. I’ll call the portfolio that suffers the loss in Year 1 Portfolio “A” and the one that achieves the market eturn instead of a loss in Year 1 Portfolio “B”.

These scenarios show that if an investor suffers a 10% loss (portfolio “A”) while the markets were moving up at 8% (portfolio “B”) the true gap, the difference in the two ending portfolio values after Year 1, is $90,000! This is after Year 1! Now let’s suppose the markets deliver 5% in Year 2. I am intentionally being conservative with a 5% return. I want to show how even a small, but positive market return impacts a portfolio that is trying to recapture lost equity.

The next calculation reveals the returned required for portfolio “A” to “catch up” to Portfolio “B”.

What this reveals is that if an investor suffers a 10% loss in Year 1 while the market was averaging 8% profit, he or she must return 11.11% to break even. Remember ‘break even’, in this case, assumes the market delivers no returns in Year 2, not even dividends. We know we can’t suspend time. In Year 2 the market returns 5%. Accordingly, the ‘catch up’ return required to match portfolio “B” is 26%. In short, it’s as if the two portfolios were on a conveyer belt moving away from you. In Year 1 it was moving at a speed of 8%. Portfolio “A” stepped off, and in fact, went backwards (-10%) while Portfolio “B” cruised along at 8%. The next Year Portfolio “B” slowed, but was still moving at 5%. It’s not unrealistic to achieve 26% in any one year. What makes the task harder is the market was only delivering 5%.

The chart below paints the picture rather clearly. It shows many scenarios of loss against an average market return rate of 8% and the number of years it takes to recover. Across the top axis is the amount of loss; across the side is return an investor achieves in the years following the loss.

These numbers reflect a purely mathematical assessment of the impact of losing your capital.

Where ever there is the potential to gain, its corollary is the potential to lose. As we have seen, the consequence of loss is severe. Does this mean that a portfolio manager should be so fearful of loss that it impedes his ability to make a profit?

No it doesn’t. Most of the stock market has a significant component of organic growth to it. By and large, most stocks should be higher today than they were twenty years ago. Most companies inherently grow.  (This cannot be said for resource or other heavy cyclical investments. They often experience booms and busts.)

As investors, we will suffer losses — it should be expected. What the data suggests is twofold: first, investors should avoid enduring large losses for sure!; and second, if investors are going to be successful at avoiding large losses they need a disciplined approach or technique to do so.

The lifestyle expectations of retirees cannot be met by today’s fixed income rates alone. Four or five percent is not enough. There must be some equity market exposure. So if you are thinking about retiring or if you are retired, you need investment techniques to avoid loss. And if you are a more aggressive investor who has placed a heavier bet on one or two sectors, your portfolio cannot be managed without techniques to avoid loss. At CastleMoore we have several loss avoidance techniques. Whether with us or with your advisor, we urge you to review your loss avoidance plan.

Robert can be reached at:
robert@castlemoore.com
1.519.635.8723 or toll free
1.877.289.5673

Worth billions and you never age

• Bruce Wayne; who, despite his wealth spent much of his time in a cave;

• Thirston Howell III, who seems to have taken most of it—along with several changes of clothing--with him on a three-hour tour; and

• Prince Abakaliki of Nigeria, who, despite being a political prisoner or suffering from some horrendous physical affliction, has managed to contact almost everyone on Earth with an email address, offering to each an “exclusive” opportunity to receive a large sum of money, a cut of a vast fortune that needs to be hosted from someone outside of his country. Of course, he has since franchised out his business; not a day goes by when I don’t receive a similar “generous” proposal.

• Willy Wonka, the chocolate mogul, and the only member of the list I whose fortune I would have personally contributed to, assuming his products were kosher. As it is, I’ve contributed to the fortune of Mr. Hershey because, after all, a waist is a terrible thing to mind.

This is actually the first year that Santa Claus has been excluded from the list, according to Forbes, not because his fictitious wealth doesn’t measure up (indeed, he traditionally held down the top spot, or, if you will, the Pole position) but because too many readers wrote the editors insisting that he’s real. To the best of my knowledge, none of those who wrote in were my clients; the jury’s still out on my colleagues.

...eccentric.

sheldon@castlemoore.com
1.416.306.5770 or toll free 1.877.289.5673

CastleMoore Inc. helps investors manage their life savings. We are not stock brokers or mutual fund salesmen. We arediscretionary investment managers specialising in “buy low, sell high” strategies instead of “buy and hold” strategies like the other guys.

Our team’s previous experience in large national firms and small boutiques provides us the ability to deliver a high quality professional portfolio management service while adding truly independent advice to our clients for reasonable costs. A CastleMoore client enjoys the benefits of having focused portfolio management without the distractions of also providing a “super market” of financial services. We just manage investment portfolios effectively – plain and simple. CastleMoore is uniquely superior portfolio management. To know more, including the first step in transitioning your portfolio, contact us.

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