Making money on the stock market is easy in principle. Just buy companies through your Questrade online trading account when their price is low and sell when the value of your shares goes up. Simple, right?
Many people have made oodles of money off of explaining their unique (or in many cases – not so unique) strategy for accomplishing that simple strategy. One of the most common investing approaches you hear is to “zig when others zag,” or as Warren Buffett says, “Be greedy when others are fearful and fearful when others are greedy.” This all sounds pretty straightforward, everyone that spends a little bit of time looking at balance sheets should be able to do better than most right?
Well, statistically, we know that the vast majority of people who try to pick their own stocks do terribly and presumably a fair number of those people have read a few books and watched the 24-hour business news channels. Due to our prehistorically-wired lizard brains we’re not good at this whole zigging thing, we’d much rather zag with the rest of the pack – it just feels safer and is reinforced by what everyone is talking about all around us.
Why Not Just Pick the Winners?
Those people who are successful in implementing a strategy of buying stocks when they are out of favour and selling them right around their peak (usually as they are being talked about the most) often refer to themselves as contrarian investors. Many people who are wannabe contrarian investors (and maybe a few who are the real deal) will look down their noses at couch potato investors like myself and make statements such as, “Why buy the index and purchase all of the losing companies when you can just pick the winners instead?” Of course this ignores all the hard data out there about our ability to pick winners, but let’s ignore that boondoggle for a second and focus on another reason these conclusions are wrong:
Being a good indexing or couch potato investor automatically makes you a semi-successful contrarian investor!
Related: Our eBook On Index Investing
“But how can this be?” you might ask. After all, you’ve been conditioned to expect only geniuses and “numbers people” can be great contrarian investors. Besides, isn’t index investing just boring and repetitive?
Yes, I admit it. Index investing is a boring and repetitive way to become a millionaire. Personally, I prefer it to an adrenaline-stimulating path to bankruptcy, but hey that’s just me and I’m a pretty boring school teacher when you get right down to it.
None of that verbiage or lingo though, changes the fact that good index investing makes you a good contrarian investor by definition.
The reason behind this lies in the idea of asset allocation and re-balancing your portfolio a few times a year (or even just once if you want to keep life really simple).
Related: Trade ETFs For Free With Questrade
Life is a Balancing Act
If you’re not familiar with asset allocation or re-balancing you can get a more thorough explanation in our free ebook. The basic idea is that depending on your age, investment goals, and risk profile, you should have a certain amount of your portfolio in somewhat risky assets like commodities and stocks, and a certain amount in less risky assets such as preferred shares, investment-grade bonds, and GICs. From this basic level you can get into more complex aspects of asset allocation if you wish, such as diversifying certain asset classes by geography or industry.
For example, many Canadians have too much of their investment money in Canadian companies. They would be much better off in terms of real returns and stability over a long period of time if they had invested in some companies from all over the world. Researching oil companies in Brazil, manufacturing giants in China, or junior mining companies in Africa would be exhausting and beyond the capability of almost all investors. This is where index investing comes in.
How you build your low-maintenance, couch potato portfolio should be based on what asset allocation fits you. From there, all that is left is to purchase the low-cost options that fit what you want and then keep the percentages straight for the next 30+ years. Personally, I prefer the extremely low MERs of ETFs purchased using discount brokerages, but how you choose to execute setting up your portfolio is up to you. The logistics usually become window dressing as long as you stick to the basic idea of low-cost index investing.
Related: Why you should Index Invest
There are some great model portfolios featured here for people who want the most simple of accounts (still virtually guaranteed to beat 70%+ of all investors) and for those who want to sink their teeth in a little deeper. At least they will be a good starting point if you haven’t read our ebook and aren’t sure what asset allocation is all about.
If you’re not quite as obsessed with cutting fees to the absolute bone as I am, but still see the wisdom in index investing, you may want to seriously consider Canada’s robo advisors. I’ve recently recommended my favourite robo (see our Wealthsimple review) to several of my friends who were a little intimidated at the thought of opening up a discount brokerage account and buying and selling their own stocks. These fintech creations will automatically buy low and sell high for you, by using a computer algorithm to simply rebalance your portfolio from time to time. It will cost you somewhere around the .5% MER range (a bit more expensive than purchasing your own ETFs, but still substantially cheaper than going with a traditional commission-based financial advisor) but in return you get the easiest way to create a “set it and forget it” portfolio – an option that is proving to be increasingly popular with Canadians!
But how does this all make me a savvy contrarian investor?
Once you have determined what percentage of your portfolio should be in each asset class and you are properly diversified you can sit back and let the numbers roll in. The thing is, those percentages won’t stay in one spot after you purchase the investments because the value of those investments will go up or down.
For example, let’s say that you had $1,000 to start your portfolio with. If you decided you wanted 60% of your portfolio in stocks and 40% in bonds you would obviously purchase $600 and $400 of whatever way you decided to get exposure to those equities (again, we recommend low-cost ETFs). If the stock market did well over the next six months, and your $600 worth of stocks were now worth $650, and your $400 worth of bonds were now worth $375; consequently, you obviously would not be balanced the way you want to be right? Some quick math tells us that stocks now account for 63.4% of your portfolio. In order to rebalance you will have to buy more bonds ($35 worth by my calculation).
This is obviously a very simple example where we are only seeking to balance two different types of investments. With small portfolios, investors can rebalance pretty easily simply by considering how much to add to each type of asset whenever they add investments to their overall portfolio. Once you start dealing with a larger nest egg, you will have to sell a part of the category that is doing well and use that money to purchase more of the category that isn’t.
If it helps, just visualize the above example with a couple of zeroes on the end of every number. If you had $65,000 worth of stocks and $37,500 worth of bonds, then you would probably want to sell about $3,500 worth of stocks and purchase $3,500 worth of bonds in order to get back to the overall asset allocation levels you wanted for yourself. It’s pretty easy to see why this practice is referred to as re-balancing.
The way this basic math makes you money is that you are guaranteed to consistently be selling assets that are doing well (re: sell high) and purchasing assets that the talking heads on TV are trashing every day (re: buy low). This makes you a contrarian investor. You should know that being a contrarian investor means that you will be often doing the exact opposite of what Jim Cramer, or anyone else on the 24-hour business news networks is telling you to do – that’s how you know you’re getting it right.
Does anyone else consider themselves a contrarian investor? How often do you re-balance? Because of my relatively meagre portfolio I only rebalance every six months at the moment.