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ALLAN SMALL HOW TO PROFIT WHEN INVESTORS ARE SCARED BUY LOW SELL HIGH Everyone knows the philosophy, but how many are doing it? How to Profit.indd 3 2014-04-10 5:13 PM Copyright © 2014 Allan Small, All rights reserved under International and Pan-American Copyright Conventions. No part of this book may be reproduced in any form or by any electronic or mechanical means, including information storage and retrieval systems, without permission in writing from the author. The right of Allan Small to be identified as the author of this work has been asserted. This book was prepared solely by Allan Small, who is a registered representative of HollisWealth™ (a trade name and division of Scotia Capital Inc., a member of the Canadian Investor Protection Fund and the Investment Regulatory Organization of Canada). The views and opinions, including any recommendations, expressed in this book are those of Allan Small alone and not those of HollisWealth. The Allan Small Financial Group is a personal trade name of Allan Small. Contact Allan Small at: email: [email protected] website: www.allansmall.com Cover & Book Design by Angel [email protected] Printed in Canada Library and Archives Canada Cataloguing in Publication Small, Allan, 1972-, author How to profit when investors are scared : buy low, sell high / Allan Small. Includes index. ISBN 978-0-9937169-0-4 (pbk.) 1. Investments. 2. Rate of return. I. Title. HG4521.S568 2014 332.6 C2014-901323-X How to Profit.indd 4 2014-04-10 5:13 PM This book is dedicated to my best friend — my wife — and my children. Without your support and understanding I could not go to work each and every day. I have said many times that what I do for a living is not a job, it’s a lifestyle. Without the support of my family, being the investment advisor I want to be and writing this book would not have been possible. Thank you. To all the other people who have influenced my life and the creation of this book, I thank you as well. I couldn’t have done it without you. How to Profit.indd 5 2014-04-10 5:13 PM Contents Preface9 Introduction 11 1 “Buy Low, Sell High” — What Does It Mean? 13 2 Simple Rules of Investing 21 3 Styles and Methods of Investing 28 4 Six Common Mistakes Investors Make 35 5 Stock Market Events That Investors Can’t Control 43 6 Volatility: How It Affects Investors’ Decisions 51 7 How to Grow Your Portfolio in Volatile Times 59 8 The Effects of Interest Rate Changes 66 9 Diversification: The Best Way to Protect Your Money 74 10 Investment Choices 83 Conclusion 93 About the Author 94 How to Profit.indd 7 2014-04-10 5:13 PM Preface My investment philosophy is based on providing sound advice and great service to my clients. In my world, investing is not gambling. From a numbers perspective, a sensible strategy is always available. I am a bottom-up value investment advisor. I buy investments if I think they represent good value and are good value. I use fundamental and technical analysis to locate and invest in good-quality companies. I hold an investment until my desired target price is reached and then I begin selling to realize the profits. I am a very patient investor, with my finger on the pulse of the market at all times! I have access to many products and no bias towards any of them. I create every portfolio from the beginning, with the investor’s objectives, risk tolerance, and time horizon in mind. All recommendations are customer specific — I refuse to categorize investors into groups that all get the same portfolio. I monitor the markets very closely, as I believe it is very important to spot trends quickly in order to advise my clients accordingly and in a timely manner. When an investor works with me, they are always dealing with the final decision-maker on their portfolio. I believe in not only recommending investments to my clients but also educating them as to what they have and why they own it. And I make sure to provide full transparency with regard to fees and any other matters at all times. — Allan Small 9 How to Profit.indd 9 2014-04-10 5:13 PM Introduction Most investors are familiar with the phrase “Buy low and sell high.” However, how many of them actually do it? For many people, buying when the market is at a low point is very hard to do. It takes an iron stomach to purchase equity investments when many are predicting that the doom and gloom in the stock market will persist. It is a lonely feeling to be buying when many individuals are exiting their investments. At the same time, exiting an investment when everyone is euphoric can be just as difficult. When everyone around you, from your next-door neighbour to your best friend, is buying into an investment, it becomes very hard for you to imagine selling it. You fear that the investment will continue to go higher and you will miss out on further gains. Thus, most investors end up doing the opposite of buying low and selling high. Many individuals buy when an investment has already gone up significantly, based on the hype surrounding it, only to sell when the value falls, after everyone else has taken their profits. Thus they are actually buying high and selling low! This book discusses the reasons why many investors fall into the trap of buying high and selling low. It talks about what influences people to buy at the wrong time and to sell after it is too late. I go over the signs and economic data that investors should be looking for so they can recognize a good time to buy an equity investment. 11 How to Profit.indd 11 2014-04-10 5:13 PM The book also discusses the different types of investments that individuals can buy, describing important concepts and methods of investing — including when buying high can make sense. Many of the ideas communicated in this book come from real-life conversations with my clients. My insights into how people think have come from many discussions over the past 15 years in my dealings with investors who represent a wide range of portfolio sizes and risk tolerance. My hope is that all the people who read this book will take away from it at least one useful idea that they can relate to their own investment experience and benefit in some way from it. 12 How to Profit.indd 12 2014-04-10 5:13 PM Chapter 1 “Buy Low, Sell High” — What Does It Mean? Investors who buy low and sell high could be called contrarians. They buy when prices are low — which usually means the investment they are buying is out of favour or being sold by investors — and they sell when an investment has had a great run and is still loved by many. This is contrary to what seems natural for many investors. We know that timing the market is difficult because investment decisions are often clouded by media hype and other emotional influences. Contrary to what people may believe, the point of maximum financial risk is when everyone is euphoric about an investment or the stock market in general. And the point of maximum financial opportunity is after capitulation, or when everyone has “thrown in the towel.” The motto “Buy low and sell high” encompasses this idea. The mindset of consumers is totally different when it comes to investments that are on sale versus buying, for example, an item of clothing. For some reason, investments are possibly the only thing that people don’t like to buy when they are on sale. If the price was reduced for a good-quality sweater at your favourite clothing store, would you buy it? Or would you question why it 13 How to Profit.indd 13 2014-04-10 5:13 PM Allan Small was on sale and cheaper than similar items in the store, and simply walk away? A wise shopper would probably check out the sweater to make sure it’s in good condition, with no flaws, and then purchase it, especially if it is high quality. Why should an investment be any different? If investors discover a good-quality investment on sale for 25 or 30 percent, they should treat it like a beautiful item of clothing. They should examine its quality to make sure there is nothing wrong with it and then move ahead with the purchase. Smart investors wait for good-quality investments to go on sale so they can buy in at bargain low prices, then eventually sell them at higher levels. Many investors like to see an investment move higher before they will consider making an effort to own it. They tend to choose the hot investment of the week, month, or year instead of the best up-and-coming investment. By nature, people look for confirmation when buying an investment: they want to see that it is moving higher in value before they buy in, confirming that it’s the right thing to do before taking that leap of faith. How silly does it sound to wait for an investment to move higher before deciding to own it? That’s like closing the barn door after all the animals have left. Contrarians act in the opposite fashion. Contrarians tend to call themselves “value investors,” which means that they will not take a position in an investment unless they believe it represents good value. Value investors know that they are buying an invest14 How to Profit.indd 14 2014-04-10 5:13 PM HOW TO PROFIT WHEN INVESTORS ARE SCARED ment at a low point and at good valuation by analyzing the economic data about that investment. The standard most often used to measure whether an investment represents good value is the PE ratio — P stands for the price of the shares and E represents the earnings of the company. The PE ratio is used most often when comparing stock prices of various companies. By comparing the price the shares trade at versus the earnings of the company, you can see if the shares represent good value. You can also compare PE ratios of stocks in the same sector, between peers and competitors. Historically, PEs of 10 or less have usually attracted the interest of investors. However, if many stocks in the same sector are trading at a price-to-earnings ratio of 10 or less, this may mean that the entire sector is cheap, or possibly struggling. To truly determine if a stock is cheap by using the PE ratio as a measuring stick, you must either compare the PEs of different companies or compare the companies with a benchmark. Some analysts take the PE ratio one step further and add a growth component to it. They look at the price of the stock versus its earnings versus its growth — this is referred to as the PEG ratio. A stock with a PEG ratio of less than 1 is usually considered to be good value. All investors want to know that the investment they are buying is cheap and a good value to buy, so they use tools such as the PE or PEG ratio to help them make their decisions. However, there are times when an investment may look good but you find yourself buying 15 How to Profit.indd 15 2014-04-10 5:13 PM Allan Small into a value trap! The share prices of some of the largest and most famous companies have at times seemed really cheap, only to become even cheaper over time. I have seen many companies appear to represent good value, only to find out shortly afterwards that they are trading at those depressed levels for a negative reason. Thus, buying an investment at a low is not quite as simple as comparing PEs between two companies and purchasing the lower one. You should dig deeper into the fundamentals to find out whether the company truly should be trading at those lowered levels. Perhaps the fundamentals won’t look so good, or the company is in a sector that has fallen out of favour for valid reasons. These “value investments” would be anything but good value. Contrarians and value investors, whose strategy is to buy at low prices and sell when something becomes fully valued or reaches a high price, do not believe in the passive method of investing — the “buy and hold” style that we’ve heard so much about for the past thirty years. Good active management tends to outperform passive management in volatile or difficult markets. When markets are performing well, everything tends to move higher — as the saying goes, a rising tide lifts all boats. Thus, in a good market, active investing can sometimes underperform the indices. However, investing passively in an index does not afford the opportunity to buy when times are tough and prices are low, or to sell when prices move higher. You own the index, in which the investments are already chosen for you, and very rarely 16 How to Profit.indd 16 2014-04-10 5:13 PM HOW TO PROFIT WHEN INVESTORS ARE SCARED does the index change its makeup. Thus the strategy of buying at low points and selling higher is made difficult by this passive approach to investing. The buy-and-hold strategy, which was made famous by the likes of Warren Buffett, has come under attack over the past decade. Today more than ever before, as volatility becomes more prevalent, investors have noticed that simply holding an investment and hoping it will move higher over time is not really a valid strategy. How many times during difficult markets have people been told to hold on to their investments and eventually they will make back the loss or go higher? Unfortunately, it doesn’t always work that way. It may take years before an investment moves significantly higher, and in the meantime you’re just sitting around waiting. Sometimes it is better to sell an investment at a loss and reinvest the proceeds in something else if the new one will move higher more quickly than the previous one. Most investors don’t like selling at a loss, but it can make more sense than waiting a long time for the investment to make its way back to break-even. Over the ten years between 2003 and 2013, the Dow Jones (the major US index) passed through the 10,000-point mark — both upwards and downwards — more than six times. Most of those times occurred between 2008 and 2010. Someone who remained invested in the Dow index throughout that time would have made virtually no money, as any gains were quickly followed by losses (and losses quickly turned into 17 How to Profit.indd 17 2014-04-10 5:13 PM Allan Small gains). However, for investors who took a more active approach, it would have been possible to make money by buying good-quality investments and then setting price targets to determine when to sell. If investors don’t at some point sell their winners and realize their gains, they run the risk of those investments falling back once again and losing out on their gains. Buy How To Profit When Investors Are Scared Today either soft copy book or ebook at the following booksellers click on the logos to go to their stores 18 How to Profit.indd 18 2014-04-10 5:13 PM ALLAN SMALL is Senior Investment Advisor of the Allan Small Financial Group with HollisWealth. He holds the professional designations FMA (Financial Management Advisor) and FCSI (Fellow of the Canadian Securities Institute) and has completed accreditation courses in Professional Financial Planning (PFP) and Wealth Management Techniques (WMT). Previously a financial advisor with Royal Trust and an investment advisor with Edward Jones, he has been an investment advisor with HollisWealth (formerly DundeeWealth) since 2002.Allan has extensive media experience as a guest speaker on financial matters, with appearances on the Business News Network (BNN), CP24, CTV News Channel, 680 News Radio, City News, and Sun TV. He was formerly a weekly columnist for the Metro newspaper online edition. Allan Small can be reached by email at: [email protected] Or visit his website at: www.allansmall.com 94 How to Profit.indd 94 2014-04-10 5:13 PM