U.S. vs Canadian Market

I know that about 50% of my readership is American and 40% is Canadian. I keep getting questions about the benefits of investing on both sides of the border depending on where you live. The question makes sense regardless if you are North or South of the US Canada border: should you invest in the U.S. market? The answer is yes. Should invest in the Canadian market? the answer is yes as well. For the sake of diversification and because both markets are completely different, I think it’s a great opportunity that we can invest on both sides of the border with minimal consideration.

Investing in the U.S. market for 3 reasons

The very first reason why anybody would want to invest in the U.S. stock market is because it is the biggest market in the world. This implies lots of great benefits such as:

  • A highly liquid market (the market value makes sense and it is easy to cash your investment)
  • A transparent market (chances of fraud still exist, but are highly diminished by many regulations in place)
  • A “stable” market (while market volatility is part of any investor pain, the U.S. market is definitely less volatile than emerging markets)

Investing in the biggest world market gives additional security to investors. It comes with the largest choice of companies in the largest number of sectors possible. This is the perfect place to start building your core portfolio.

The second reason to invest in the U.S. stock market is to benefit from international markets’ growth perspectives without having to take additional risk. Companies like Procter & Gamble (PG), Pepsi Co (PEP), Coca-Cola (KO), Johnson & Johnson (JNJ), 3M Co (MMM), Colgate Palmolive (CL), etc. are present in many countries around the world and generate roughly 50% of their revenues overseas.  You can then invest in the U.S. market in companies you know and easily get information while a large part of their revenues comes overseas. This benefit allow you to avoid additional taxes charged on dividends income from international companies, worry about currencies (we will cover this topic later as it deserves a full section) and the difficulties getting timely information you need.

Finally, the third reason to invest in the U.S. market is the pool of high quality dividend paying companies. This is the only market where you can find in 2017;

  • 18 Companies with 50+ years of consecutive dividend increases (Dividend Kings)
  • 50 companies with 25+ years of consecutive dividend increases (Dividend Aristocrats)
  • 272 companies with 10+ years of consecutive dividend increases (Dividend Achievers)

This is like heaven for any dividend growth investor. You obviously can’t count on past performance to guarantee the future (I’m sure you have read this before, right?), but it gives you a very strong start to build your watch list.

Why do you need the Canadian market then?

If you are Canadian, you will obviously invest in your own market for simplicity, the currency factor and tax purposes. However, is there a definite advantage for anybody else to invest in the Canadian market? There is more in this market than you think!

First, there are sectors paying higher dividend yield than anywhere else in the world. Regulations have created two special dividend pools in the financial and telecom sectors. The financial sector includes an elite group of 5 Canadian banks (Royal Bank (RY), TD Bank (TD), ScotiaBank (BNS), CIBC (CM) and BMO (BMO)) paying yields between 3.5% and 5% most of the time. The best part is that Canadians banks have beaten the TSX total return over the past 20 years. The second sector that is also protected by federal regulation is the telecom industry. Telus (T), BCE (BCE) and Rogers Communications (RCI.B) control over 80% of the market in Canada. Barriers to entry are very strong offering a unique opportunity to these companies to pay a strong dividend to their shareholders. All companies mentioned in this paragraph are also trading on the NYSE under similar tickers (Telus is the only exception as it trades under TU on the U.S. market).

Second, the Canadian market also offers great opportunities for income seeking investors in the oil & gas industry along with REITs. Both sectors have been part of the Canadian core economy for several years. The oil & gas sector offers higher volatility, but with additional growth perspectives as well. On the other hand, REITs are quite stable income generating vehicles with limited growth potential. Both industries can serve an interesting place in your portfolio while you look for additional diversification.

If you are Canadian, I think it would be wise to invest 50% of your portfolio in the U.S. market. I personally have 65% of my portfolio invested in the U.S. market. If you are American, I think it would be fair to invest between 10% to 20% of your portfolio across the northern border. This would help increase your dividend yield without adding any more risk.

Should I keep cash in my portfolio?

Another great question that comes with portfolio management is the question of liquidity. Some investors advise to keep 5%-10% in cash in order to seize opportunities. Others will advise to keep a higher amount around 25%-30% in cash to avoid market crashes and be ready to pick-up the market when it is at its lowest.

I personally think you should keep lower than 2% of your portfolio in cash.

I’ll explain you why in a minute. But first, let’s take a look at the theory of keeping an important amount of cash in your portfolio.

Seizing opportunities

Interesting enough, there are lots of pessimists investing in the stock market. Those people are always looking for the next market crash, the next recession to invest their money. They think they are able to make a better return if they “time” their entry in the stock market.

We have already demonstrated that time in the market is more important than market timing. The problem is that it’s nearly impossible to know when the market is about to drop or jump. Therefore, it is a safer strategy to stay the course and ride the market as long as you can.

Now, if you do not have intention to time the market, but rather use lump sum investments during down time, it might make sense in a few occasions. For example, if you receive a sizeable amount of money to invest (an heritage, sell of another asset or a bonus received at work for example), you might want to wait for the next 10% drop of the stock market. Since this happens on a relatively steady basis, you may end-up waiting only a few months or a year before going in the market. This is probably a strategy that is worth it… as long as the market goes down. For example, if you were in this situation in early 2012, there wasn’t a 10% drop before September 2014… after the market went up by 55%. Even after a 10% drop, you still “lost” 45% of market return by waiting on the side lines:

 

Source: Ycharts

This is the main reason for me it doesn’t make sense to have an important amount of money waiting on the sideline: the downside of missing a bull market is more important for me than getting into a bear market. This is even hard to capture a bull market as only 3 calendar years shows losses over 10% over since 1988:

Source: ycharts (note that 2000 shows -9.10%).

In other words, you would need to follow the market closely to identify the 10% drops during a year as a yearly check-up is not enough to capture any market drops. Chances are you would need to check the market every 2 weeks to make sure you capture one (remember how fast the market recuperated from the Brexit of 2016?). Do you have this much time to spend on your portfolio?

Let the dividend payment convince you

The other reason why I prefer to invest almost 100% of my money at all time is the payment of dividends. Imagine dividend stocks in your portfolio generate 3% on average. This is a very easy yield to achieve for any dividend investors, but I rather use conservative numbers (plus you know my affection for low dividend yield stocks). This is a 3% cheque you receive on a yearly basis no matter what is happening on the stock market. This is quite a good payment to keep you waiting and doing nothing. Does your money market fund is that generous?

If you are not in a hurry to cash your investment, letting dividends getting paid and compounding in your portfolio is a much better investing strategy than waiting to capture a 10% stock market loss. As you can see on the previous chart, the stock market rarely stayed in the red very long. Therefore, if you are patient enough, you will not only see your initial portfolio value gaining in value, but you will also get paid a juicy yield in the meantime. And this, off course, is during the worst investing case scenario where you would enter the day before the market crash. On the other side, if you invest at the beginning of a bull market, your return will only get stronger.

Do you still have any doubts by now?

 

Time Horizon and Risk Tolerance

Risk is a crazy thing. Take on too much and you either crash and burn or make out like a bandit. Take on too little and you either just float along or make out like a bandit. The “trick” is figuring out the happy medium that you will be comfortable with. I have spent some time determining what my risk profile is and have asked myself several questions…

  • Do I prefer stability over high returns?
  • How can I make money without risking too much?
  • Do I feel bad when all my friends are making double digit
  • returns and I’m not?
  • My Portfolio is down by 27% (2008), it hurts… how bad
  • does it hurt?
  • Should I sell my stocks and change my strategy?
  • When is the right time to invest in the market? I don’t want
  • to invest right before a crisis!

The funny thing is that I don’t have the same risk profile depending on why I invest. Therefore I have different answers to these questions depending on which account I invest in. For example, my retirement account is fairly aggressive. Therefore, when I invest in my retirement account, I’m 100% invested in stocks. I’m in the stock market for the long run and I don’t fear a market crash.

On the other hand, I’m also putting money aside for my kids’ education. I’ve added 25% of fixed income to this portfolio because I don’t want to risk losing too much in this account. Furthermore, I’m also saving money for my nephew’s education. Since this money is set aside for a gift, I have put 75% in fixed income and the rest in equity. As you can see, I manage three portfolios from 100% in stocks (retirement account) to as little as 25% in stocks for my nephew.

The time horizon for your project (that you previously defined) will also affect your investor profile. If you plan a trip in 9 months, skip the stock market and put your money in a savings account. If you are about to retire, you can still take a good amount of risk as chances are you will be living off your investment for 30 years (I bet you didn’t think of this one, huh?).

For each account, you should ask yourself the same question. Contextual reasons may encourage you to take more or less risk. Here’s a quick definition of different investment profile:

Conservative:

You have a need for a predictable flow of income or have a relatively short investment horizon. Your tolerance for volatility is low and your primary goal is capital preservation.

Moderate:

You seek a regular flow of income and stability, while generating some capital growth over time. Your tolerance for volatility is moderate and your primary goal is capital preservation with some income.

Balanced:

You’re looking for long-term capital growth and a stream of regular income. You’re seeking relatively stable returns, but will accept some volatility. You understand that you can’t achieve capital growth without some element of risk.

Growth:

You can tolerate relatively high volatility. You realize that over time, equity markets usually outperform other investments. However, you’re not comfortable having all your investments in equities. You’re looking for long-term capital growth with some income.

Aggressive:

You can tolerate volatility and significant fluctuations in the value of your investment because you realize that historically, equities perform better than other types of investments. You’re looking for long-term capital growth and are less concerned with shorter term volatility.

Action of the day: Setup your investing profile

To answer this tricky question, there is nothing better than answering a questionnaire. I’m sure you have answered this sort of thing before. They seem cheesy sometimes but trust me; it will help you put things into perspective. Based on my experience, I feel that most people believe that they are braver than they are! The real investor in you tends to show up when the market crashes. Speaking of which, I found this investor questionnaire over @ Vanguard . I’m in no way linked or paid by this group to refer you to their risk profile questionnaire. I just find it is one of the best around since they help you relate to 11 questions that include practical facts that happened in 2008. With no surprises, I finished mine with a 100% stock profile:

What’s yours?