Topic: Value Stocks
Conservative Investing as an Investment Strategy
A conservative investing approach means building a well-balanced portfolio gradually, over time
Conservative investing is an investment strategy that involves a focus on lower-risk, predictable and stable businesses. This strategy typically involves the purchase of blue-chip stocks and other low-risk investments. A conservative investing approach also means building a well-balanced portfolio gradually, over time. The number of stocks in your portfolio will depend on where you are in your investing career.
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Some rules can undermine your conservative investing decisions at crucial moments
Look beyond price in deciding when to sell your conservative investments
When investors ask us about our conservative investing strategy, they often wonder when they should dump a weak stock from their portfolio and replace it with something new.
There is no simple formula for deciding when to sell a weak performer, regardless of whether you follow an aggressive or a conservative investing strategy. But there are some helpful guidelines.
First, you’re never going to sell at the top or buy at the bottom. That’s why we’re so selective about the stocks we recommend in our newsletters. The better the quality of the investments you buy, the less you have to lose by failing to sell.
In fact, regardless of whether you practice aggressive or conservative investing, the quality of your investments matters much more than your skill at selling.
Second, you should be quicker to sell aggressive stocks than conservative investing picks. With stocks we rate as “Speculative” or “Start-up,” it pays to apply our sell-half rule. That’s when you sell half of a stock that doubles in price.
Keep long-term conservative investing goals in view
In our view, your goal as an investor, particularly if you follow a conservative investing strategy like the one we recommend, is to make an attractive return on your investments over a period of years or decades. Failure means making bad investments that leave you with meagre profits or losses.
Unsuccessful investors can still make some profits. They just don’t make enough to offset the inevitable losses and leave themselves with an attractive return. If you focus on the idea that you never go broke taking a profit, you may be tempted to sell your best investments whenever it seems the investment outlook is clouding over.
On occasion, you may succeed in selling just prior to a major downturn, and buying back at much lower prices. More often, prices will soon hit bottom and move up to new highs. If you buy back, you’ll pay higher prices. If you had followed this strategy with Canadian bank stocks, for example, you could have missed out on some big gains over the years.
In hindsight, market downturns are easy to spot. Spotting them ahead of time is much harder, and impossible to do consistently. After all, if you could consistently spot market downturns ahead of time, you could acquire a large proportion of all the money in the world, and nobody ever does that.
The problem is that you’ll foresee a lot of market downturns that never occur. All too often, the market-downturn clouds disperse soon after skittish investors have sold. Good reasons to sell do crop up from time to time, of course, even if you follow a long-term conservative investing approach. But “You’re never go broke taking a profit” is not one of them.
Why you should be very wary of index-linked GICs
Index-linked GICs maximize the promises but minimize the payouts.
Index-linked GICs (guaranteed investment certificates) provide the buyer with a return that is “linked” to the direction of the stock market in a given period. A quick look at the rules on these deals may give you the impression that the investor can profit substantially with little risk. However, the link depends on a formula or set of rules that is buried in the fine print.
These investments are marketed as offering all of the advantages of stock-market investing with none of the risk. But banks and insurance companies aren’t in the business of giving customers something for nothing. The capital gain that holders get depends on an ingenious formula which is cleverly designed to sound generous while minimizing the potential payout.
For instance, the payout may depend on the average level of the index over the course of a year, rather than the year-end value. This will tend to diminish the performance that determines investor returns.
Index-linked GICs fail to offer the big tax advantages of stock investing.
Another drawback is that returns on index-linked GICs are taxed as interest. That’s because you’re not actually investing in the stock indexes themselves; you’re just getting paid interest based on the change in the indexes. That’s a drawback because interest is the highest taxed of all investment returns.
Usually, stock-market investing produces capital gains and dividend income, both of which are taxed at a much lower rate than interest. (Of course, if you hold the GICs in an RRSP, all income is tax deferred.)
These GICs do protect your principal. But few investors if any make a good return on index-linked GICs. Most make less (at times substantially less) in index-linked GICs than they would have made in old-fashioned GICs.
5 easy investment tips for better long-term returns from conservative investing
- Be skeptical. No matter how attractive they may seem, always take a skeptical approach to investment products that add an extra percentage point or more to your yearly costs. Make sure the expense is worth it.
- Understand compounding, It’s how your personal wealth grows. Compound interest is earning interest on interest. Over time, your long-term investments will earn more and more money from the effects of compound interest. Compound interest is what makes investing a worthwhile pursuit.Compound interest is applied to dividend-paying equity investments like stocks, as well as to fixed-return, interest-paying investments like bonds. When you earn a return on past investment returns (including dividends), the value of your investment can multiply. Instead of rising at a steady rate, the number of dollars in your portfolio will grow at an accelerating rate. It’s very important to keep an eye on investments or expense fees that affect the amount of interest you earn. Even 1% a year can be huge drain on your portfolio.
- Seek dividends in your investments. If you’re new to investing, one tip we share often is to invest in companies that have been paying a dividend for 5 or more years. Dividends are typically cash payouts that serve as a way for companies to share the wealth they’ve accumulated. These payouts are drawn from earnings and cash flow and paid to the shareholders of the company. Typically these dividends are paid quarterly, although they may be paid annually or even monthly as well. Canadian citizens who own shares in Canadian stocks that pay dividends will also benefit from a special tax break they may be eligible to receive.
- Don’t take advice that comes from advisors or institutions that sell insurance or other fee-heavy investment/financial products. The financial software they use just naturally spits out investment plans that involve the kind of sometimes-hidden costs in point 1.
- Only buy bonds or other fixed-return investments if interest rates are high enough to be attractive. Don’t buy bonds just to “cut your risk.” Adding bonds to the mix will simply cut the volatility of your portfolio value in any given year. But it does so at the cost of increasing your risk of loss to inflation.
How conservative investors can add low risk investments to their portfolio
Low risk investments equate to safer investments. For conservative investing, focus on investing in high-quality stocks that offer hidden value.
These assets include long-time real estate holdings that are worth much more than their balance-sheet value (usually original cost minus depreciation). Under-used brand names are another good example. When they are developed in-house, they won’t show any balance-sheet value. Another key hidden asset—one of our favourites is research spending. Companies write off their research outlays in the year in which they spend the money, but benefits such as new or better products may only materialize years in the future.
- Well-established companies are the key to profitable and low risk investments Instead of moving between extremes of risk, we continue to think investors will profit most—and with the least risk—by buying shares of well-established companies with strong business prospects and strong positions in healthy industries. That’s not to say that there won’t be surprises that affect every company in a particular industry. But well-established, safety-conscious stocks have the asset size and the financial clout—including sound balance sheets and strong cash flow—to weather market downturns or changing industry conditions. You can get our advice on investment issues, plus buy/sell/hold advice on stocks you may be considering buying in our Successful Investor newsletter.
- Be skeptical of companies that mainly grow through acquisitions when seeking low risk investments Making acquisitions can speed up a company’s growth, but it also adds risk that can undermine a conservative, safe investing approach. Great acquisitions are rare finds. Many acquisitions come with hidden problems or risks, or they turn out to have been over-priced. Despite the risks, some acquisitions turn out hugely profitable. So, your safe investing strategy shouldn’t automatically discount companies that have grown through acquisitions. Just keep the risks in mind, and avoid companies that seem unaware of them.
- Take a broad view when looking for low risk investments When we’re looking for the best investments to recommend in our newsletters and investment services, we start by putting all the important information we know about a company into perspective. But things are never quite so simple. Your stock pick’s latest earnings may reflect unusually favourable or unfavourable conditions. This can make the company look safer or riskier than it really is. In addition, the company may put the funds it borrowed to immediate profitable use, increasing its earnings and its ability to pay interest. It may plan to sell assets to reduce debt, or cut costs to increase earnings.
5 more powerful long-term investment strategies for higher returns
Here are five long-term investment strategies that we are certain will enhance your long-term investment results.
- No stock can ever be so undervalued or desirable that it overcomes a lack of integrity on the part of company insiders
We’ve always believed that investors should sell a stock if they have any doubts about the integrity of the people who are in charge of the company. In other words, if you think a company is run by crooks, you should sell the stock right away, no matter how attractive it seems as an investment.
- Compound interest—earning interest on interest—can have an enormous ballooning effect on the value of an investment over the long-term
Compound interest can be considered the mother of all long-term investment strategies. This tip is especially important for young investors to learn. This stock trading tip’s benefits apply to both stock and fixed-return, interest-paying investments, like bonds. When you earn a return on past returns, the value of your investment can multiply. Instead of rising at a steady rate, the number of dollars in your portfolio will grow at an accelerating rate.
- As a group, investment long shots are overpriced.
If you have nothing but long shots in your portfolio, you are likely to make meagre returns or lose money over long periods, rather than making the high returns you seek. That’s why you need to be particularly cautious and selective when adding anything to your portfolio that offers the potential of high returns. This advice is especially applicable to new investors, who may seek outsized returns from investments such as IPOs, penny stocks and stock options. These market vehicles are certain to hold you back from long-term investment success.
- Financial incentives have an enormous impact on the beliefs of otherwise honest people.
That’s particularly true when it comes to what purveyors of investment products are willing to say in order to spur you to buy something. Failing to spot these conflicts of interest can be very damaging to your investments. We’re not just talking about stock brokers. As the saying goes, never depend on your barber to tell you that it’s too soon for you to get your hair cut.
- The markets for fungible goods like oil, interest rates and gold are inherently unpredictable.
Markets like these are so enormous that there is no practical limit to how much you can trade in them. It follows that if you could predict them, you could wind up acquiring a measurable proportion of all the money in the world, and nobody ever does that. That’s why it’s a mistake to build your portfolio in such a way that you have to accurately predict the future direction of fungible goods like oil, interest rates or gold. The key to being a Successful Investor is to invest in well-managed companies. The unpredictability of the market facilitates the need for this rule. Well-managed companies can weather financial downturns and bear markets better than other companies.
Follow our three-part Successful Investor strategy
- Invest mainly in well-established companies;
- Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; the Consumer sector; Finance; Utilities);
- Downplay or avoid stocks in the broker/media limelight.
Do you have conservative investments How have they performed? Share your experience with us in comments.
This article was originally published in 2017 and is regularly updated.
