In the wake of the dire market crash of October-November 2008, many analysts have talked about investments and investors – almost as though the two words are synonymous.

But they’re not. In my experience, there’s a dramatic gulf between “investment performance” and “investor performance.” The former has to do with markets; the latter has to do with human behaviour, which is tricky and unpredictable.

Let’s talk first about investments. We’re often drawn to stocks based on their past performance, which we hope will predict their future performance. For example, in 1946 the S&P500 stock index stood at 19 points. Today, it’s 1350 points. That means an investor who put $10,000 into the S&P500 back then, and re-invested dividends ever since, has about $1,350,000 today. That sounds pretty good, an impressive history.

The problem is, though, that investors are often too jumpy to hold on for the long term. They tend to buy stocks when things look good, and sell them when things look bad. At the stock prices of today, which will soon be recognized as part of the trough of this particular bear market, investors are liquidating hundreds of billions of dollars of equities.

Investors typically pile into stocks when times are good, and then abandon them when times are bad. This only has to happen once or twice to create the yawning chasm that exists between investment returns, and investor returns.

One expert who’s analyzed this phenomenon is Jeremy Siegel, in his book Stocks For The Long Run. He points out that annual returns on stocks are actually far more consistent than returns on treasury bills – provided you’re willing to measure over 20-year periods. The market returns on large-cap U.S. stocks are approximately 10.8%, compounded every two decades over the last 200 years.

But that 10.8% is way, way bigger than the return most investors receive over the long haul. Dalbar, a Boston financial research firm, estimates that investors earn only a little over 3.5% over a similar time frame. As you can see, there’s a big difference between the two numbers. Where does the other 7.3% go?

We’ve all heard the simple adage “buy low, sell high.” Unfortunately, it’s easier to repeat than it is to actually follow. Consider the awful experience of late 2008, one we’re still feeling the effects of. The world’s financial system was brought to a near collapse by a credit crisis that no one really saw developing – a crisis created in the boardrooms of financial institutions around the globe. The fall in real estate prices was the catalyst for the eventual collapse, which brought banks and even governments to their knees.

In that kind of environment, you might well have nervously wondered: “Should I hold onto my stocks, or sell out?” Most investors answered in the negative. They voted with their feet and sold out of equity markets, likely close to the bottom. Some, though not all, may one day buy back their investments – probably for above-average prices.

The pain investors feel in response to wildly gyrating markets is very real. For those who rely on their investment returns for income, such as retired people, these are difficult days indeed. In such times, it’s completely normal to feel insecure and depressed about your investments – and completely inadvisable to actually act on those feelings.

Just tell yourself firmly that the world has been through financial crises before – and has always recovered. Think back to WWII, or the Cuban missile crisis of 1962, with its threat of imminent nuclear annihilation. Yet if we look at average stock returns since those traumatic times, they’ve been just as usual: 11% compounded. The market is like a ship that always rights itself, even though panicked investors may already have thrown themselves overboard.

Consider one of the smartest guys in the financial world: “the Sage of Omaha,” Warren Buffet. Back in a 45-day period in July and August 1998, Buffet – like many others – was caught in an extreme market turndown. On paper, he “lost’ more than six billion dollars. Except he didn’t actually lose a single dime: he just held tight to his investments, and waited for the market to correct itself – which it did.

Alan MacDonald an Investment Advisor with Richardson GMP Limited, helps investors with over $500,000 of assets make smart decisions about money. Alan is the co-author of “The Copperjar System, Your Blueprint for Financial Fitness” available on Amazon.

Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.

The good news, for all those who love life, is that every generation has lived longer than the previous generation. This generation of baby boomers will be no different. We will, on average, live longer than any generation that came before.

When the clock struck midnight on December 31, 1899, the average lifespan was less than 50 years. Today, it looks like most of us will live into our 80s. In fact, I happened to be at a speech given by a prominent medical scientist who claimed everyone in the room had a pretty good chance of making it to 100 years old. We are sitting at the doorsteps of so many advances in medical science. Many of the things that used to do us in will simply be cured by the time it’s our time.

The flip side of this ample lifespan is that we have to fund long retirements. It’s no fun being old and broke, so making your money last is a big deal. If you have taken a look at what it takes to produce income from capital over a long period, you know that the three great risks are inflation, outliving your money and losing money.

One of the arguments for stocks in a senior’s portfolio is that you need growth even after you retire. Since inflation takes away half of your money every 20 years, your portfolio will have to double between the age of 60 and 80 just to keep its purchasing power. If you are drawing income from that portfolio at the same time, it usually takes a pretty big return number to make it all work.

As financial planners, we will often encourage a mix of stocks and bonds to reach a higher rate of return.

Let’s say the required rate of return to reach your goal is 7%. A return of 7% should be fairly easy to achieve with a good balanced portfolio. A portfolio of 50% stocks and 50% bonds will normally do the job.

Markets, however, often do not co-operate with our financial projections. While it is true that you might average 7% over a 15-year time frame, you can have pretty wide swings in returns along the way.

The S&P 500 index, an index composed of the 500 largest companies in the U.S., sat at 1,500 at the end of 1999. Today, this same index sits at 1,350. So the 8-year return on this index is negative 10%. If you care to get more depressed, you can consider the appreciation of the Canadian dollar against these U.S. stocks. A Canadian investor in large U.S. stocks has lost over 40% to currency over the same 8-year time frame.

The investor who, in 1999, bought a portfolio of world-beating U.S. stocks as a retirement strategy, and then took 5% per year for income, is likely broke today.

They are broke in spite of the fact that large U.S. stocks averaged 11% per year over the last 200 years.

So how do you avoid this potential pitfall of stock market returns disappearing just when you need them the most? We still need growth in our portfolios to defeat inflation, and we still need a portfolio that will last through retirements that can span 30, even 40 years.

The first step is not to rely on long-term assets, like stocks, to satisfy short-term needs such as income. Stocks become reliable over periods of 10 and 20 years. So whatever income you are going to need over the first 10 years of your retirement should not be in stocks.

One strategy is to take the amount of income you need and put it into a ladder of bonds or GICs. A $50,000 per year income would see you buying 10 bonds that mature at $50,000 per year for the next 10 years.

Once this income stream has been protected, you can now invest the balance, or a reasonable portion of your portfolio, for growth. To increase your safety, you might consider adding some growth investments which are not stocks. Pension funds, for years, have used real estate and private equity to get returns that are as high, or higher, than stocks. Private equity and real estate take their dips like any other equity investment, but the timing of the dips will be different from stocks.

The best retirement portfolio is one that is allocated according to time frame. Your short-term income needs in short-term investments like GICs or bonds. Long-term growth allocated to long-term investments like stocks, private equity and real estate.

Alan MacDonald an Investment Advisor with Richardson GMP Limited, helps investors with over $500,000 of assets make smart decisions about money. Alan is the co-author of “The Copperjar System, Your Blueprint for Financial Fitness” available on Amazon.

Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.

I met with a potential new client and his business advisor a few weeks ago. The client, an entrepreneur who had recently sold his business, was trying to decide how to invest his new fortune. He asked what my opinion was on how, when it comes to investing, to decide whether or not to stay with a particular course of action.

Before I could answer, the business advisor jumped in and said: “It’s simple. Each year, you add up everything you have, and see if the number is bigger or smaller than the previous year. If the number is smaller, get rid of the things that aren’t working.”

Now, this advisor had been working with my potential new client for about 20 years. I was eager to stay on his good side, so after running through a number of possible responses in my head, I came up with the most tactful way I could think of to express my honest opinion: “I think that is the worst advice I have ever heard.”

Not surprisingly, the client ended up accepting his advisor’s advice, and found someone who was more amenable to his “annual measuring stick” approach. I have no doubt this advisor had served his client in many valuable ways over the years. But even though it cost me his business, in this particular case, I remain convinced that the advisor was as far off base as he could possibly be.

The problem is that successful investing is a fundamentally different activity from running a successful business. Annual check-ups work well when it comes to assessing business effectiveness. This is because a year is usually long enough to tell if a particular strategy or employee is working out. If the strategy or employee is unproductive, you cut bait and move on to something that is potentially more productive.

But preserving wealth requires a completely different set of skills, routines and timeframes than it took to create that wealth in the first place. There’s nothing wrong with taking stock of your investments on an annual or even quarterly basis. You just need to be very careful about what you do with that information.

If you followed that business advisor’s strategy, for example, every year, you would get rid of any stocks that hadn’t performed well over the past four quarters. But the performance of a single stock, industry or even sector over any given 12-month period gives little to no indication of what its long-term performance will be, especially if it’s part of a balanced and diversified portfolio.

Regrettably, making bad choices based on faulty or short-term information isn’t unusual in the investment world. Just consider how most people go about making their first (often bad) investment decision: selecting the right manager.

The first thing most investors do is pore over the track records of any mutual fund or investment manager they’re interested in. They diligently check the past three months, six months or even ten years to see if the right person is steering the ship. After all, it’s only common sense that someone who had good results for the past ten years should continue to do well over the next decade or two. Right?

The answer, unfortunately, is all too-often wrong. Some very smart people crunched some very large numbers a few years back, and they figured out how long you need to measure the performance of a particular fund or manager, to determine if their success is the result of superior skill or just random chance.

The number they came up with, for a fund with an average annual standard deviation of 6% relative to its benchmark (the average standard deviation of a Canadian equity fund), was 36.

As in, 36 years. 144 fiscal quarters. 432 months of consistently beating the market, just to be 95% sure you’re measuring skill and not random noise.

I don’t know about you, but for me, 36 years is a long time to wait to find out if you’ve hitched your wagon to the right horse. From an investment point of view, that’s pretty close to an entire investing lifetime. If you pick wrong, there isn’t going to be a whole lot of time left at the end of those 36 years to regroup, and make up for past mistakes.

The worst thing about picking the wrong timeframe or parameters for measuring success is that it can lead to all kinds of counter-productive behaviour. Take the annual check-up approach as an example. If you had been following that advice for, say, the last 15 or 20 years, here’s what your investment lifecycle would’ve looked like.

In the late 1990s, you would’ve sold all of your under-performing gold, oil and banking stocks (we all know what poor investments those turned out to be), and sunk everything you had into the one surefire sector of the time: high tech.

In fact, by the time the 90’s were drawing to a close, close to 100% of your holdings would have been in technology stocks – just in time to watch your life savings get decimated by the guillotine blade that hit technology investors in the year 2000.

If you were foolhardy enough to continue with this strategy, you would’ve taken whatever was left of your fortune and looked for some new powerhouse stock on which to gamble. Based on short term performance, some of the likeliest contenders might’ve been a couple of superstars by the names of Lehman Brothers and Enron.

My advice – to you, as it was to that potential new client – is to learn to ask better questions.

Don’t ask how you can change your portfolio every 12 months to grab a seat on the latest bandwagon. Ask how you can protect the capital you’ve worked so hard to build from the forces of inflation and market volatility, or what will the cost be to maintain your current lifestyle over the reminder of your life.

The advantage of questions like these, is that they can actually be answered. The answers may not be simple. They’ll likely involve certain sacrifices, asset class selections, routines and strategies for avoiding the risks that can occur over longer timeframes. And they’ll almost certainly never tell you what stock will be next year’s top performer.

But what the answers to these kinds of questions will do is give you real information that is relevant and meaningful to you, your family, and your unique goals and circumstances. Because when it comes to investing, the right questions aren’t always obvious. And the answers to the wrong questions can often be fatal.

Alan MacDonald an Investment Advisor with Richardson GMP Limited, helps investors with over $500,000 of assets make smart decisions about money. Alan is the co-author of “The Copperjar System, Your Blueprint for Financial Fitness” available on Amazon.

Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.

No one likes to see their portfolio decline in value.

It’s only natural. After all, who wouldn’t rather watch their investments bring in nothing but an uninterrupted series of dramatic gains? The problem with this all-too natural desire, is that it can sometimes lead us to make some very bad decisions.

Psychologists will tell you that, for most people, the aversion to loss is far greater than the attraction to any potential gain. That’s why, when our portfolios decline for more than a few days in a row, we begin to feel like all the gains we worked so hard to achieve are about to slip through our fingers. So we ask ourselves, why are we stuck with these crappy investments, while all around us other investments are going up in value every day?

It’s no wonder that investors are constantly searching for some way to be sure they pick the “right” investment – namely, one that gives us all the upside of investing in equities, but which never goes down in value. A sort of risk-free, high-paying, guaranteed investment certificate.

This quest to distinguish the winners from the losers has spawned a gigantic (and hugely profitable) industry, whose only goal is to tell us which are the “best” stocks, mutual funds, money managers and analysts to entrust with our cash. “Best,” of course, meaning those that only ever move in one direction: up.

But what all those highly-paid stock pickers don’t tell you is that, when you sign on to join them in their quest, you aren’t really starting down the road to investment nirvana. What you’re actually signing on for, is the right to subject yourself to an enormous amount of unsubstantiated risk, which could seriously compromise your long-term investment results.

Why? Because as strange as it may sound, the vast majority of investors who focus their efforts on picking the “best stocks” and avoiding market fluctuations, actually end up putting themselves in far greater peril than if they’d simply left well enough alone.

The reason for this seemingly bizarre result is simple: there are two types of risk in investing, and they’re present whether you’re putting your money into stocks, bonds, gold, real estate or just about anything else you can imagine. The only real choice investors have, is whether they want to take on one of these risks – or both of them.

The first is systematic risk. This is the risk that any given asset class, such as stocks, could go up or down over time, due to the macroeconomic swings and conditions that affect the market as a whole. If you have a broadly diversified portfolio of stocks, odds are, your portfolio will go up or down when the market goes up or down. Individual stocks within your portfolio may swim against the market tides. But if your portfolio is sufficiently broad, over time, it will essentially do more or less whatever the overall market does.

The second risk is unsystematic risk. These are the risks that are unique to a particular company, stock or piece of property. Because these investments are unique, they have a tendency to go up or down all on their own, no matter what the larger markets may be doing.

Sometimes this is good. For example, if you own a piece of land and you happen to discover that it’s sitting on a massive untapped oil reserve, the value of your property would increase significantly. On the other hand, if that same patch of land turned out to be contaminated with toxic waste, it’s going to go down in value rather drastically, regardless of what the market for real estate happens to be doing.

The same is true for stocks. If you own a stock in the company that discovers a cure for the common cold, you’re about to become a very wealthy investor. But if you own shares in a company whose CEO becomes embroiled in an accounting scandal, those shares will drop in value even if the rest of the market is climbing.

The good news about unsystematic risk is that it can be diversified away. If you buy one share of one company, you’re opening yourself up to a whole world of potential risk. But if you buy 1,000 stocks across a whole range of industries and geographic regions, then you make yourself immune to the changing fortunes of any particular company.

You’ll still see drops and increases in value as the market goes up and down. But the fate of any one firm, or even country, will no longer be a significant event in your investment life.

The bad news about unsystematic risk is that people still insist on taking it. They voluntarily choose to take on both the unavoidable systematic risk of the market, as well as a healthy dollop of unsystematic risk, by concentrating all or most of their portfolio into a few single stocks or sectors.

I have no doubt that they’re doing this with all the best of intentions. They just want to protect themselves from the gyrations of the market, by making sure that their money is always in the right place, at the right time. We even have lots of names to help investors find these perfect stocks. We call them “defensive,” or “highly recommended,” or we tell them to do whatever else is currently perceived to be beating the rest of the market.

This would be a great strategy, if only there was ample evidence that any investor – even the most overpaid experts – can successfully and consistently predict which stock or sector today, is guaranteed to go up tomorrow.

Unfortunately, no such evidence exists. In reality, a whopping 90% of the experts – all those people you’re paying to tell you which stocks to invest in – fail to beat the market over the long haul. And the 10% who do outperform the market? Evidence suggests that they change pretty much every year, so this quarter’s superstar is just as likely to be next month’s deadweight.

All of this would still be okay, if the consequences of trying to pick the single “best” investment resulted in only a minor underperformance relative to the market. But far too many people who put all their eggs into a “sure thing” wake up to find those eggs permanently scrambled, when that sure thing falls to pieces over a sector downturn, the collapse of a foreign bank, or any other specific risk that no one saw coming.

Over the long haul, a broadly diversified portfolio of stocks, bonds and other securities has been proven to provide a superior rate of return over market timing or stock picking strategies, if it is held onto throughout the ups and downs of the market. Broad diversification eliminates unsystematic risk, and the chance for disaster that comes with it.

Why make it any more complicated – or riskier – than it has to be?

Alan MacDonald, an Investment Advisor with Richardson GMP Limited, helps investors with over $500,000 of assets make smart decisions about money. Alan is the co-author of “The Copperjar System, Your Blueprint for Financial Fitness” available on Amazon.

Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.

I recently attended a rather depressing presentation from a very well-known market strategist, who shall remain nameless.

The presentation wasn’t exactly terrible. In essence, it was just a re-hash of all the headlines we’ve become so painfully inundated with of late – the Greek debt crisis, European financial contagion, the stubbornly high levels of U.S. unemployment and consumer debt, the never-ending real estate doldrums, and on and on.

What struck me, though, both throughout the presentation and particularly at its conclusion, was that not once did he put any of this information into any kind of meaningful context.

By context, I mean one thing and one thing only: why should I as an investor care about any of this? What does it mean to me, or more specifically, what can I do to take advantage of it?

The doomsayers and day traders would say all of this means that the world as we know it is clearly coming to an end, and as investors, we should therefore probably diversify our portfolios into an even mix of potable water and firearms. The more realistic investor, on the other hand, will ask a very different question: in the context of everything that’s going on, are investments cheap or expensive?

If investments are expensive, it’s likely a good time to sit on any excess cash you may have, and hold tight until prices come down. But if investments are trading at cheaper prices than their underlying value says they should be, then the serious investor will say great, it’s time to buy more!

So what do the numbers tell us? From a purely numerical standpoint, corporations today are awash in cash, earnings are solid, and stock valuations are the cheapest they’ve ever been relative to interest rates. If you ask me, that all adds up to a pretty great buying opportunity.

But don’t take my word for it. Ever heard of an up-and-coming investor by the name of Warren Buffett? In November 2009, he decided that investments were offering a pretty attractive deal – so attractive, in fact, that he dipped into his cash reserves and dropped $34 billion on a railroad.

Now, I’ve never had the pleasure of buying a $34-billion railroad. But I suspect at least a few months must have passed between the decision to buy and the actual transaction.

If the transaction occurred in November, that means Mr. Buffett must have decided to buy the railroad somewhere around the spring of 2009. Not surprisingly, that just happened to coincide almost perfectly with the absolute bottom of the latest market downturn, at a time when the news analysts were churning out their direst economic predictions.

If smart investors are supposed to be running away when the news is bad, why does the smartest investor on the planet go on a buying binge right when everyone else is frantically burying gold and freeze-dried lasagna in their backyard?

The fact is, despite all the warnings to the contrary, average investors still tend to sell their investments at the worst possible time – when the markets hit bottom – and then buy back in again only after things start to look rosier – namely, once the price of stocks has already shot back up.

This isn’t anecdotal theory or idle conjecture. If you want to see what the average investor is up to, just take a look at the flows in and out of equity mutual funds.

The large equity funds have all recorded net redemptions every year since late 2007. Conversely, looking back a little farther, we can see that those same funds almost always registered a peak in cash flowing in right around the top of every market cycle.

To put it another way, while most investors know they’re supposed to buy low and sell high, in reality, they tend to do the exact opposite!

The silver lining to this self-defeating behaviour is that it gives those few truly long-term investors like Mr. Buffett ample opportunity to step in and scoop up stocks, mutual funds, railroads and just about anything else at rock-bottom valuations.

I know, I know – it’s hard to be rational about a declining stock market. When every network news anchor is warning you that the sky is falling, and it looks like all your hard-earned savings are going straight down the drain, it can feel like the only way to stop the pain is to take what’s left of your money and flee to safety until the storm passes.

But for really savvy investors, declining stock prices are our best friends. If you invest a set amount each month, declining stock prices mean you get more bang (and more shares) for your buck. If you’re holding stocks, declining share prices are a great time to re-invest those dividends in preparation for the inevitable recovery.

And for those who don’t believe there ever will be a recovery, all I can say is, take a look at history. Over the past 200 years, every 20-year period on record has seen the stock market offer annual compounded returns of somewhere between 8% and 11%. It was true through two World Wars, it was true through the Great Depression, and it’s almost certainly true today.

Unfortunately, all good things must come to an end. The bad news won’t last forever, and when it stops, those fire-sale stock prices will jump back up through the ceiling, and our opportunity to use the steady stream of doom to our advantage will have run its course.

Until then, I don’t know about you, but I’m going to keep buying low for as long as I can. Even if I can’t afford my own railroad. At least, not yet.

Alan MacDonald, an Investment Advisor with Richardson GMP Limited, helps investors with over $500,000 of assets make smart decisions about money. Alan is the co-author of “The Copperjar System, Your Blueprint for Financial Fitness” available on Amazon.

Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.

I’ve been in this business for nearly 27 years. During the course of my career, I’ve had the pleasure of meeting thousands of investors, each of whom had a unique story to tell.

As we get ready to celebrate the beginning of another new year, I’d like to take a few moments to tell about just two of the more fascinating people I’ve met over the years. Both have now passed away. But their lives can offer us all a profound lesson about investing, the power of inflation, and the true cost of fear.

As chance would have it, both of these two unrelated people were widows. In each case, their husbands were men of means who had left them relatively early in their lives, but with significant sums of money.

By another odd coincidence, the amount they inherited was almost exactly the same: about $300,000. Now, $300,000 may not sound like a vast sum today. But 50 years ago, it was a fortune, worth more than $2-million in today’s dollars.

I met both of these women fairly late in their lives. As I soon discovered, despite the similarities between them, they had made very different decisions about what to do with their money. As a result, they were now leading very different lives.

The first woman had invested her savings in a combination of savings bonds and GICs. This was a careful, reasoned decision she had made with her husband, who told her that if he were to pass away, she should avoid taking any foolish risks with her money. Instead, she should invest it all in only the safest of guaranteed investments. That way, he promised her, the money would last, and she would be well taken care of her entire life.

Unfortunately, this lovely lady followed her husband’s well-meaning advice to the letter. As a result, by the time I met her many years later, her fortune had dwindled to almost nothing, and she was living on only the 3% interest from her Canada Savings Bonds and a tiny old age pension.

Her words to me were: “I have no idea what happened. I once had a lot of money, and now my money doesn’t seem to be worth anything.”

The thieves that robbed her of her life savings were time and inflation. By letting her money sit in “guaranteed” investments that paid only a few per cent in interest each year, she had allowed inflation to eat away more than 80% of its value.

She learned too late a lesson that all investors should be aware of: inflation is the enemy of all those who allow their fear of risk to push them into taking too “safe” an approach. And as this woman found out the hard way, it’s an enemy that always wins.

Compared to the wild ups and downs of the stock market, inflation is more like a war of attrition. We may not feel the cuts and bruises as they happen. In fact, it’s much more comfortable to see your capital stay safely intact rather than fluctuate up and down on a yearly, monthly or even weekly basis.

But given enough time, inflation can wear down even the largest fortune. And by the time we realize what’s happening, the damage may already be too great.

The second lady I want to tell you about had a very different experience. When her husband passed away, she bought an assortment of blue chip stocks. Then, she simply sat on them, somehow finding the strength to resist every new trend or frenzied media prediction about the next sure-fire money-maker or world-ending disaster.

Imagine how difficult it must have been at times, to hold onto her portfolio straight through the Cuban Missile Crisis, the Vietnam War, Watergate, hyper inflation, countless recessions, the default of South American governments on their debts, and on and on. But hold on is exactly what she did, and for 50 years, she stayed invested in that same, balanced portfolio of stocks.

When I met this woman, she had most of the same stocks she had started out with half a century earlier. Only now, her portfolio was worth about $2.5 million, and paid dividends of $75,000 a year. She didn’t think there was anything particularly extraordinary about either her results or what she’d done. She assumed it was just common sense, and figured that everyone else must be doing the same thing she did.

These two investors started in the same place. What’s most remarkable about their stories is that neither was conscious of the monumental difference that their initial choices would make over the course of their lives.

One investor lost everything she had, slowly over time, to inflation. In the end, her house was gone, she could no longer afford to keep her car, and her once gracious lifestyle was transformed into a daily struggle to survive.

The other investor hadn’t really noticed much of a change in things. Everything cost more, but her income and capital had grown in a similar proportion. Her lifestyle had hardly changed at all, or if anything, it had slightly improved.

As I reflect on these two lives, I realize that it was never about which course kept one investor or the other out of the fight. It will always be a struggle to get through your investing life and stay true to what you know is the right decision. Whichever path you take will result in challenges of one kind or another. The question is which fight actually gives you a real chance of winning.

My New Year’s wish to investors is that they choose to face the slings and arrows of the market, and hold fast against all the too-familiar forecasts of doom and gloom. Then, 30 or 40 years from now, maybe they, too, will be fortunate enough to notice that their lifestyle hasn’t changed much, either.

Happy holidays, and may you and your loved ones have a healthy, safe and productive New Year!

Alan MacDonald an Investment Advisor with Richardson GMP Limited, helps investors with over $500,000 of assets make smart decisions about money. Alan is the co-author of “The Copperjar System, Your Blueprint for Financial Fitness” available on Amazon.

Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.

In 2002, Dr. Daniel Kahneman won the Nobel Prize in Economics for his research into the role cognitive biases play in decision-making during times of uncertainty. Specifically, he observed that we tend to have pre-conceived notions on just about everything, and those notions can influence almost everything we do.

According to Dr. Kahneman, our brains come hard-wired with two systems. The first is the system we use almost effortlessly to make quick judgments, such as reacting to a threat or reading the expression on someone’s face. The second is our “thinking system,” which, for example, kicks in when we have to do our taxes or multiply 27 times 38.

As a species, we tend not to like using System #2. Deep thinking causes us to burn glucose, dilate our pupils and increase our breathing. It’s much easier and quicker to use System #1. Unfortunately, relying on quick, easy conclusions can also get us into a whole lot of trouble.

Take the following example from Kahneman’s latest book, “Thinking, Fast and Slow” (named by Amazon.com as one of the Best Books of 2011). Let’s say you’re introduced to someone who is single, bookish, quiet, and who prefers their own company to the company of others. Would you tend to think this person is more likely to be a librarian, or a farmer?

Based on this description, most people immediately lean towards librarian. Yet in reality, there are almost 20 times as many farmers as there are librarians, so it’s actually statistically much more likely that the person we’re meeting is a farmer.

Of course, this isn’t to say that System #1 thinking is all bad. Our “think fast” system works quite well at a lot of things. For example, you don’t want to pause to analyze the physics of jumping when a speeding car is barreling down on you. Similarly, there’s no need to stop to calculate whether or not to hug your child when you see them in tears.

But our tendency to rely on the quick-and-easy System #1 for everything can often get in the way, particularly in areas where you may only occasionally need to focus your full attention. One of the best examples of these is your investments.

We all like to think we make sensible choices when it comes to our investments, and that we use our objective capacity to ensure our money goes to the right places. Too often, however, we let our feelings guide even our most basic and fundamental investment decisions, such as where to put our money or what to sell and buy.

I had a conversation recently with someone who’s in the process of selling his stock portfolio in order to go out and buy a condominium as an investment. After all, real estate, as we all know, has been on a tear for the last 10 years, and he wanted to get in while the getting was still good.

In other words, he was making this major life decision using only his System #1 thinking, which told him that real estate is always the best investment, without testing his assumption to see whether or not it was actually true. But what happens if we slow down for a second, and bring our System #2 “deep thinking” skills into play?

Consider the facts. The price for this particular condo was $500 a square foot. At this price, the rent he would be able to charge comes nowhere near covering the cost of his mortgage, let alone all the other expenses involved. In addition, renting out the condo would mean taking on the burden of tenants, and adding to his already-busy workload.

On the other side of the equation, the stocks he wants to sell currently have a dividend yield of about 3%. Stocks these days are trading around eight times cash flow, and are arguably at a very low point in the market cycle. They take no time or effort to own, and if history is any guide, they will return three to four times their capital over the next 20 years.

Now, I have nothing against real estate. I own some myself, and we’ve advocated incorporating real estate into some of our clients’ portfolios. The difficulty I see in this case isn’t that this person decided to buy a condo. It’s that, when asked what his reasons were for making the switch, all he could say was he’s “just more comfortable in real estate,” and “it’s real estate, so it will always go up.”

Doing something for no reason other than because it makes us feel “comfortable” is classic System #1 thinking. It’s what allows us to confidently make important decisions that completely ignore, or even outright reject, the actual facts.

If we take a look at the broad historical experience of the North American real estate market, we can definitely say that real estate doesn’t always go up. Just ask someone who bought a condo in Las Vegas or Miami five or six years ago.

But this person’s System #1 thinking told him that real estate is a can’t-lose investment. As a result, he felt comfortable making this choice, without taking the time to find out whether or not it was really the right choice for him.

The problem with his decision to sell the stocks isn’t about either the stocks or the real estate. The problem is that it’s a big financial decision, which should be made with careful, slow and detailed System #2 thinking.

System #1 works great for some things. Investments just aren’t one of them.

Alan MacDonald an Investment Advisor with Richardson GMP Limited, helps investors with over $500,000 of assets make smart decisions about money. Alan is the co-author of “The Copperjar System, Your Blueprint for Financial Fitness” available on Amazon.

Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.

$26.3 billion.* That’s the dollar value of equity mutual funds that retail investors have liquidated in Canada since the start of 2011.

In the U.S., things are even worse. South of the border, a total of $266.2 billion* in equity funds have already been redeemed in 2011 alone. But that’s not the scary part. The scary part is that so many investors are cashing in their equities at a time when stocks are perhaps the cheapest (relative to interest rates) they’ve ever been.

At first glance, this may seem like a classic case of aberrant behaviour. Unfortunately, despite the fact that we all claim to know better, the pattern of investors buying high and selling low is anything but new.

If you were to look back over the last 40 years and draw a chart tracking the highs and lows of market cycles, and then overlay another chart of equity mutual fund purchases and redemptions along the same timeframe, you would see a very disheartening picture.

Most mutual fund purchases occur in a feverish frenzy at the very top of a market cycle, when demand is high and prices are even higher. And as we’re seeing now, most investors just as furiously sell their equity funds at the worst possible time, when the markets are at or near the bottom.

In other words, the lines on our chart are perfectly inverted to the way they should be, with the most redemptions at the bottom and the most purchases at the top. As an investment advisor, I have to ask the question: why? Why do investors continue to fly in the face of everything history has to teach us?

One argument I often hear is that the stock market is fixed, leaving little chance for the “little guy” to succeed. The only problem with this argument is that it simply isn’t true. The market is, by definition, almost perfectly liquid. Stocks don’t care whether you have $100 to invest or $100 million. They’re for sale regardless of who wants to buy, or how much money they have.

As a result, there are no real barriers to enter the market. Unfortunately, there are also no barriers to making a bad exit, either. This is where, over and over again, the little guy sabotages his own investment life, by buying at the peak and selling in the valley.

If you were to randomly ask 100 average investors, and 100 Wall Street tycoons, the single most important secret to success in the equity markets, the answer you’d probably hear most often from both groups would be to buy low and sell high. On the one hand, it seems like the simplest, most basic piece of investment advice. Yet, in my experience, it remains one of the most difficult things for most of us to do.

Take the current situation as an example. We are either at, or very close to, a market bottom. The record-low valuations tell us this beyond almost any shadow of a doubt. Logic would therefore dictate that investors should be flocking to buy equities while they’re still on sale at discount prices.

In reality, the opposite is happening. Thanks in no small part to the predictions of impending doom we’re being fed nonstop by all those 24-hour news channels, the average investor has forgotten that valuation will always trump fear and bad press sooner or later.

Of course, not everyone has given in to panic. Warren Buffett – who called the stock market an incredibly efficient tool for the transfer of wealth from the impatient to the patient – recently announced that, after never buying a single share of his own stock in his 40-year career, he will now be buying back up to $28 billion of Berkshire Hathaway stock because the prices are just too good to resist.

This isn’t to say that the declines we’ve experienced have no basis in fact. There will always be some crisis, some convincing list of woes that will make it hard for us to do what we know we should.

This is because it is hard. It’s not easy to hang onto your stocks right now, let alone have the temerity to go out and buy more before they double or triple in value. As human beings, we are genetically imprinted with a desire to follow the pack, and do what we see others do around us.

We read our investment statements when they come in, and month after month, we see our numbers – our hard-earned life savings – getting smaller. Fear trumps common sense, risk wins out over opportunity, and the sell orders go in. The more sell orders go in, the more stocks drop, which leads to even more sell orders, and the whole vicious cycle begins all over again.

But if you can step outside of this downward spiral, just for a moment, there are a few important clues happening that just might suggest an alternative strategy.

Right now, professional investors and insiders are busy buying. These are the people who focus on valuation, not the headlines on last night’s evening news. They know that stocks trading at eight times cash flow are a better investment than stocks trading at 15 times cash flow, especially when the alternative is a Treasury Bill paying one per cent interest.

So you have a choice to make. You can follow the herd, sell all your equities and stay on the sidelines out of the certainty that things will never get better, and stocks will keep going down until they hit zero. Or you can take the lead of insiders, professional investors like Warren Buffet, and some of the world’s largest publically-traded corporations, and take advantage of what may well eventually be remembered as the greatest buying opportunity of our generation.

It won’t feel good, mind you. Doing the opposite of what the crowd is doing never does. And the news will make you feel like a fool every day. That is, right up until the day they suddenly break the “surprising” news about the strong and sustained recovery, that no one could possibly have seen coming.

It may not happen tomorrow. It may not happen next week. But 200 years of history has proven that it will eventually happen. And when it does, all those “little guys” who got out of the market when it was at rock bottom will have missed the boat all over again.

The bottom line is, if you own stocks and equity mutual funds, and long-term growth is your objective, in my opinion, you’re in the right place. If you have the means, you might even want to buy a few more shares.

After all, there’s certainly no shortage of motivated sellers.

*All figures are obtained from Dimensional Fund Advisors, Canadian Business Update 2011.

Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.

I know, I know. You read the headline for this article, and immediately assumed that I was either: (a) being facetious; (b) referring to some time long, long ago; or (c) crazy.

While there are days when my wife would insist on (c), the real answer to this question is none of the above. Believe it or not, over the past three months, the companies that make up the S&P 500 index earned more money than they have during any other three-month period in history.

Let’s stop for a moment and let that sink in. During the last fiscal quarter, while newscasters have been screaming non-stop that the global financial sky is falling, corporate profits for the S&P 500 – some of the largest and most important companies in the world – just set a brand new, all-time record high.

That’s not all. Most of the largest publicly-traded corporations in the U.S. are also trading at around eight times cash flow. When you factor in current interest rates, that means U.S. stocks today are the cheapest they have ever been.

Now, if you were to ask the average person on the street, they would probably have said that corporate profits must be down. Perhaps as much as 25% or 50% off from their pre-crisis levels, or at least as big a decline as their national stock markets, which (in Canada) is down 15% from its 12-month high as I write this.

So the fact that corporate profits are actually way, way up is great news, right? Then why haven’t we been hearing about that on the news, the same way we’ve been hearing about the riots in Greece or seeing the requisite shots of commodities traders with their heads in their hands, standing before a screen that’s awash in a sea of red?

Because news is also a business. And stories about Armageddon inevitably sell better than stories that say everything is eventually going to be all right.

Of course, you could also argue that it’s only a matter of time before corporate profits join the rest of us huddled together in the doom and gloom. After all, how long can companies continue to increase their earnings? Surely the party has to end at some point?

To answer that question, let’s look at one of Canada’s biggest companies: the Royal Bank. About 15 years ago, there was a protest by anti-poverty activists on Sparks Street. (Sound familiar?) The subject of their protest was the Royal Bank, which had just made history by being the first bank in Canada to surpass $1 billion in annual earnings.

If they had stuck around, those same protestors would have a whole lot more to complain about now. In the last quarter alone, the Royal Bank earned $1.8 billion. This year, they’re on track to earn northwards of $7 billion.

Today, if you have money to invest, you have a choice. You can buy a five-year GIC that will pay you about 2.73% per year. Or you could buy Royal Bank stock, and pocket a 4.5% annual dividend, plus the promise of lots of ups and downs as the market reacts to current events.

Despite earning 40% less than the dividend-paying stock, the GIC is proving to be far more popular these days, for the simple reason that we know it will never go down in value.

Stocks, on the other hand, have been going down a lot lately. As a species, we tend to extrapolate what’s happening in the present (or recent past) into the future. That’s why people who think they’re “on a roll” continue to make casinos one of the most lucrative business models on the planet.

But not all investors are so certain that the bad times are going to last forever. Remember those corporations with all their record profits and newfound cash flow? While the rest of us were running for shelter, they’ve been busy buying back their own stock at a furious rate.

In the U.S., for example, corporations have bought back almost $500 billion of their own stocks over the past year. Directors and corporate insiders are also buyers these days, taking advantage of the unprecedented fire sale to pick up stocks at rock-bottom prices.

In the near future, we can expect more volatility as the governments of the world wrestle with debt challenges and the unemployment rate remains stubbornly high. But in the midst of all the headlines heralding crisis after crisis, it just might be a good idea to take a few seconds, take a deep breath, and remember that 2011 is also the year of record-high earnings and low valuations for publicly-traded companies.

Then ask yourself: do you want to wait until things get better and prices go back up? Or do you want to follow what the smart money is doing, and buy low while you still can?

Alan MacDonald an Investment Advisor with Richardson GMP Limited, helps investors with over $500,000 of assets make smart decisions about money. Alan is the co-author of “The Copperjar System, Your Blueprint for Financial Fitness” available on Amazon.

Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.

A grandfather was recounting an amusing moment with his young granddaughter. They were getting into a minivan and, as the granddaughter inserted her favourite DVD; she asked granddad what sort of DVDs he watched in the car when he was six years old.

When he told the youngster that there were no DVDs, certainly no cars capable of playing them, and television had yet to be invented when he was six – he was met with a simple stare of incomprehension. Then the six year old went back to selecting her favourite scene on the remote control.

I relate this story because it’s almost impossible for us to grasp the enormous progress that mankind has made over the past 50 years. The diseases that threatened children and adults alike 50 years ago have mostly been wiped out in the developed world. We have technology at our finger tips that, even 20 years ago, would have had NASA in a swoon.

It’s also almost impossible to imagine the wealth creation that has occurred in the stock markets over the last 50 years. To give an example, the S&P 500 stock index, on October 1st 1959, stood at 59.89 points. As I write this column (October 6, 2011 the S&P 500 stands at 1147 points). That’s a pretty good run, but it doesn’t include dividends. If an investor were to reinvest the dividends paid out by the stocks in the index, the wealth creation would be a multiple of the 17 fold increase in the index.

Today there is a lot of pessimism. We are just starting to work our way out the other side of one of the worst bear markets in history. Comparisons to the great depression abound and, implicit in the fear and the pessimism that rules the day, is the notion that there will be no further progress. We have had the good times, now comes the permanent hangover.

Like most hangovers, they rarely seem to end quickly enough. But the markets and progress will march on. The two are tied together through the economy, which has also grown and will continue to grow in the face of relentless progress.

In the modern age, every generation lives longer than the previous generation. It was only a hundred years ago that you were lucky to make it past 50. We tend presume that our experience in the future will be much as it is today. It’s human nature to extrapolate whatever is happening today into the future. But as the little girl at the start of this story shows us, progress creeps up on us and things that were once impossible become as routine as morning coffee.

If you can remember the leap from no television to playing your favourite DVD in the back seat, it’s not hard to conclude that a lot of our problems today will be solved by innovation we have yet to experience. Innovation will spark growth, growth reflects in the economy and the economy moves the stock market. It is not about if this will all happen – it’s merely a question of when.

What happens in the next few years to capital markets is anybody’s guess. But portfolios are usually built to fund long term liabilities such as retirement. As both progress and the S&P 500 tell us, growth is inevitable. In spite of recent experience and the uncertainty of today – stocks remain one of the best possible assets to fund the expenses of a long lifetime.

Alan MacDonald an Investment Advisor with Richardson GMP Limited, helps investors with over $500,000 of assets make smart decisions about money. Alan is the co-author of “The Copperjar System, Your Blueprint for Financial Fitness” available on Amazon.

Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.