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Financial Advice or Financial Quackery?



You gotta be careful if you don’t know where you’re going, otherwise you might not get there.” - Yogi Berra

How can you tell whether financial advice you receive is real financial advice or financial quackery?

Much of what happens in the financial industry is financial quackery, but because the common methods are familiar to most of us, they appear normal. You can’t really see how inadequate and funny many financial procedures are until you compare them to other fields.

“Quackery” is a fun word that normally refers to medicine. It is a type of health fraud that promotes products and services that have questionable and unproven scientific bases.1

Unproven, usually ineffective, and sometimes dangerous medicines and treatments have been peddled throughout human history. “Snake oil salesmen” heavily promoted “patent medicines” that promised to be a “miracle cure” for everything. Most had no healing ingredients and many contained alcohol or morphine to simply make the patient feel better.

How can you tell the difference between advice and quackery in medicine? The issue is not whether the product actually works or even whether the promoter “quack” honestly believes it works. Penicillin is often called a “miracle cure-all”. It clearly has medical benefits, but mass promoting it for everyone would obviously be quackery.

You can identify quackery by:

  1. The focus on selling the product or service
  2. Without using accepted standard medical diagnosis and treatment.

Advice must be specifically for you. No treatment is for everyone. Essentially any promotion of medical treatments is quackery unless you have been checked or tested by a qualified doctor to diagnose that you have the condition and recommend the proper dosage and use of the treatment.

What is Financial Quackery?

The financial world is also full of quackery. Just like there are established medical procedures for diagnosis and treatment, there are established procedures for financial advice. Any qualified financial advisor knows the “6-Step Process to Financial Planning”. Step 2 (determining your goals) and step 3 (analyzing your full financial position) should both be done before making any recommendations in step 4 (developing and presenting a written financial plan).

Recommending a product before setting goals, analyzing your entire financial picture and creating a financial plan is not following accepted financial planning procedures, which makes it financial quackery.

Financial quackery is essentially any promotion of financial products or services by someone that does not know your goals and your full financial position. Just like with medical quackery, the emphasis is on selling products, instead of providing real advice.

Why is it a Major Problem for Canadians?

In our opinion, financial quackery is one of the main reasons that most Canadians struggle financially. Because of it, most Canadians don’t set financial goals, make financial decisions one-by-one, don’t look at their entire financial picture – and don’t even realize that they did not get real advice.

For example, here is a typical scene. You have $5,000 to invest and go to see a financial advisor. The advisor does some chit-chat to establish rapport, and then asks you to fill out a Risk Tolerance Questionnaire. Then he recommends you buy Funds A.and B in your RRSP. This is financial quackery.

Can you imagine this in another field? Can you imagine going to see your doctor who asks you to fill out a Pain Tolerance Questionnaire and then prescribes a treatment? That would be ridiculous.

No examination. No medical history. No medical tests. And the treatment is not the most effective treatment but the one that fits your “pain tolerance”. Obvious quackery.

Why specifically is it financial quackery? Making recommendations after only knowing your risk tolerance is ridiculous. The “advisor” must know your entire financial position and your goals before making any recommendation.

Without knowing your goals and your entire financial position, the advisor does not know:

  • Is this money for your retirement?
  • Do these investments have the growth potential to achieve your goals?
  • Is $5,000/year enough for you to have the retirement that you want?
  • Given your tax position today and in retirement, do RRSPs even make sense for you?
  • Given your tax bracket today, is $5,000 a smart amount to contribute?
  • Is there something smarter you should be doing with that $5,000?
  • Is it smarter to invest in your name or your spouse’s?
  • Do Funds A and B fit with all your other investments? Are you properly diversified?
  • Is your overall investment allocation suitable for your goals and your risk tolerance?

Many doctors consider homeopathic medicine to be quackery. While most of it has never been tested for effectiveness in proper medical studies, at least some of it probably works. The biggest problem with homeopathic medicine is when you use it INSTEAD of following your doctor’s advice.

That is also the biggest problem with this story where you put $5,000 into an RRSP with an advisor to buy 2 funds. After seeing this “advisor”, you may be tempted to believe you received real financial advice. But there was no real advice. You just had a financial “quack” do a transaction for you INSTEAD of giving you real advice.

How Can it Ruin your Retirement Plan?

To clearly illustrate the problem with financial quackery, here is how it ruins the retirement plan for most Canadians.

One of the most common investment errors in our experience is investing too conservatively to achieve your retirement goal – and this error most often results from financial quackery.  The problem is that you may sit down with some advisor (a.k.a “financial quack”) who fills out a Risk Tolerance Survey and determines that you are “conservative” and then recommends you “diversify” into a low risk, low return portfolio. This low risk/low return portfolio may have a low risk of temporary market decline, but may very likely have a 100% risk of failure to fund the retirement you want. What’s more – you don’t even know about this 100% risk of failure. This “safe” investment may make you feel good, just like the “snake oil” made you feel better by containing alcohol or morphine. But it is certainly not effective in treating your financial goals.

This is a huge problem with retirement for Canadians. We have sat down with literally thousands of Canadians to help them figure out specifically what lifestyle they want to have in retirement – in detail, expense item by expense item. Then we figure out the nest egg they will need and what they need to do in order to build up that nest egg. Our experience is that what Canadians are doing will leave them far short. What the people we have met were doing before we met with them will, on average, give them only about 20-30% of the nest egg they will need to maintain their current lifestyle.

Why will they have so shockingly little in retirement? When we ask them, they say they never received retirement advice before. They have retirement investments, but no specific retirement goal. In our opinion, that unfortunately means they worked with “financial quacks” INSTEAD of getting real advice.

Making an Informed Decision about your Risk Tolerance AND your Goal

Imagine that you need to be in Los Angeles for a meeting tomorrow morning. You go to a trip advisor who gives you a “Fear Tolerance Questionnaire” and determines that you have a low fear tolerance. You could fly, drive or walk to L.A. Since you have a “low fear tolerance”, the trip advisor recommends you walk. Obviously, that is quackery.

Real advice needs to take into account your goal. You need to be told that if you walk, you will not be there for the meeting at all. Period. If you drive, you must leave now without packing or stopping for anything (even meals) and you must drive right through the night.

Your best advice is to pack properly and get there early by flying. So let’s discuss your fear of flying. You need to know that there will be turbulence, but that it will be okay. You may fear flying, but statistics show that flying is quite safe – as long as you don’t get off when there is turbulence or during the stops along the way.

You may fear flying, but it provides by far your best chance of success in achieving your goal.

This does not mean you definitely must fly, but if you choose not to, then you need to know now that you will not be at your meeting. You will need to plan now to postpone your meeting or meet somewhere closer. Or you can choose to fly, even though it scares you. It provides the highest chance of success, but you need advice on what you can do to fly effectively and deal with your fear.

This is similar to retirement planning. Your retirement nest egg can be in stock market investments, bond/income investments, or GICs/cash. Most Canadians will need to have a significant portion or even all of their retirement investments in the stock market to have the best chance of maintaining their current lifestyle after they retire.

The problem is that most Canadians have only been asked their risk tolerance and don’t know their goal. So, they are walking or driving to Los Angeles and don’t even know they will miss the meeting.

When you know both your retirement goal and your risk tolerance, you can make an informed decision:

  • You can buy GICs, but you need to know now that you will almost definitely not maintain your existing lifestyle after you retire. You should plan now what specifically you will cut back, so it is not a shock when you get there. Downsizing your home will probably be just the start. That is why we call GICs “Guaranteed Insufficient Cash”. We have not seen anyone successfully save for a comfortable retirement with just GICs.
  • You can invest conservatively in bonds/income investments, but then you may have to work hard to save every possible penny and possibly even cut back your lifestyle today.
  • You can invest in stock market investments, but you have to know there will be turbulence – but it will be okay. Statistics show it is reasonably safe if you invest long term in the proper way and don’t get off when there is turbulence.

The point is that with real advice, you can make an informed decision about this tradeoff between your goal AND your fear tolerance. With the quack’s approach, you will just find out tomorrow that you didn’t make it to the meeting, after it’s too late to do anything about it.

Summary

In our opinion, financial quackery is one of the main reasons most Canadians struggle financially. Because of it, most Canadians don’t set financial goals, make financial decisions one-by-one, don’t look at their entire financial picture – and don’t even realize that they did not get real advice.

Financial quackery can ruin your retirement plan by not letting you make an informed decision about your risk tolerance AND your goal. It can lead you to invest too conservatively so that you have a high risk of failing to have the retirement you want.

It is common because very few Canadians know precisely what their goals are and because very few financial advisors follow the “6-Step Process to Financial Planning”, which should include preparing a written plan to document their clients’ financial goals and complete financial position.

Financial quackery is any financial “advice” you receive that does not look at your entire financial picture and your specific financial goals.

Now that you know what to look for, it can be fun to quack like a duck when you recognize it.

1 www.answers.com

About the Author: Ed Rempel is a Certified Financial Planner (CFP) and Certified Management Accountant (CMA) who built his practice by providing his clients solid, comprehensive financial plans and personal coaching.  If you would like to contact Ed, you can leave a comment in this post, or visit his website EdRempel.com.  You can read his other articles here.





34 Comments, Comment or Ping

  1. 1. Vips

    Very impactful article!

    Nice work,Ed….

  2. 2. Heaven7

    Great article. Great quality!!!! Congratulation Ed.

  3. 3. js_cooldude

    Well written article!

    Especially love the plane comparison!

  4. Great article! One quibble about your metaphors, homeopathic “medicine” does not work. It’s just water. To say that “some of it probably works” is misleading. People get better after using homeopathic treatments because they would have gotten better anyway, but that is not the same as saying it “worked”.

  5. 5. ITS

    I find your analogy flawed with all due respect.

    Medical science is an exact science (to a high degree) whether giving financial advice, educated or not is quackery in its core.

    Even if you are the good kind of financial planner that are so in tune with your clients’ needs you can’t possibly know what: (the market as a whole, the price of a barrel, energy, earthquakes, precious-metals, middle-east uprisings, the emerging markets, commodities, fancy financial derivatives, inflation, real estate, the American dollar, the Chinese economy) are going to do.

    If a financial advisor was an expert in all the above fields, then I would pay top dollar for his advice. All I see is colorful graphs of past performances. And whether 95% of people get fooled by these graphs, I know that past performance is no indicative of the future. (even 100 years of past performance at that matter)

    Until then, I say everybody become educated in the fundamentals of finance, invest in what they understand, place their own bets and stop listening to financial advisors altogether.

  6. 6. bob

    You mean like those financial advisers who provide blanket mortgage advice over the internet such as:

    1) “Avoid 5-year fixed. Sometimes, they are tempting, but always assume they will end up costing much more”.

    (UNTRUE — they do NOT always end up costing more)

    2) And who says “At the end of the 5 years, they will probably owe less than if they took the 5-year fixed (if they have the same payment), but in the unlikely event that they owe slightly more – who cares?”

    (WHO CARES?!!? It is all about monthly payments, not how much you pay overall?!)

    3) Or a financial adviser who presents “historical” stock market returns as an argument for owning stocks, but who fails to
    reveal the true risks of investing in equities.

    (You need to actually include what *real* investors actually make from equities, not just index benchmarks. Otherwise, you are just disguising the risk involved by making it sound like $100 invested in Canadian Equities in 1950 would turn into $30,000. There are a lot of missing steps in that equation — and those missing steps are exactly the risk that needs to be presented if you want investors to be fully educated.)

  7. Whew! Is it really limited to just Canadians? I don’t think so, many people are financially illiterate and fall for these schemes. I would like to start a movement for financial literacy as a graduation requirement from high school. Perhaps everyone would make better financial decisions.

  8. 8. Ed Rempel

    Hi Vips, Heaven7, JS_Cooldude & Dancing Samurai,

    Thanks for the kind comments. I’m glad you enjoyed the article.

    Ed

  9. 9. Ed Rempel

    Hi ITS,

    I think you have illustrated my point. There is a very common mis-perception that financial planning is about investments.

    Financial planning is about your life. It’s about knowing what’s important about money to you, your various goals, handling your money effectively, structuring debts effectively, planning to minimize tax throughout your life, appropriate inexpensive insurance, and designing the most effective investment strategy and allocation for you.

    Financial planning is planning for the money necessary to have the life that you want.

    Therefore, it is a relatively precise process, although it relies on long term projections based on reasonable, conservative assumptions.

    Specific investments may or may not be part of financial planning, but they should only be discussed after the main financial plan is created. You need to decide where you are going before you decide on transportation.

    All the items you mentioned in your list are part of investment speculation (except inflation).

    From our experience, most people benefit far more from financial planning than from investment A vs. investment B. Knowing what you want to achieve, having a plan, knowing what you need to do to achieve it, structuring all your finances in the most effective way, are the main keys to financial success.

    Investing effectively is another topic, but is usually best done with a good strategy and lots of research, not speculating on all the items you mentioned.

    Ed

  10. 10. Ed Rempel

    Hi Bob,

    Nothing written on financial blogs can be considered “advice”, including my articles and posts. They are all intended to be general education.

    Anything written on financial blogs would have to be in the category of “financial quackery”. The writers of articles and posts on blogs don’t know everyone’s entire financial picture, so the comments may or may not apply to specific people in their specific situation.

    Our opinions on 5-year fixed mortgages are from seeing so many people waste thousands of dollars on them, and because we think they are massively oversold by the mortgage industry.

    We also believe strongly in equities from seeing how important they are for most people to be able to have the future they want. Most people believe equities are far riskier than they actually are, which makes them invest too conservatively to achieve their goals or to use all kinds of strategies that don’t really work but make them feel safer.

    We believe strongly that both of these are generally true, but they may or may not be true for any specific person in their specific situation.

    Ed

  11. 11. Ed Rempel

    Hi krantscents,

    I’m with you completely! I can’t believe that basic life skills like handling money are not taught in schools. Many of our clients that are parents struggle with trying to educate their kids about money and schools are no help at all.

    We have seen horror stories, such as university grads owing tens of thousands on credit cards. Most young people tend to believe they are far more knowledgeable than they are. When people don’t know a lot, the Dunning-Kruger effect makes them believe they are knowledgeable.

    Many Baby Boomer parents think they are helping their kids by paying for everything for them and giving them lots of money, so they never learn about how to manage it effectively.

    If you start a movement, we’re behind you, Krantcents.

    Ed

  12. I definitely agree with Krantcents… baby boomers are trying to help generation Y but they’re really not.
    Spoon feeding us isn’t going to make us learn to work hard for our money because it isn’t ours.

    Anyway, I liked your post, Ed. It definitely rings true- I felt like i was in a factory lineup when asked to fill out questionnaire, and that means I can get “Allegro Portfolio B”. Then that was it. Nothing else, nothing talking about my goals, how much I should save etc.

    I do somewhat disagree with your analogy with regards to homeopathic medicine and western medicine. Homeopathic medicine is actually quite popular in Europe (e.g. Germany).
    In medicine, people believe in large research studies that prove whether something works or not. The problem with homeopathy is that there are research studies- there is no money for it, no big pharmaceutical companies paying for it.
    Sometimes western medicine may contain quackery too- so many of these big scale research studies are funded by the same pharmaceutical companies trying to endorse their own product.

  13. Thanks Ed – Best Article Ever! It’s so rare to see a financial advisor who’s managed to burst outside the industry foolishness that gets passed on as truth.

    If there’s one thing that grinds my gears, it’s the standard risk questionnaire followed by an asset allocation pie chart. Voodoo science at it’s best. It works because it feels good, not because it’s right.

  14. 14. Canuckabroad

    A gem. This is hands down one of the best articles on financial advice I have read in a long time.

  15. 15. Richard

    I was reading this until he said,
    “Many doctors consider homeopathic medicine to be quackery. While most of it has never been tested for effectiveness in proper medical studies, at least some of it probably works. The biggest problem with homeopathic medicine is when you use it INSTEAD of following your doctor’s advice.”

    Nope. Homeopathy doesn’t work. Ever. Why? Because it violates the known laws of science. If you really want to sort out the quackery from real medicine. Science-based Medicine is a good place to start: http://www.sciencebasedmedicine.org/

    edit: I will say that this comment aside, the article was a good read

  16. 16. bob

    Nothing written on financial blogs can be considered “advice”, including my articles and posts. They are all intended to be general education.

    If you say say, Ed.

    I’ll just point out, however, that the “Conclusions” to your mortgage post cited above sound suspiciously like “advice”. How would a reader know that you are not actually “advising” anything, when you use the following language:

    “Conclusions:

    1. Stick to 1-year fixed or variable mortgages. Usually, you should take whichever is lower, but only take variable at a good discount, such as prime -.8-.9%.

    2. Avoid 5-year fixed. Sometimes, they are tempting, but always assume they will end up costing much more, plus you will have lost your flexibility and negotiating power for 5 years. Remember that even when rates leaped 9% in 2 years from 1980-82, short term rates still saved money.

    3. Never take a mortgage term longer than you expect to stay in your current home.”

    The terms “always’ and “never” are awfully categorical for the purposes of “general education” as opposed to “advice” . . .

  17. 17. Thomas

    Got to agree with Ed, since I began on concentratiing on being a Fee Based Financial Planner instead of a mutual fund order taker, I have attracted a more financially astute clientelle and have been able to put my CFP to good use doing estste planning, risk mangement, long and short term savings planning, budgetting, mortgage planning, oh and a little bit of investment planning as well.

  18. Ed:

    What you seem to imply in your post is those who do not know what they want out of life are more susceptible to financial quackery than those who do. Perhaps the greatest tool any investor can be armed with is not math and finance but knowing oneself well.

  19. 19. Erick

    Good article, but the subsequent discussion of the effectiveness (as opposed to popularity) of homeopathy reminded me of a great TED talk from James Randi:

    http://www.ted.com/talks/lang/eng/james_randi.html

    The whole talk is pure gold, but if you’re pressed for time, the debunking of homeopathy begins at 11:42 .

    Enjoy!

  20. 20. Ed Rempel

    Hi Glenn,

    Thanks for the high praise. I really like the way you described the standard process of a risk questionnaire followed by an asset allocation pie chart as “industry foolishness”.

    What bothers me the most is advisors that pretend do financial planning. It’s one thing to call yourself an “investment advisor” or “mutual fund salesperson”, because people know to expect advice only about investments.

    But so many call themselves a “financial planner” and even claim to do “holistic planning”, but a few simple questions show they have probably never done a single financial plan – believe it or not.

    If you want to find out, ask simple questions about how they do planning. I like to ask: “When you do retirement plans, how large a nest egg to your clients normally need to have the retirement they want?” If you get a lizard look, like they don’t know what you mean, you know they haven’t done a plan.

    If they did retirement plans regularly, they should be able to tell you what types of numbers they commonly see.

    At a conference, I ask one “financial planner” what planning software he uses and he eventually admitted he does not have any planning software! Can you imagine that in any other field? It’s like a “hockey player” that does not own a hockey stick.

    When I ask “planners” how about their planning process, many admit they will refer you to someone else in their company that does the planning.

    In the industry, there is an educational requirement before you can claim to be a “financial planner”, but there is no requirement to ever prepare even a single written financial plan.

    Ed

  21. 21. Ed Rempel

    Hi Bob,

    Read the disclaimer at the bottom of every page on MDJ. Blog posts are not advice.

    My posts and articles are intended to share things I believe in and try to be generally helpful. They may be answers to a question by a reader and are general comments based on the information given.

    However, my answer is not advice. If I knew that readers complete financial picture and goals, I may well recommend something completely different.

    Ed

  22. 22. Billie 2 Willies

    If a financial advisor was worth his salt, he wouldn’t need to be one.

    WBG

  23. 23. Thomas

    Billie, wtf is that supposed to mean? Is an FA supposed to have a crystal ball and know exactly what to buy, when to buy it, when to sell it so that he can make so much money he doesn’t need clients? The majority of people DO need a Financial Planner, not a mutual fund/seg fund/stock salesperson.

  24. 24. Lily

    Great article Ed.

    I once saw a Financial Advisor at a bank branch to see what type of advice they might give. He tried to sell me mutual funds (including BRIC funds), even though I told him I’d want to use my money to buy a home in a few years. I have a background in finance and banking, so I probably know a bit more than the ‘normal’ person about finances, so I just laughed and left. There should be more disclosure about how advisors are paid, so that clients can make a more informed choice about the partiality of the advisor.

    - Lily

  25. 25. marie

    @Billie…I ageed with the general message of the article and do agree in part with your comment. Ive had similar advice from others who say to pick a financial advisor who is doing at least well financially as you aim to be (preferably more so). However, there are those who are both very good at what they do and financially wealthy as a result. They continue in thier chose career or job, despite the financial success from a genuine passion and a love of doing it. I think the message of educate yourself and always trust your gut are a good general rule of life and applies here.

  26. 26. Art Lane

    Nice article, thanks. I’ve known more than one financial ‘planner’ in my time. I’d be hard pressed to explain how they manage to dress themselves, let alone guide people on the path to prosperity. They come off like a magic 8 ball where every answer is “Buy Mutual Funds from me”.

    Homeopathy is bunk (as has been well demonstrated by now). None of it works, even by accident, more than placebo. But the packages are pretty.:)

  27. 27. Dee

    That was the best financial blog post I’ve ever read. A real eye-opener. As I sift through various sites, books, etc., it’s difficult to sift out what is applicable to my situation, what will work for me, whether the author is coming from the same place as I am, etc. This will be really helpful to me in deciding what I want to apply to my own situation.

  28. 28. Ed Rempel

    Hi Lily,

    You have time to blog on your travels? Thanks for the comment.

    Regarding disclosure of compensation, I agree. Independent financial advisors are required to disclose how they are paid, but to my knowledge, that disclosure does not apply to bank advisors.

    Just think, if you had read this article before seeing that advisor, you could have “quacked” at him! :)

    Ed

  29. 29. Ed Rempel

    Hi Marie,

    I agree with your comment for the most part. The exception is that some advisors make a lot of money because they are exceptional sales people, not because they are good advisors. This type of advisor often displays signs of wealth as part of their image. The fact that they are well off does not necessarily make them a good advisor.

    Identifying financial quackery is also generally better done by your brain, than trusting your gut. Of course, your gut may give you an indication of whether to trust someone. However, many financial “quacks” focus on giving people what they ask for and what makes them feel good. We call these advisors “placebo” advisors”.

    These advisors usually focus on being liked. They are usually very nice, give you exactly what you ask for whether it makes sense or not, give you safe investments that make you feel comfortable, but rarely do any planning. Very often, the investments are too conservative to give you any chance to reach your goal – but you don’t know it and they make you feel good.

    Just like a placebo makes you feel good, but doesn’t actually contain any useful ingredients.

    Your gut will tend to favour placebo advisors, so you need to be aware of it and use your brain as well.

    Ed

  30. 30. Ed Rempel

    Quite a few posts here referred to my one paragraph on homeopathic medicine. I don’t want to get the conversation sidetracked and I know very little about homeopathic medicine.

    However, I do know a lot about people, which may apply. Human beings tend to see patterns that don’t exist. If you take a remedy and then feel better, you are likely to think the remedy works. It might work, but, it could be that the “placebo effect” just made you feel better, it could be your body healed itself, or it could be coincidence.

    We see this all the time in financial areas, where human beings also tend to see patterns that don’t exist. In fact, many people base their investing strategy on principles they believe – but that are false.

    For example, all of the following commonly-held beliefs are false, and yet many investment strategies are based on them:

    - Investing in your home country is safer.
    - Looking at the economy can help you determine when and where to invest.
    - You can forecast the movement of an investment by looking at a chart.
    - A good algorithm can forecast an investment.
    - “Sell in May and go away.”
    - Stop-losses stop losses.
    - Government debt, deficits, or trade deficits are bad for the stock market.
    - Gold goes up when there is inflation.
    - Investments or sectors that are “doing well” are likely to continue to “do well”.
    - Countries with faster growing economies have faster growing stock markets.
    - Following your gut is a good investment strategy.

    Ed

  31. 31. Ed Rempel

    Hi Dee,

    Thanks for the nice comment. I’m glad you found it useful.

    Ed

  32. [quote]If a financial advisor was worth his salt, he wouldn’t need to be one.[/quote]
    That implies the belief that financial advisors have some sort of way of becoming filthy rich in the short term, and that kind of belief/desire is what feeds into many of the problems in the industry. You think a financial advisor should be stinking rich because they made it rich in the stock market?

    That’s the last person I want anywhere near my money. Those folks will lose it as fast as they made it. Unfortunately, it’s exactly what tastes so good to most people.

    A decent advisor should be able to limit the risk of my not achieving my long term retirement goals. If they’re doing that, they’re probably also having to work for a living. But try defining that to most Canadians – “I want you to limit the risk of not achieving my long term retirement goals”. Holy cow that’s boring. I can make a lot more sales if I was a FA (which I’m not) by calling people up and showing them how my clients made 15% last year.

  33. 33. Aaa

    “You can invest in stock market investments, but you have to know there will be turbulence – but it will be okay. Statistics show it is reasonably safe if you invest long term in the proper way and don’t get off when there is turbulence.”. I’m sorry but this is an example of financial quackery. You are selling people a yarn. The only certain way to finance retirement is through sufficient savings or continued income. Anything else is snake oil and you do your clients a disservice by selling them this phantom notion that they will still be ok if they spend too much or don’t save enough just because they invest in the salvation of stocks. It is true bonds or gics may not offer very large returns but they are ‘relatively’ safe and have a ‘relatively’ low probability of making people materially worse off in retirement than they are now. This is not the case for stocks. True ‘western’ stock markets have exhibited around a real 6% annual growth with a standard deviation of 20%. But “past experience is no guarantee of future returns”. Solely on the basis of the fact that stock returns do not follow a normal distribution means that, with a standard deviation of 20%, in any given year you have a minimum 1 in 7 chance of being down 15% and a minimum 1/50 chance of being down 35%. Reality is, depending on how fat tailed the actual distribution of stock returns is, your chance of losing material amounts of money is even higher and the losses even greater. There is no physical law that says stocks have to mean revert following a large decline, just cause they have in the past doesnt mean they will in the future. Aside from this stocks in the western world have benefited from the tailwind of the largest population and economic expansion in human history. Finally, ask anyone in czarist Russia or imperial china how their stocks are doing, not so good. There is huge selection bias in this ‘stocks for the long run’ tale.

  34. 34. Ed Rempel

    Hi Aaa,

    You are mostly correct if you have a 1-year time horizon, but if you have a 30-year time horizon (like most people), then stock market returns have been very reliable.

    Of course, investing in the stock market is not enough on its own. You need to have a financial plan, so that you know how much you will need.

    Here is the point. Investors tend to arbitrarily look at 1-year periods or even shorter. If you can look at your investments with a 30-year time horizon, which would be appropriate for retirement planning, stocks have beaten bonds 100% of the time.

    When you take 30-year blocks of time since 1871, stocks have higher returns than bonds 100% of the time and also have less risk. Bonds lose money after inflation in four 30-year periods, but stocks have never lost money after 30 years even after inflation.

    There is a reason that stocks consistently go up long term. The stock market is a bunch of large companies that mostly raise their profits over time. They have many ways to do this – increase sales, new products, new markets, cut costs, reduce employees, reduce debt, buy other companies, sell out to a large company, setup more efficient systems, etc. Having worked as a controller for a manufacturing company, I can tell you that when profits are down, there is always a lot of pressure to find a way to get profits up.

    Rising profits in most companies over time is why the stock market consistently goes up long term.

    In the classic book “Triumph of the Optimists”, they track stock and bond markets since 1800 in 14 different developed countries and found the same conclusion in all countries. The US and Canada are usually in the middle of the pack.

    In contrast, bonds have gone to essentially zero in many developed countries. In the last century, government bonds went to zero in Germany, Japan, Italy, Brazil, Russia and possibly France. In all cases, it was high inflation that wiped out the government bonds. Today, it is happening again in Greece and may happen in more countries. The stock markets were able to adjust for inflation in every case, but the bond markets get massacred in high inflation.

    The only major country to have the stock markets get essentially wiped out was czarist Russia and only because the government nationalized companies.

    Your time horizon does not need to be the full 30 years. The S&P500 has not had a 15-year losing period and the worst 25-year period was about 5%/year. The worst 30-year period in the last 50 years was about 8%/year.

    In short, when you look at 30-year periods (and assuming you have the confidence to stay invested), stocks have higher returns than bonds 100% of the time and also have less risk.

    With today’s low interest rates, government bonds and GICs are not really an option for retirement planning. We call GICs “Guaranteed Insufficient Income”, since we have not seen anyone successfully save up for a comfortable retirement with GICs since the 80s.

    Many people have lost faith in the stock market because the last decade was the 2nd worst ever. I think the main reason for that was that the 90s was the best stock market decade ever and the market was in a bubble at the end of the 90s. However, company profits have been rising steadily the last few years and are now at the highest profit/share in history. The forward P/E is only 11.7%, which is the lowest (excluding periods of high interest rates) since 1954.

    It is these periods when it is hard to maintain confidence in the stock market that are the most difficult. To be fine long term, you have to maintain faith in difficult times.

    Most investors also mess up stock market returns by always buying whatever is currently popular. This means they always buy high and sell low, and therefore get long term returns far lower than the stock market and even lower than the returns of the investments they own.

    However, the stock market has always rewarded long term investors over 30-year periods of time, which is why it is generally the best investment for retirement planning.

    Ed

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