My answers:
1.D
2.B
3.A
4.B
5.A
6.C
7.B
8.A
9.B
10.C
11.A
12.A

Is anyone else brave enough to post their results? This is not a proper study, but we are very interested in hearing how people did on the quiz and what areas they were not correct about.

Ed

That is a good point. In addition to the risk of the market, there is the risk associated with the specific investments or investment strategy of the investor.

Behavioural finance and many studies show the average investor makes far less than the investments they own. This is mainly from bad market timing, which seems to be a fundamental flaw in the human brain when it comes to investing.

However, this is a separate issue. It is possible to deal with this. Some investment strategies are definitely inferior to others. In general, the more trades and investor does, the worse they do.

Also, individual stocks would have far higher risk than the market as a whole. They don’t usually publish the standard deviation of a stock like they do with a mutual fund because they are so high. For example, Royal Bank is probably about triple the risk of the TSX.

How investors do compared to their investments would be another good article.

This article is about the stock market as a whole and the risks related to it.

Ed

Thanks for responding. My only concern is, that if the point of the post is to be educational and to reveal the true risks of investing in equities, then 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.

There is, as I know you are aware, lots of publications arguing exactly the opposite — that the general public has been led to believe that the market is less risky than it really is.

The point of the article is not that you should get the return of the stock market. It is meant to be educational. The returns of the markets are much higher and the long term risk is much lower than most people believe.

Everyone needs to decide their own allocation, but there is a tendency to have too little in equities because of fears that they are riskier than they actually are. If you invest for the long term and keep investing in bear markets, the long term risks can be surprisingly low.

If you are able to ride the ups and downs, the returns are much higher.

You mentioned that being 100% equities 5 years before retirement can set you up for a big crash. That is true, but the part people forget is that the markets have consistently recovered quite quickly. 88% of declines have recovered fully in 1-2 years and the longest recovery was only 4 years (excluding the 1930s).

Also, most retirees live 20-30 years after retiring. The most common mistake is to have too little in equities and therefore run out of money too soon and not keep up with inflation. The #1 risk of retiring is not a market crash, but running out of money.

I agree that very few investors earn market returns. That even applies to index investors, since they tend to buy more after big gains and less when the markets are cheap.

We think everyone should choose their own benchmark from the indexes that represent their portfolio and then regularly compare their returns to their benchmark. That keeps you focused and can help you avoid mistakes.

For those that want to make index returns or higher, they need a strategy to do that. To beat the index, you probably need to be 100% equities. We have a strategy we believe will beat the indexes over time, which is partly the investments we choose and partly avoiding behavioural mistakes.

Ed

That’s why I wrote these articles – because much of the conventional wisdom about the stock markets is wrong.

Ed

Comparing recent returns to 100 years ago, the returns are similar. The main difference is that the market is much more manic now.

I wasn’t around then and don’t know for sure, but I have a guess as to why the main difference today seems to be bigger ups and bigger downs, but similar returns over time than 100 years ago.

I think the average investor is less knowledgeable today, despite all the information available. 100 years ago, it was an “Old Boys’ Club” with most investors knowing the company and CEO, their competitors, they read the annual reports, went to the annual meeting (mostly for the drinks), and they had a good idea what the company was worth.

There are a lot more trend followers now. So many investors know hardly anything about the companies they invest it, often buying based on a trend or graph.

It could also be that it is just so much easier to trade and so many more people are trading, but I do think the average knowledge level of investors about their investments in lower today than 100 years ago.

Ed

It might be true in principle — but in practice what % of investors actually achieved that? Less than 5%? Less than 1%?

Partly because (most) people don’t invest 100% in equities — and especially not for 50 years straight. Anyone who is 100% in equities with 5 years to go until retirement sets themselves up for a pretty big fall if the market crashes on the home stretch.

Just as you find Trahair’s argument misleading, I find equities arguments such as those misleading. It pretends that it is easy to get (or even beat!) the index. In practice, it is pretty difficult to do consistently.

I’ll grant that most investors are not 100% in equities. So let’s imagine someone 60% in equities and 40% in GICs. This investor would end up with about double the money over 50 years as an investor 100% in GICs. This is a big difference even though the percentage difference each year may be small.

Except that in order to get the 50-year return for stocks you have to own 100% equities . . . do you?

That apparently small difference in percentage between 50-year returns for stocks and GICs corresponds to a factor of more than 3 in cumulative return.

Assuming, for simplicity, that everything is held in a TFSA or RRSP and that inflation hits both the same:

Here is the S&P/TSX Composite Total Return Index (includes dividends)

* 10 years to August 31, 2009 – 9.41%
* 20 years to August 31, 2009 – 8.86%
* 30 years to August 31, 2009 – 10.76%
* 40 years to August 31, 2009 – 9.77%
* 50 years to August 31, 2009 – 9.80%

Subtract 1-2% for MER
Subtract a bunch because few are 100% invested in equities.

I don’t see the return being anywhere near what you claim.

I also don’t see the return on GICs being anywhere near the low return you claim. Trahair’s GIC data show:

* 10 years to August 31, 2009 – 3.35%
* 20 years to August 31, 2009 – 5.11%
* 30 years to August 31, 2009 – 7.28%
* 40 years to August 31, 2009 – 7.71%
* 50 years to August 31, 2009 – 7.35%

Not all that different from equities index once management fees and asset allocation is accounted for.

I agree that if you stick with a stock for long term and if a company you invested in is in good shape- you’ll just ride through and maybe you’ll do well.

So really, I don’t think you know for sure 100% which direction a stock will go – you can only speculate.

Most interesting to me is that a lot of “conventional wisdom” of the stock market don’t actually match well with the facts.

I detect a little bit of cherry picking with the gold numbers. If you choose 1975 instead of 1978, I suspect the numbers turn out differently.
Not that I think gold is a good investment, I just like playing Devils’ Advocate. :)