Getting rich slowly

  By Guest Blogger Sinan Terzioglu

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As equity markets have recovered significantly over the last year and are making new all-time highs, some are taking on more risk to supercharge their returns.  Whether it be by purchasing individual securities like GameStop, utilizing leverage or speculating in crypto currencies and derivatives, risk management has increasingly become looser. The last few months remind me of the early 2000s as the tech bubble was forming.  Free trading apps like Robinhood and WealthSimple have made it all too easy for people to speculate and engage in dangerous behavior.

Leverage
Borrowing to invest is risky.  Some have achieved great results with leveraged investing over the long term but many have not.  Markets inevitably test investors, so if you don’t have a long term mind-set, leveraged investing is definitely not for you.  Those who have succeeded did so by not overleveraging their equity and developing a plan for turbulent times.  Most importantly, they invested in high-quality productive assets where the risk of a permanent loss of capital was low.

We all know about the success of Warren Buffett and his right-hand man Charlie Munger, but few have heard of Rick Guerin, once considered a super investor after achieving market-beating returns in the 1960s and early 1970s.  Guerin had worked with Buffett and Munger on a number of deals.  Buffett supposedly said Guerin was just as smart as he and Munger, but the big difference was simple: Guerin was in a hurry.  Heading into the market downfall of 1973 and 1974, he was levered with loans and got margin calls he couldn’t meet. Thus, he had to sell his Berkshire Hathaway shares to Buffett for under $40 a piece.  Today those Berkshire shares are trading around $400,000.

Reddit Stocks
One of the most traded stocks recently on the WealthSimple app is the theatre chain company AMC.  This security has a large short interest and has been one of the most talked about securities on the online chat forum Reddit.  Most individual investors should not be purchasing a security like this as there’s the real possibility of the company going bankrupt.  AMC owes over $5.7 billion and some of the debt has taken on over the last year bears a double-digit interest rate.  Over the last 12 months AMC has paid more in interest than it earned in operating income in each of 2017, 2018 and 2019.  Of course it is possible the company can turn around but its share price could significantly fall in the meantime as the company works on changing its operating model.

If you are going to invest in highly speculative securities like this at the very least don’t hold them in registered accounts like TFSAs and RRSP since all of the contribution room for these accounts should be handled with care.  Once lost you cannot get the contribution room back.  Speculative securities should only be held in a non-registered account so you have the ability to utilize capital losses to offset future capital gains.

Crypto Currencies
I am often asked about crypto currencies like Bitcoin and why we don’t invest in them.  There is no denying digital currencies will increasingly become a part of our lives but our view is that this is not an investible asset class.  While the price gains have been spectacular no one can value something like Bitcoin because it produces no cash flows and therefore lacks an intrinsic value.  That is not to say the price cannot continue climbing because it certainly can but without the ability to calculate an intrinsic value you are simply speculating on what others will pay.  One of the most important things when striving for long term investing success is to not lose money and since we cannot value crypto currencies there is no margin of safety.

Some argue that if you allocate 5-10% to crypto currencies this provides diversification benefits to a portfolio.  While that may be true for a period of time it still does not reduce the risk of permanently losing capital.  From a technical perspective, I wouldn’t bet against BTC right now but fast forward a year or two and I would not be any more surprised if Bitcoin doubled in price or lost 50%.  So if you have conviction and are ok with the speculative nature of this asset class than good luck to you but at the very least position size responsibly.

Derivatives
Recent news about a US family office blowing up after using swaps to leverage their equity by over 5x has once again highlighted how dangerous derivatives can be. History is full of disasters like this where a recent streak of success led to increasing greed and ridiculous amounts of risk.

Over the last few months there have been many stories of individuals buying call options on GameStop and making boat loads of money.  They have shared their profit screens online and this has led to others to bet big on call options as well.  As GameStop jumped from $20 to over $440 per share this produced enormous gains for those lucky few but as the stock dropped like a rock from its highs to $40 a share there is no doubt many lost significant amounts of money.  This is no different than taking most of your money and spending it on lottery tickets.  The options market is very complex and unless you are willing to put in the time to learn and manage risk most individual investors should stay away from it.

Always Think Long Term
You will greatly increase your probability of achieving investment success by adopting the mind-set of getting rich slowly.  Being patient is key.  What made Buffett and Munger so successful is that they have been patient investors for over 2/3rds of a century.  Earning a reasonable rate of return is important but longevity is significantly more important.  You must ensure you stay in the game and continually evaluate your risk and behavior.  As Buffett once said:

“It is not necessary to do extraordinary things to get extraordinary results”

By developing and following a long term plan you significantly increase the odds of meeting your financial goals.  Investing intelligently is about controlling your expectations, your risk and your tax implications.  Most importantly, intelligent investing is preventing yourself from being your own worst enemy.  Until you have achieved a portfolio that will be able to provide a pension-like income stream for several decades most should not even consider investing in individual securities.  This takes time and the earlier you start and invest in tax-advantaged accounts the sooner you will achieve your financial goals.

Sinan Terzioglu, CFA, CIM, is a financial advisor with Turner Investments, Private Client Group, Raymond James Ltd.  He served as vice-president of RBC Capital markets in New York City and VP with Credit Suisse in Toronto.

About the picture: “I’m recently retired, have lived and worked all over the world in the last 20 years – Dominican Republic, Cuba, France, Hong Kong, Singapore, Brunei, Indonesia, Thailand, Abu Dhabi and South Korea,” says blog dog Carole. “Amazing expat life of adventure, but happy to return to live in Canada (expensive but worth it). Picked up this “desert shepherd” from the streets of Dubai while working in the UAE. Maybe you can use this photo of Peepster. I’ve got a great diversified diy portfolio of equities (dividend stocks, etfs) and am grateful for direction gleaned from your blog. Thanks again.”