Are you a stock or a bond?

Meet Tula, age 33. She is the child of a baby boomer. After university she wasn’t able to get a job in her field, so she travelled the world. When she finally returned home from her travels, she moved back in with her parents. She pays her parents rent (and doesn’t have to cook). Today she has her dream job, and earns a base salary of $45,000 plus bonus. After paying off her credit card and loans for travel, she is now considering saving for long term objectives such as purchasing a home and eventually retiring.

To start a savings program, Tula met with a financial advisor. After the meeting, she realized she did not know some basics about investments or investing.

One of Tula’s questions was regarding the ‘volatility’ of investments. To better understand volatility, she checked out Moshe Milevsky’s book, Are You a Stock or a Bond: Identify Your Own Human Capital for a Secure Financial Future.  Milevsky is an associate professor of finance at York University’s Schulich School of Business and executive director of the IFID Centre at the Fields Institute.

Milevsky writes that if you are a business owner, your business represents the equity portion of your portfolio and  you should invest in bonds, GICs and low risk investments. Conversely, if you have a steady job with a salary, ‘you’ represent the bonds in your portfolio and your money should be invested in equities.

Tula identified herself as a having a steady job and therefore she should invest primarily in equities with a small portion in GICs and bonds.

Milevsky goes on to explain how long term investing and volatility is purely mathematics. For example, if you invest $100,000 and have sequential returns of +27 per cent, +7 per cent and -13 per cent, at the end of three years your portfolio would have a balance of $118,224.

Now change the order … with returns of -13 per cent during the first year, +7 per cent in the second and +27 per cent in the final year, starting with the same $100,000 investment, you end with exactly the same, $118,224.

Tula’s other question … What is a stock index?

An index follows a certain market and gives investors a single number to summarize its ups and downs. It is a means by which the world’s institutional (and retail) investors can track a market without having to buy the underlying components. It is a convenient way for someone interested in a broad, narrow or extremely narrow group of securities to track them.

The most commonly followed indices in North America include:

• The Dow Jones Industrial Average, known as the DJI, is a stock market index. It is comprised of 30 large publicly owned companies based in the US.

• Standard and Poor’s 500, known as the S&P 500. This is similar to the DJI. The companies selected are representative of the industries in the US economy. In order to be added to the index, a company must have a market capitalization of at least US $4 billion.

• The S&P/TSX Composite Index is an index of the stock (equity) prices of the largest companies on the Toronto Stock Exchange (TSX) as measured by market capitalization. The Toronto Stock Exchange listed companies in this index comprise about 70 per cent of market capitalization for all Canadian-based companies listed on the TSX.

Tula has just begun to investigate investing for the long term. She has consulted a financial advisor as well as doing her own research. As a further tool for educating herself, Tula purchased the Stock Trader’s Almanac. It provides stock market analysis, stock market trends and reports in much the same way as a Farmer’s Almanac provides historical information for farmers.

If you would like to invest but do not have the cash flow, try investing hypothetically. Pick mutual funds and stocks and an amount to invest. Periodically follow the results of your hypothetical investment on the internet or in the financial/business section of the newspaper. In this way you will gain experience and expertise. When you finally are ready to invest, you will be knowledgeable.

J McPherson, 416-738-1555

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