Monday, October 24, 2016

We Are Not Always So Rational, Part 3

Montparnasse derailment, 1895. Source: Wikipedia

In the previous 2 posts, we discussed the common behavioral biases that we suffer and where they originate from. In this third post, we discuss the impact of our biases: on ourselves, our portfolios and on the markets.

Impact on ourselves

The financial markets affect all investors’ mental health, at least to some degree.

Even the most conservative, long-term oriented investors felt some shock during the 1987 ‘Black Monday’ crash, 2008 financial crises and 2010 flash crash. On the other end of the spectrum, there are the aggressive types that treat the markets like a casino. It is this group that is particularly damaging their mental well-being.

Aggressive traders are ones that routinely do one or more of the following:
  • Watch every tick of the market and binge on financial media
  • Trade based on emotion without a process, or use a highly complex process
  • Take concentrated and/or leveraged positions in volatile securities (eg. micro-cap stocks)
  • Over-trade / day-trade

Engaging in these activities chronically can lead to addiction, stress, anxiety and even depression. It cannot be overstated how bad stress is for us. How can we prove there is a definitive link between money and mental health issues?

Source: Scott Camazine—Getty Images

There has been extensive scientific research done on how the brain is affected by money. There’s even an entire discipline devoted to it: Neuroeconomics. Studies from the past two decades have revealed that there is a whole lot happening in our brains when money comes up.

In 1997, a study performed brain scans on 12 people that played a game in which they could win or lose money. What they found was that players who were about to make money had increased neural activity in their nucleus accumbens – the region of the brain tied to reward, pleasure, motivation and addiction. These scan images were compared to those of addicts who were high on cocaine. Remarkably, the scans were nearly identical.

In one 2003 study, test subjects were paired with complete strangers. Each pair was given a sum of money and asked to split it. One person would act as the “proposer” while the other as the “responder.” If the pair cannot agree on a split, then neither walks away with cash. The study found that the responders rejected over half the unfair offers (which is irrational since something is better than nothing). But more interestingly, the study found these unfair offers activated a part of the brain in the responders associated with anxiety, pain and hunger.

In 2005, a study was done at Stanford University using Functional Magnetic Resonance Imaging (fMRI). Brain activity of participants was monitored as they chose between stocks and bonds given limited performance info of each. The researchers found they could predict whether a participant would choose to buy a riskier security, like a stock, or a less risky one, like a bond, just by scanning their brains. The subjects who had naturally elevated stimulation of their nucleus accumbens would most likely buy the stock.


Impact on our portfolios

"When it comes to investing, you are your own worst enemy." – Barry Ritholtz

Not only do biases cause the average investor to suffer health consequences, they also cause serious financial consequences. Our individual biases cause us to make all sorts of portfolio mistakes:
  • Poor allocations: holding concentrated positions in a few stocks or holding too much cash 
  • Poor timing: Holding losers too long, selling winners too early
  • Frequent trading: getting too caught up in day-day noise, falsely believing you can outsmart the market in the short term, trying to irrationally climb out of a loss

Over the 20 year period ending Dec 2008, the folks at Dalbar show us exactly how much damage the average equity investor did to their portfolios: 

Impact on markets

We see that our irrationality in the markets hurts us mentally and financially. Interesting things happen when you look at the behaviour of all individuals as a group.

Each individual investor may make different mistakes (due to their unique biases, genetics, experiences, knowledge, etc.). They may be more loss-averse or suffer greater overconfidence bias than their neighbour. Occasionally, their biases will even cause them to get lucky. However, it turns out that as a group we are extremely consistent at being wrong.

The chart below shows the average individual’s asset allocation between 1988-2010. The average person had a record high allocation to stocks in Jan 2000 (the peak of the tech bubble) and record low allocation to stocks in March 2009 (the exact month the markets bottomed after the 2008 financial crises).  

We can take this one step further.

The chart below shows the average household’s % allocation to equities (blue) and the subsequent 10 year return for the S&P500 (black). This chart is often dubbed the “single best stock market predictor” because of how accurately current investor allocation to stocks can predict future 10-year returns of stocks.

Source: MarketWatch and Ned Davis Research

Note that the scale for the S&P 500 is inverted. Basically, when everyone is in love with stocks, future stock returns are low (and vice versa).

Thus, the collective biases of all market participants cause markets to deviate from perfectly efficient. The momentum anomaly which I discuss often on this blog is partly explained by two behavorial biases: regret aversion ("herding effect") and availability bias ("recency effect"). Other factors are explored in the first post on this blog: Philosophy of Momentum.

In theory, investor sentiment can directly be used to outperform the market. Contrarian investors buy when the herd is bearish and sell when the herd is bullish. But how is sentiment measured? The main methods include: surveys (eg. AAII), money flows, portfolio allocations and options activity (eg. put/call ratios). There are a few research outfits such as and Ned Davis that make a living off selling sentiment research.

However, sentiment trading suffers the same problem as value investing: something that is hated can become even more hated.  A great recent example of this is commodity stocks, which have repeatedly trended lower since 2011 despite breaking all sorts of sentiment records as early as 2013. John Maynard Keynes famously said: “The market can remain irrational longer than you can remain solvent.

Another point I want to make clear is that sentiment is but one factor that drives markets and for the short-term. There are other factors (such as the business cycle, institutional buying/selling, central bank actions) that also influence markets in the short-term. Over the long-term (eg. 10 years), markets have been observed to respect valuations and mean-revert (eg. the current Shiller P/E ratio is a rough indicator of future 10-year stock returns).

Trend following (and momentum) is a much better approach* at outperforming the market. It aligns itself with the market’s trend, which is the collective result of several forces (sentiment being one of them). *It is important to note that this approach must be simple, systematic, evidence-based, robust and of course, forecast & bias free. GEM is one such approach.

To summarize:

Actively investing solely on your cognitive & emotional biases will result in drastically underperforming the broad market and at a cost to your health. The collective irrationality of individuals (among other factors) leads to markets being less than efficient. By being cognizant of this, we can take a trend following approach to outperform the broad market while simultaneously reducing our stress & anxiety.

I will need to add one more post to this series. In part 4, we will look at techniques that will help reduce the impact our emotions have on our investing to ensure we stick to our plan. Stay tuned.

Sunday, October 2, 2016

We Are Not Always So Rational, Part 2

Recall from our previous post that we investors suffer from behavioral biases that lead us to make poor decisions. There are two main types:
  • Cognitive biases (resulting from lack of knowledge, faulty logic and memory errors) 
  • Emotional biases (making decisions based on impulse and feelings)
We discussed some cognitive biases already, so let’s take a look at the other type.

Emotional Biases

  • Loss Aversion (also known as Prospect Theory) – this is when we strive to avoid losses rather than seek gains.
An investor is said to be risk-averse if they feel more pain from a $1 loss than pleasure from a $1 gain (and risk-seeking if they feel more pleasure from the gain). If offered a stock and told there’s an equal chance of it either falling to $90 or rising to $100, the risk-averse investor would not pay more than $95 (ie. the expected value of the stock) while the risk-seeking investor would. 
An investor that is loss averse may initially be risk-averse, but when faced with losses, can become risk-seeking in an irrational attempt to climb out of the loss. The implications of loss-aversion are massive. They include:  
- Holding excessively conservative portfolios (eg. heavy in bonds or cash)
- Not selling losers in order to avoid a realized loss
- Trying to climb out of a loss by doubling down on losers or trading excessively  
  • Overconfidence Bias – Overestimating your own intuitive ability or reasoning. 
Example: Ask an audience how many think they are below-average investors and few hands will go up. In fact, studies show that 95% of us view ourselves as above-average drivers! Truly astonishing.
  • Endowment bias - We give greater value to things we already own or are familiar with. In investing, this leads to holding securities too long or in concentrated sizes. This is also related to the tendency for investors to concentrate their portfolio in their home country, as it's familiar. 
Example: You're deciding between a Toyota Camry and a Honda Accord and have no idea which is better. 6 months after purchasing one, that car becomes familiar and you say "I don't know what I was thinking even considering the other car!
  • Regret aversion - Making choices simply to avoid potential regret. People often do what others are doing in fear of being left behind, leading to the "herd behavior effect"
Example: During the NASDAQ bubble of late 90's, many individuals were buying into the market for fear of missing out. 
  • Status Quo Bias – Comfort with an existing situation leads to an unwillingness to make changes or consider other, better options. 
Example: Selecting the default asset allocation on an employer defined-contribution plan and not changing it with the passage of time. This leads to a portfolio with inappropriate risk
  • Self-Control Bias - Lacking self-discipline and favoring immediate gratification at the expense of not meeting long-term goals. Too many people do not save enough to fund retirement needs

We’ve now looked at 12 cognitive and emotional biases. This just scratches the surface as it turns out there are at least dozens more that we suffer from. The more you study our decisional flaws, you realize that we are nowhere near the rational, number-crunching computers that efficient market theory assumes we are.

Where do our biases come from?

Psychology identifies what our biases are while biology explains where they originate from. 

We humans evolved very slowly over 6 million years from more primitive origins. Each generation produced offspring with some genetic variation. Those with traits providing a better survival edge (no matter how slight) had higher probability of passing on those traits to the next generation. We were shaped in this progressive and cumulative process over millions of years (though the above picture makes you question the “progressive” part!)

The majority of our history was lived in a perilous world. Our traits are well adapted to suit this environment, helping us fend off predators, hunt prey, build shelter & tools, etc. It is only in the last 6,000 years (or 0.1% of our human history) that civilization as we know it has been around, and only 200 years (0.003% of our history) that we’ve been living in an industrialized world. In a very short period, we enjoyed a dramatic increase in our standard of living. Suddenly, we no longer needed to spend the majority of our time and energy worrying about our survival. 

Our mind and bodies, however, have not been able to keep up since evolution is a slow process. It can be argued that this has led to some major health issues we face today from: a sedentary lifestyle, radically different diet and constant barrage of information and interruptions to name a few. We especially are poorly equipped to manage our investment portfolio. Handheld phones with stock prices refreshing every second are sabotaging our ability to maintain a long-term mindset. 

Perhaps we may never fully adapt to this new world: our standard of living is so high that our biological imperfections don’t significantly hurt our chances of survival. You will still be able to eat even if your portfolio isn’t holding the right asset allocation or if you don’t understand what standard deviation is!

Evolutionary Psychology is a separate discipline that attempts to explain mental traits—such as memory, perception, or language—as products of natural selection. On the most basic level, we feel positive emotions (euphoria, excitement, confidence) when we receive things that increase our survival and replication chances. We feel negative emotions (fear, anger, panic, frustration) when it’s the opposite. 

Some of the behavioral biases we discussed can at least be partly explained by Evolutionary Psychology as follows: 
  • Loss aversion: "For an organism operating close to the edge, the loss of a day's food could amount to death, while the gain of an extra day's food could lead to increased comfort but (unless it could be costlessly stored) would not lead to a corresponding increase in life expectancy." - Wikipedia
  • Endowment bias and Status-Quo bias: you stick to what is familiar because it is safer and reduces risk. It could cost your life if you wandered into a new, unfamiliar part of the woods alone. 

So far in the series, we discussed several behavioral biases that cause us to make poor investment decisions and where these biases originate from. In the third (and last) part, we’ll look further into the impact of our biases on our investing as well as how we can minimize this impact. But first…

Quiz Time!

See if you can identify the behavioral bias in each Dilbert comic strip below. Answers can be found on my twitter feed (@sharpeReturns).

Sunday, August 28, 2016

We Are Not Always So Rational, Part 1

A personal note

I’m proud to say that I have recently been awarded the CFA charter.

Although I’m fortunate to have passed each of the 3 exam levels on the first try, it took me a long time to complete the program. I wrote level 1 in 2009, followed by level 2 in 2011. At that time, I was working as an engineer and didn’t see the value in finishing.

Also around that time, I first discovered the work of Meb Faber and Gary Antonacci. I continued to research markets on the side since then and Gary has really been instrumental in accelerating my learning curve. A little over a year ago, Gary nudged me to start this blog. And earlier this year when I met Gary in person for the first time, he encouraged me to finish the CFA program. It’s been a very interesting journey so far and I hope to share more announcements with you in the future.

Incidentally, both Meb and Gary are coming to my hometown Vancouver on Sept 6th to give presentations. Small world. If you live in the area, I highly recommend you attend. Register here.

The most interesting topic in finance

Of the 3 CFA levels, the third one taught material I enjoyed the most. It skips the humdrum accounting and statistics of other levels and instead focuses heavily on portfolio management. There were a couple chapters dedicated to Behavioral Finance (BF) – what I consider to be the most interesting topic in investing.

BF is the study of human nature and its impact on our investment decisions. It challenges the main assumption of traditional finance: that individuals are rational and that the markets they shape are efficient. It is where the world of investing intersects the disciplines of psychology, history and biology.

As we will see, investors suffer from numerous behavioral biases that lead them to wreck havoc on their portfolio. It is truly amazing how many distinct biases there are that they need to be categorized into two main categories:
  1. Cognitive – faulty decisions that arise from the lack of knowledge, information processing errors or memory errors
  2. Emotional – faulty decisions that stem from feelings, impulses or intuition

The remainder of this post will discuss some common cognitive biases. There is so much to discuss on the topic of BF, that we will follow up with 2 more posts:
  • Discussion of common emotional biases, plus a quiz!
  • Impact of our biases, how to minimize this impact as well as additional resources

Cognitive Biases

  • Anchoring – New info is not viewed objectively, but rather in relation to an initial view or thought.
Example: Studies show that when a group is asked to estimate the price of a car, the average estimate tends to be reasonable. However, if asked first what the last digit in their phone number is, people who had a higher digit tend to over-estimate the car's price.
  • Framing - When the same information is presented in different ways, it leads to different outcomes.
Example: Sally is loss averse. When her advisor presents a new fund in terms of historical return and volatility, Sally invests. However, when the advisor presents the same fund in terms of probability of a loss, Sally declines to invest.
  • Availability Bias - Giving undue emphasis on info that is readily available and fresh in our minds. This leads to giving higher importance to recent events rather than old events (the "recency effect"). 
Example: Bob chose to invest with XYZ fund because of a billboard ad he sees on his daily commute.
  • Confirmation Bias – looking for new info to support an existing view.
Example: Soon after buying stock XYZ, you selectively search for bullish articles while ignoring any bearish articles.
  • Hindsight Bias – Overestimating what could have been known. People often remember their correct views while forgetting their errors
Example: “I saw the 2008 crises coming all along” 
  • Conjunction Fallacy – before explaining this one, I want you to participate in this question:
Linda holds very strong views about the environment. Which is more likely?

a) Linda is a bank teller, or
b) Linda is a bank teller that donates to an environmental organization

If you said (b), that is incorrect. But don’t feel bad, 80% of people choose that answer.

The probability of Linda being a bank teller is already small. But for her to make a donation in addition to being a bank teller reduces the probability further. This example shows how we can be tricked into believing that two events have a higher chance of occurring together than either one occurring on their own. That’s the conjunction fallacy.

In part 2, we’ll look at some common emotional biases. Stay tuned

Wednesday, July 27, 2016

Momentum on Individual Stocks vs Asset Classes

I had the pleasure of finally meeting Gary Antonacci earlier this year.

Gary is the creator of the momentum strategy that I follow and have been discussing on this blog.  I first came across his work in 2011 on the blog Abnormal Returns (which should be a daily read for investors). Gary and I have been e-mailing each other ever since. After over 4 years, it was nice to finally see him in person.

Gary gave an excellent 2+ hour presentation on momentum in Seattle. There were over 100 people in attendance and it was the local AAII chapter’s largest turnout. The presentation covered everything: what momentum is, why it works, its history and correct use.

Two main ideas on the correct use of momentum were discussed:
  1. Momentum applied on asset classes works much better than on individual stocks
  2. The role of absolute and relative momentum and the synergistic effect of combining the two
In this post, I will focus on point #1. When momentum is applied on individual stocks, there are 3 main drawbacks:
  1. Low scalability
  2. High volatility
  3. High transaction costs
Let’s discuss each of these in detail.


When applying momentum on individual stocks, trade execution can suffer for large trade sizes or thinly traded stocks. The very act of buying and selling changes the market price, hence reducing the alpha that can be achieved.

Contrast this with momentum applied at the asset-class level. You can enter/exit large positions in an ETF such as SPY (SPDR S&P 500 ETF) and the vast liquidity of this ETF would absorb the buying/selling pressure.

The chart below shows that momentum on individual stocks is theoretically best when both the number of stocks and holding period is small. However, a small number of stocks means low scalability and high volatility while a small holding period means high transaction costs.


The second drawback to trading individual stocks is that they are also more volatile. This is due to company-specific risk such as earnings reports or regulatory changes. It can also be due to stocks being thinly traded or belonging to a volatile industry such as mining.  

The table below shows a momentum strategy using individual stocks compared to the S&P 500. While the returns are higher for the momentum strategy, the volatility is also a lot higher. The Sharpe Ratio does not improve much (after trading costs, it may actually be lower for the momentum strategy).


In an individual-stock momentum strategy, you typically will hold a much larger number of stocks than you would ETFs in an asset-class momentum strategy. This results in a higher volume of trades and hence, transaction costs.

The table below shows that after transaction costs, momentum applied on individual stocks (whether large cap or small cap) actually performs worse than a buy-and-hold strategy.

We can alleviate the drawbacks of scalability, volatility and transaction costs by instead applying momentum at the asset-class level. But which asset classes should we use? 

The book “Stocks for the Long Run” by Jeremy Siegel shows that equities (especially US equities) have had the highest risk premium among all asset classes, so they should be the focus of any momentum model. Bonds should also be included since they tend to outperform equities during recessions. 

The GEM strategy I follow uses 3 asset classes: US stocks, non-US stocks and bonds. You can refer to this page to see how the strategy has fared over the past 40+ years compared to each of the 3 assets on their own. 

Despite all the evidence supporting asset-class momentum over individual-stock momentum, it is astonishing to see so many commercial momentum funds doing the opposite: AQR Mutual Funds (AMOMX, ASMOX, etc), PowerShares ETFs (PDP, PIZ, PIE, etc), iShares ETF (MTUM), Alpha Architect ETFs (QMOM, IMOM). 

Results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Additional information regarding the construction of these results is available upon request. Past performance is no assurance of future success. Please see our disclaimer page for more information.

Thursday, June 16, 2016

Be Thankful

I apologize that I haven’t posted on this blog for the past several months - I was studying for the CFA Level 3 exam, which I wrote earlier this month. It is a great feeling to be back into my regular routine again and have some spare time. So here is a simple post that I hope you can apply not only in your investing but life in general. Enjoy

Being grateful

I was talking recently with my friend Deep who I’ve known since about age 4. He told me how he just started wearing eyeglasses again. This seems like a minor lifestyle change until you learn the history of my friend’s eye condition.

When Deep was 5, he got his first pair of eyeglasses. But his vision kept deteriorating that he needed a stronger prescription lens every year. By age 11, he was on the strongest lens available. The optometrist told Deep that if his vision didn’t stabilize soon, he would be legally blind.

At that time (over 20 years ago), we did not have proven, mainstream eye surgery techniques like Lasik or PRK. Of the limited procedures that were available, there was no internet to do research, evaluate risks and learn from testimonials of other patients. Instead, Deep did the only thing he really could do. He prayed. Every day.

At age 12, Deep underwent a procedure called Radial Keratotomy. “Weren’t you scared?” I asked. “Of course, it’s your eyes after all. But I really didn’t have much of a choice. There wasn’t much to lose” he replied.

I can’t help but think how grateful Deep must be that the surgery was successful. How he went from barely being able to see to not needing glasses until recently (something the optometrist said was inevitable later in life). His life dramatically improved. Deep is currently a Senior IT Manager and one of the most passionate people I know about computer technology, motorcycles, and life in general.

There’s an important message here. Too often we’re constantly listing all the things we’re missing in life. “If only I had ____, life would be better.” This leads us to being unhappy and even depressed.

One of the simplest and most effective ways of increasing our happiness is to stop focusing on what’s missing and instead be thankful for the things we already have: A home. Modern medicine & good health. Wide selection of fresh food at your local grocery store that even the wealthiest didn’t have in past civilizations. It is a great feeling once you believe we are not owed anything in life and that everything we have is a bonus.

As applied to investing, it is easy to be unsatisfied with your portfolio size, returns or both. In addition, it is easy to get sucked in by the media and dwell on the constant barrage of negative news. These factors often lead us to make sub-optimal decisions with our portfolio, which in turn further add to our stress and misery.

Instead, focus on all the positives of being an investor:
  • It is easier now more than ever to follow the research of professional investors. I am especially grateful for having a simple & proven strategy and evolved philosophy thanks to the generosity of Gary Antonacci, Meb Faber, Tadas Viskanta, Ben Carlson, and many others
  • Be grateful that you have savings to invest (no matter how small). A large % of the population unfortunately does not have this benefit
  • Perhaps you have developed a sound investing plan at a young age. Be grateful for that, as many go their whole lives not having figured out their finances
  • ETFs have given us diversification at low cost. Online brokerages have made it cheap & easy to execute trades 

Evaluating thyself

Related to the problem of overly focusing on our negatives is the problem of comparing ourselves with those that are more successful than us.

Often, as investors it is tempting to compare our performance with other investors. Did I beat XYZ
manager? This is one of the worst things you can do. There will always be someone out there better than you. You can never always be the best, nor should you care to be.

Seth Godin has an excellent blog about general business & marketing philosophy. But so much of what he writes applies to investing. He recently wrote a post titled “It’s not a race.” Seth writes: 
A race is a competition in which the point is to win. You're not supposed to enjoy the ride, learn anything or make your community better. You're supposed to win. Once you see it that clearly, so many things are clearly not races. And when we treat life that way, we cheat our customers, the people we seek to serve, as well as ourselves.

Instead of trying to compete with other investors, I recommend you compare your present self with you one year ago. And I’m not talking about portfolio returns. I’m talking about:
  • Was I more disciplined this year?
  •  Did I have less stress?
  • Was I able to ignore the noise?
  •  How many people did I help with their finances?
  • What did I learn?

Please feel free to share you own thoughts in the comments below. Thanks for reading

Saturday, March 5, 2016

Buffett's Advice to Young People

Dear readers, I will be away for the next 3 months studying for an exam. I see some of you have left comments – I will respond to you in June.

In the meantime, I’d like to leave you with a speech given by Warren Buffet to a young audience. The video is almost 20 years old but the advice is timeless. Some of the key takeaways:
  • Qualities of great employees: integrity, intelligence, and energy. You must have integrity in order for the others to matter. 
  • The importance of forming good habits at a young age in order to develop into the kind of person you most admire. 
  • Do what you love, not what makes you the most money
  • Stay out of debt and live frugally. Compare two people: one with net credit card debt of $10K paying 18% while another has net savings of $10K growing at say 8% over the long-term. You want strive to become the latter at an early age. 


Thursday, February 4, 2016

You Gotta Be Here

Source: Kenn Leonhardt

In 2010, Vancouver BC hosted the Winter Olympics and the city ran catchy marketing slogans including “The Best Place on Earth” and “You Gotta be Here.”

Vancouver has supernatural scenery with the ocean and mountains in the backdrop. We have world-class ski resorts just 30 mins away from the city core and enjoy a very moderate climate.

We also have some of the most expensive real estate on earth. In fact, last month the average detached house in Greater Vancouver has surpassed $1.8 million!

Source: REBGV

As you can see from this graph, prices of detached homes have gone parabolic in the past year. The locals here are dangerously in love with real estate and it seems it’s the only market they ever talk about. You got to be here to witness it.

According to the annual Demographia housing study, Vancouver real estate is regarded as the 3rd most expensive in the world (based on average housing prices divided by average local incomes).

Source: Demographia

Our housing valuations (Price/Income and Price/Rent ratios) are now over 3 standard deviations from their historical norms. Yes, I know. Something that’s expensive can become even more expensive and that’s why I’m a trend follower instead of a value investor.

So what's the point I'm trying to make?

I want to show you (especially if you’re a local) something that may surprise you. I want to show you that as hot and exciting as Vancouver real estate might look, boring old bonds would have made a better investment over the past 40 years.

Going back to the price graph above, a single detached home went from about $80K to $1.8M in 39 years. That’s an annual price growth of 8.3%. If you count rental income, then the total return would be closer to about 10%.

Over the same period, an Aggregate Bond Index such as AGG (which mostly contains AAA-rated government bonds with an average 5-year maturity) grew at a total return of 8%. OK, not quite as high but consider these important things:

  • Bonds are low-cost. They don’t have the enormous costs of property tax, insurance, maintenance and repairs. Just property tax alone in Vancouver would be $34K/year on the average $1.8M house.
  • Bonds are more liquid. To sell a home in Vancouver, realtor fees alone would be $60K on the average $1.8M average house. To sell a bond ETF, it would cost you $10 and it would be instant and painless.
  • Bonds are less volatile
  • Bond indices are more diversified

When you factor in the high costs of owning a home, we can say that the total return for a detached home is closer to 9% annually. I’d much rather take the 8% that bonds gave and have the benefit of lower volatility, better diversification and better liquidity. (Actually, I’d much rather take the 18% that GEM has produced over that same period but I’m making another point here).

Despite all these points, no one ever talks about bonds. That would just be a buzz kill at cocktail parties and nobody wants that!

I’d like to end with a quick discussion on interest rates. Here’s a chart for the 10-year US Treasury Yield going back over 100 years:


The stellar growth in both bonds and Vancouver real estate for the past 30 years was on the back of falling interest rates. In fact, if you look at pre-1982 and post, you can see how rising and falling interest rate environments have affected bonds: 

Going forward, we no longer have that tailwind of falling rates. Instead, over the next 20 years we may see something more like the 50s and 60s. This would mean a low-return environment for bonds and real estate.

And when you also factor the current stretched valuation of Vancouver real estate, I wouldn’t be surprised to see a couple lost decades in this market.

But I promise not to mention any of this at a party.

Related posts: