Index Investing Stock Market Strategy

JORDAN'S STORY (Stock Market Investing Case Study 1 of 8)
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​Jordan was first introduced to the stock market when he was in his early twenties, during the dot com technology bubble. At that time, he was working for a firm that provided technology services to investment banks. Since they had free access to trading tools and real-time market data, many of his co-workers were active day traders . 

Early experience forms what later became Jordan's index investing strategy

Jordan witnessed first-hand the excitement that quickly rising markets produced. He also saw the flip side, the devastation when the market started to collapse in 2000 and his co-workers were losing large sums of money. He saw both extremes of the emotional roller coaster ride.

In addition, because he sold his first and second home at a loss he decided that real estate wasn’t for him. His first house, he had built himself and he had to move only two years after building it. With the building costs higher than anticipated, two years wasn’t sufficient time to recover his investment.  A few years later, he bought a condo but timing wasn’t on his side then either, because he happened to buy it at the peak of the real estate market, and when he sold it, it happened to be during a real estate downturn. His two real estate experiences caused him to turn to the stock market for investing because he knew that if he wanted to reach his financial objectives having a job wasn’t going to be enough. ​
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Financial security​
For Jordan, financial security is about having the means to choose how he spends his time, and where he lives.

His financial objectives, in effect, drove his strategy:

• He plans to retire around 45 years old.
  
  
• He wants to travel for months at a time.
  
  
• He wants to have the possibility of living abroad, in a particular region for maybe 3-4 years at a time.
  
  
• He wants his investments to provide the choice of retiring from the traditional work life, and he wants to have the freedom to do the type of work that he chooses to do for the enjoyment of it, not for financial reasons.
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• He wants to optimize his tax bracket and reduce his taxes as much as possible.

Index funds versus individual companies

Before putting his money into the market, he spent 18 months reading to form his opinion and develop his personal strategy. 

​He likes index investing, in comparison to choosing individual companies, because he believes that even if he picked 10 or so very reputable companies, there is still some risk that one of them could go bust. For instance, he cites the Enron example, and he says unexpected scandals or extreme events can happen anytime. In his opinion, the market at large is a very complex system with too many variables and unknowns for him to evaluate the entire system correctly and accurately predict how an individual company might be impacted. This is why index investing is the perfect solution for him – since it represents a large sampling of the market.

He also likes that the fees are minimal. And, that liquidity is high because it means he has the possibility of selling his investment whenever he chooses, even though he doesn’t plan on doing so.  He is standing by his current allocation strategy for the next five years at least. He might adjust it slightly but he doesn’t intend on making drastic changes. 

Jordan devised his strategy based on a 30-year outlook 

Jordan developed his investment philosophy over time. At the beginning, he was invested in mutual funds.  Index funds came after when he saw the difference in fees. The high fees charged for mutual funds, upwards of 3%, were difficult to ignore.  He is now fully invested in index funds.

He chose funds based on his analysis of equity risk, currency risk and inflation risk. He limits his investments to four funds that provide solid and quality exposure to the Canadian, United States and international markets. He allocated 25% of his available money in each one. Jordan periodically adds to his investment by supplementing the fund that dropped in price to bring it back to the original 25% allocation ceiling.

He says that normally he would also have a bond fund, for 20% allocated equally in five funds. But since his wife is fully invested in the bond market, he feels their allocation as a couple is adequate. 

In the last seven to eight years, Jordan has been more serious, adding significantly to his portfolio. He doesn’t worry about downward trends because he believes the historical growth pattern will continue its upward movement, from a long term perspective. He lets the dividends accumulate in his account and he reinvests the money into the fund that is below the 25% allocation.  He stays in when markets fluctuate downward. He never sells. He reasons that if he were to sell, what would he buy instead? 

As smart as he is, he learned that he can’t predict tops and bottoms.

For example, he remembers a particular moment in time when he felt certain the market was at a high, thinking this might be the right time to sell to protect his unrealised profit. The gurus in the industry all agreed that the market was at top and the doomsayers agreed that a correction was coming. It was just before May when the so-called market-timing strategy, referred to as ‘sell in May and go away’, was on the horizon. But in this instance, the market did exactly the opposite of what it was ‘supposed’ to do. It shot up even though all indicated that a downward trend was imminent. This experience taught Jordan that even as certain as he or the experts might be, there is no guarantee that it will work out as expected.

The advantage of investing in tax-free accounts

Jordan invests the maximum contribution into his tax-free retirement account. He likes the program because of his instant return on investment, that is, by saving taxes and immediately reinvesting the tax refund, his savings go to work for him right away. He also anticipates that when he retires his income will be lower, meaning that the withdrawals from his retirement account will be taxed at a lower rate.

When he tops out with his tax-free accounts, his next step is investing through his corporate entity. This is an advanced strategy that he plans on implementing in the next few years. Currently he is researching options and implications, and consulting with tax professionals. He wants to use this strategy to leverage the growth and minimize the tax implications.
 
For beginners, Jordan offers the following suggestions:

• Identify what your needs are, now and in the future.
  
  
• Know what your financial objectives are.
  
  
• Understand what instruments are available to you, such as tax leverage and types of investments.
  
  
• Stay true to your chosen strategy. Make small adjustments if you must but be careful about making drastic changes.
  
  
• Know that risks change based on age, for example, when we are younger, we can afford to take more risk.
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• Think long term. Correctly identify your time horizon: how far into the future do you see yourself?

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* This case study is based on the November 16, 2015 interview conducted by Y. Gagnon

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