Reboot Your Portfolio

Dan Bortolotti is well known as the creator of the authoritative Canadian Couch Potato blog and podcast.  His latest book Reboot Your Portfolio: 9 Steps to Successful Investing with ETFs is my pick for best investing book for Canadians.  The writing is clear, the advice is practical, and it anticipates the challenges readers will have in following through on his 9 steps.  Whether you work with a financial advisor or manage your own investments, reading this book will make you a better investor.

Stop Trying to Beat the Market

One of the many strengths of this book is that Bortolotti explains why his advice makes sense without being dogmatic.  While explaining the advantages of investing in index exchange traded funds (ETFs), he allows that “Some skilled (or lucky) investors have been able to” “outperform the overall market,” but “research reveals that the probability of beating the market over the long term is distressingly low.”

“The first step in becoming a successful investor is to let go of” the idea “that investing is about trying to beat the market.”  Most people think they need to pick great stocks or find an advisor or star fund manager who can pick great stocks.  Ironically, it is this pursuit of outperformance that causes people’s portfolios to underperform.  Over the long term, markets provide excellent returns, and those who choose to capture these returns with minimal fees will do well.

Stock pickers may brag about their successes, but that doesn’t necessarily mean they outperform markets.  “Individual investors almost never calculate their returns accurately,” and they rarely talk about their failures.  Even well-known successful stock pickers like Benjamin Graham and Warren Buffett think most investors shouldn’t pick individual stocks.

Not So Fast

After you’re convinced that you’re better off not trying to beat the market, you might leap to “What ETF should I buy?”  But Bortolotti says that puts “the cart before the horse.”  First you need to set your financial goals and choose an asset allocation.

Even before worrying about financial goals, there may be debts to deal with.  “In most cases, you shouldn’t even think about investing until you’ve paid off any non-mortgage debt.”  Presumably this includes car loans, which makes sense to me, but others may disagree.  I’d go a little further: if your mortgage is larger than about two-thirds of the maximum a bank would lend you, it makes sense to at least split your savings between investing and making extra payments against your mortgage.  Just in case your life and investments don’t always have a smooth ride, avoiding ruin is more important than trying to squeeze out the last dollar of upside.

Asset Allocation

An important lesson about what it means to have an asset allocation is one “that many people never fully grasp.”  When you have new money to add to your portfolio, rather than ask yourself “is now a good time to buy stocks” (rather than bonds), you should just invest the money according to your long-term asset allocation.

While explaining the benefits of diversification, the author mentions Modern Portfolio Theory (MPT), but doesn’t go very deeply into it.  This is a good thing because that’s about all that makes sense in MPT.  Discussions of mean-variance optimization can sound impressive, but it often produces highly-leveraged portfolios.  All people should remember from MPT is that diversification is a good thing.

“It’s fine to change your asset allocation if you realize you overestimated your risk tolerance.”  Unfortunately, people tend to do this after stocks take a beating.  It’s not too bad to lower your stock allocation once, but if you raise your stock allocation again later when stocks seem safer, you’re just in a damaging buy high and sell low cycle.  It’s when stocks are high that it makes sense to think about how you’d feel if they dropped 40%.  This is a much better time to permanently reduce your stock allocation.

Bortolotti says you don’t need any asset classes other than stocks and high-quality bonds.  He recommends excluding real estate, preferred shares, junk bonds, gold, and other commodities.  He also argues against real return bonds because of their extremely long maturities.  “You don’t need that kind of volatility on the bond side of your portfolio, which is supposed to be the stabilizer.”  I think this argument carries over to any long-term bonds.  I prefer to stick with maturities of 5 years or less.

Taking Action

It’s only once you’ve examined your financial goals and chosen an asset allocation that it’s time to choose some ETFs and open some accounts.  At this point Bortolotti pauses to ask the reader whether do-it-yourself (DIY) investing is the right choice and “to consider the other options: hiring a human advisor or working with a robo-advisor.”  “Few people have the skill set or the desire to manage an ETF portfolio on their own.”

Although Bortolotti discloses that “I make my living as a portfolio manager and financial planner,” he paints a grim picture of your chances of finding a good full-service advisor.  Unless you have about half a million or more, “your choices may be limited to old-school salespeople who are paid by commissions,” which “creates an obvious conflict of interest.”  Even larger accounts are needed to get a break on fees.  “Although many advisors now include ETFs in their client portfolios, the vast majority use them in active ways, making tactical moves or choosing narrowly focused ETFs, which are very different from the ones I’ve recommended here.”

The author is much more upbeat about robo-advisors for those who don’t want to go the DIY route.  He provides practical advice about what you can expect from robo-advisors, even for people with small portfolios.  He continues with practical advice for DIY investors on choosing a discount broker, opening accounts, using limit orders, ETF liquidity, not trading ETFs when U.S. markets are closed, the anxiety you’ll feel making your first trades, and being wary of your brokerage trying to train you to become an active trader.

Leaving your advisor

Another good section is on “Cutting ties with your advisor.”  “Breaking loose from your advisor can be awkward if he or she is a friend or family member,” and “most people don’t relish the thought of firing someone.”  “When you break the news, don’t make it personal.  Just explain that you’ve done the research and concluded that active management is not worth the fees.”  “You should expect some pushback.”

If your advisor challenges the “research on the benefits of indexing,” “entering a debate” with your advisor” is “futile.  No active advisor is ever going to concede that indexing is a superior strategy.”  “You don’t need to change each other’s minds.”

Some advisors may try to scare you with the claim that “Active managers can protect you during a downturn,” but even if they succeed at selling out before the bottom, “these managers are often sitting on the sidelines when the markets rebound.”  Another scare tactic is the nonsensical claim that “ETFs are dangerous.”

Rebalancing

Over time, your portfolio will deviate from your carefully-chosen asset allocation percentages.  Restoring these percentages is called rebalancing.  “Many people assume rebalancing is designed to boost returns, but that’s not necessarily the case.”  “The real goal is to keep your portfolio’s risk level consistent over time.”

The book covers the three ways of rebalancing, and rather than dogmatically picking one, “There’s no reason why you can’t use some combination of all three rebalancing strategies—by the calendar, by thresholds and with cash flows.”

It’s at this point that Bortolotti makes a strong case for asset allocation ETFs that hold all the asset classes he recommends and do the rebalancing for you.  This is likely the best and easiest option for DIY investors.  “If your equity allocation is a multiple of 20 … you can build your portfolio with a single fund.  If it falls between those numbers … then you can combine one of the all-equity ETFs with a bond ETF and, when necessary, rebalance with just two trades.”  This would work, but owning two asset allocation ETFs, say those with 60% and 40% equities to get to a desired target of 50%, would require much less rebalancing.

Staying on Track

It’s one thing to start on a sensible investing path, but staying on track is it’s own challenge.  “Analysis paralysis continues to afflict people even after they have implemented their new portfolio.  They second-guess their early decision as they do more reading or learn about more funds.”  “Investors may also feel paralyzed by the thought of investing a large sum.”

Media commentators make lots of pointless predictions designed to scare us into some sort of action.  They can’t just say the same thing every day: “investors should just stick to their long-term plans.”  “You should also keep in mind that many market commentators work in the financial industry.”  “They write for free simply to get exposure … and to make investors feel confused and uncertain so they can lure new clients.”

The urge to pick stocks can be powerful.  If you give in and buy stocks with some fraction of your portfolio, “The real risk here, in my view, isn’t that you will fail miserably as a stock picker; it’s that you will enjoy some initial success.”  If you decide your luck is actually skill, you might shift more of your savings to your risky stock picks that might fall flat later.

Other things that can knock you off course are “the urge to do something” when your long-term plan calls for sitting on your hands, “fear of missing out” on the latest big thing in investing, “overestimating your risk tolerance,” “believing the industry’s BS,” and “not giving [indexing] time to work.”

Conclusion

This book is now my number one choice for lending to friends and family who show some interest in investing.  When it comes to the investing part of personal finance, this book gives readers the tools they need to succeed, whether they invest on their own, use a robo-advisor, or work with a human advisor.