Lessons from an investing time machine

Dan Richards is president of Strategic Imperatives. He is a faculty member in the MBA program at the Rotman School at the University of Toronto. He also hosts a weekly conference call called Monday Morning Jump Start, which is about strategies for financial advisors. Advisors can see it GlobeAdvisor.com. He can be reached at richards@getkeepclients.com

Time travel is every investor's fantasy - imagine if you could go back 40 years and make investment decisions, knowing then what you know now. That's precisely the opportunity I gave a group of investors one recent evening.

That morning, I had received a call from a financial adviser I know, who had just got off the phone with a high-profile economist who was scheduled to do a presentation to 200 of his clients that night. The economist had called to say that he had a family emergency and he wouldn't be able to deliver this talk - and the adviser was inquiring if I might be able to fill in.

That night, I stood up in front of the assembled audience (who politely hid their disappointment of having shown up to hear a celebrity economist and getting me instead) and talked about the future.

I asked them to imagine it was Jan. 1, 1970 - and they had $100 to invest. They could put that $100 in one of six stock markets - Canada, the U.S., Europe, Japan, Hong Kong and Australia. Further, they could divide it up any way they wished - all into one market, divided up among the six or any combination in between.

An exercise in time travel

In essence, the people in the room had a chance to go back in time 40 years. I gave the audience a few minutes to decide on their allocation - and then we talked where they'd placed their bets. The most popular choices were Canada and the U.S., with some putting money into Hong Kong and Australia; almost no one put any of their $100 into Europe or Japan.

(As an aside, the reason I chose 1970 as a starting point is that's when global market data began to be gathered by MSCI, the industry standard for tracking investment returns.)

I then shared the outcome of that $100 investment in each market, all in U.S. dollars for the sake of consistency. The table below shows how that $100 tracked over the past 40 years.

Four observations

This exercise prompted lots of conversation - and I shared four of my observations with the audience.

First, looking at points in time often masks big market swings and lots of volatility along the way. When they saw the numbers, many of the audience indicated they'd changed their minds and said they'd increase their allocation to Hong Kong - until I showed them a chart of the incredible roller coaster ride that investing in Hong Kong has been, with 50-per-cent moves up and down common.

Second, beware of the "recency" effect. This is a phrase academics who study investor behaviour use to describe our tendency to place greater weight on more recent events. Because Canada has done well of late, many in the audience gave it a big allocation, forgetting Canada's decades of underperformance prior to 2000. And because Japan has done so miserably over the past 20 years, it got an almost zero allocation - because members of the audience had forgotten the 1980s, when the Japanese stock market was the eighth wonder of the world.

Third, you need to be conscious of currency swings when investing globally. One of the contributors to Canada's poor performance versus the U.S. in the 1990s was our weak currency; part of the reason we've done well compared to the U.S. over the past 10 years is because of our strong dollar.

Along the same lines, in U.S. dollars the Canadian market is up 50% since the beginning of the year, compared to a 20% gain in the American market. Some of that difference is a function of performance - but much stems from the weak U.S. dollar.

Finally, check the facts before acting on stereotypes.

When you talk about investing in Europe, most Canadians instinctively think of militant unions, stodgy ossified companies and interventionist, sclerotic governments - and yet over the past forty years investors in Europe have done substantially better than those in the United States or Canada.

It's fine to have impressions and opinions - just be sure to check the facts before acting on those opinions. Unless you do that, even going back in time won't improve your investment performance.