If I tell you that you can build an everlasting portfolio with minimum effort that has beat the Canadian S&P TSX for the past 20 years and will pay on average 4% in dividends, would you become my client? And this portfolio currently pays a 4.14% dividend yield.
Fortunately, you don’t have to pay me for building this portfolio. In fact, you don’t need much…. Just a crazy thought. Since I’m a nice guy, here it is; I’ll give you the ultimate trading secret portfolio managers want to hide from you.
Here’s the crazy idea: why don’t you fire your broker, sell all your stocks and mutual funds and buy the big 5?
Say what? Yes: there is an investment philosophy (that is not ready to stop) showing the simplest investments with one of the highest returns. All you have to do is to buy the five biggest banks of Canada:
TD Bank (TD)
Royal Bank (RY)
Good news for US investors; you can buy Canadian banks on the NYSE as well! There is no reason why this is not a good investment strategy. After all;
#1 Canadian banks form the strongest banking system in the world
#2 They evolve in a heavily regulated country where the Government protects them from themselves
#3 Canadian banks barely suffered from the 2008 credit crisis
#4 They are among the first ones to increase their dividends, year after year.
#5 Canadian banks are part of a comfortable oligopoly where their business is not threatened by foreign players.
#6 Canadian banks trade at a low P/E ratio helping their dividend yield beat inflation.
Before I keep going, I must tell you that I’m not the one who discovered this fantastic investing strategy. In fact, Peter, a long time Dividend Guy Blog’s reader, sent me two articles from the Globe & Mail asking for feedback:
Should I bank on all-bank portfolio?
Why an all-bank portfolio is bonkers
In short, the author tells you it’s not a good idea in the first article and keeps telling you the same thing in the second post after reading so many comments from bank lovers. As you probably realized by now; I’m being sarcastic; there are millions of reasons why investing it all in the big 5 is a VERY BAD IDEA.
John Heinzl, the G&M journalist, gives a pretty good explanation but I thought I would demonstrate my point of view with a single analogy. I’ll compare the insurance and the investment world for a second. By investing all your money into 5 stocks, you ignore the diversification principle to make more money based on the past 20 years of data. In financial theory, the diversification principle works as insurance on your portfolio that you won’t lose everything tomorrow morning. Here’s the comparison with the insurance world:
Let’s take my situation for example; I’m 33, married with 3 kids. I make about 4 times my wife’s income and we have a mortgage and a car loan. I could decide to not buy insurance. After all, what are the odds of a healthy non-smoker 33 year old man of dying in the next 12 months? Barely none, right? So why do you think I’m insured anyway? There is a huge difference between the word “hazard” and “risk”.
Searching through the business dictionary, you will find the following definitions:
Hazard: Condition or situation that creates or increases chance of loss in an insured risk, separated into two kinds: Physical hazard and Moral Hazard.
Risk: A situation where the probability of a variable (such as burning down of a building) is known but when a mode of occurrence or the actual value of the occurrence (whether the fire will occur at a particular property) is not. A risk is not an uncertainty (where neither the probability nor the mode of occurrence is known), a peril (cause of loss), or a hazard (something that makes the occurrence of a peril more likely or more severe).
Source (Business Dictionary)
So my situation (hazard) doesn’t really increase my chance of dying in the next 12 months. However, the impact of death on my family’s financial situation (risk) is too important to ignore.
If you invest all your money into Canadian banks, your hazard is not too big. However, the risk of losing 50%+ of your money during a crisis is too important to leave your portfolio unprotected from it.
The world is full of individuals who haven’t paid a cent in insurance and that are now 60, 70 or 80. Imagine all the money they have saved! But for the few who died uninsured in their 30’s or 40’s, ask their families what they went through.
In 1998, nobody thought that GM, the world biggest car constructor would fail 20 years later. Nobody thought that Lehman Brothers, a more than century old financial institution would bow down on their knees one day. Who knows what is going to happen to Canadian banks in the next 20 years from now. I’m not taking the risk to go through it!