Tag: stocks

Alpha and Long Tail

Ever wonder how professional managers handle all that money and what they do with their own? Often, it comes down to two things: alpha and long tail.

Alpha is the portion of your portfolio that chases huge financial returns. It’s the component that swings for home runs by searching for big gains. Tech companies and stocks in new markets are prime examples. Tesla, marijuana-co, Netflix, and Beyond Meat—currently or in the past—fit into this category. And their potential upside isn’t just to double your money, they can grow it by 10-20 times. That’s why they’re called alpha and everyone should have an allotment dedicated to this. 

Professionals hold 10-20 of these companies with the strategy that winners will grossly outweigh the dogs. Why? Because nobody knows which stocks will make it. You’re not only guessing whether the market is real, you’re also gambling on whether this is the right pick. Everyone knows that not every company is successful and many new markets never take off. Just look at the computer business, loads of players were great at the beginning only to crash and burn when goings got tough.

Long tail is the exact opposite. It’s the allocation waiting for the world to end. This type of risk is called long tail because it doesn’t happen very often. As a matter of fact, it’s really quite rare. But nobody knows when the big quake is coming so have some money dedicated to this. 

If the market tanks by half, you should still be able to live. It may only be on beans and rice but at least you’ll have something. Then the rest of your dough should be sitting in dividend-paying stocks or high-quality bonds. Nothing too risky, nothing too big, just the types that provide decent returns.

What percentages you put into each compartment is your choice. Just make sure you’re ready for the big one and if a Canadian, hold alpha in TFSA.

TSX 25

Ask any financial adviser and they’ll say a big part of their job is “talking people off the ledge.” Soothing investor nerves is the psychological contribution they make for all those fees. But why do we freak-out so often? Is it because we’re not always organized in our financial thoughts and at peace with our plan? If so, let’s get organized.

Money can only be placed into four groups: cash, GICs, bonds, and stocks. The most confusing of these is stocks.

Canadian stocks

Canadian stocks come in limited flavours and though we have a TSX 300, you only need to know about 25. The primary sectors are: financials, utilities, resources, and telecommunications.

Financials means banks and insurance companies. Here are the ones to watch:

  • Toronto Dominion (TD)
  • Bank of Montreal (BMO)
  • Royal (RY)
  • Manulife (MFC)
  • Sun Life (SL)

Utilities primarily means pipelines and power companies.

  • Enbridge (ENB)
  • TC Energy (TRP)
  • Pembina (PPL)
  • Fortis (FTS)
  • Capital Power (CPX)

Resources in Canada means oil companies and mining.

  • Suncor (SU)
  • Canadian Natural Resources (CNQ)
  • Cenovus Energy (CVE)
  • Imperial Oil (IMO)
  • Teck Resources (TCK.B)

And our big telecoms are:

  • Bell (BCE)
  • Rogers (RCI.B)
  • Telus (T)

Good companies in other industries are:

  • Canadian National Railway (CNR)
  • Canadian Pacific Railway (CP)
  • Magna (MG)
  • Empire (Sobeys) (EMP.A)
  • Loblaws (L)
  • Canadian Tire (CTC.A)
  • Nutrien (NTR)

Honourable mention goes to Arc Energy, Encana, and Emera. This list gives you a good cross-section of the Canadian economy. So if Canada does well, you do well. And there’s no reason to believe that Canada won’t do well.

If I had a million dollars

The next question is: how should I invest my dough? Here’s what I’d do with a million dollars.

  • Cash – 10%
  • GICs & Bonds – 30%
  • TSX 25 – 60%

You always need cash in the event something goes on sale (i.e., a market correction).

Bonds and GICs give you stability. GICs need to be CDIC insured and laddered over 2-5 years. Bonds should also be laddered and only honoured by quality companies. Note: bonds must pay a premium to compensate for their risk over a GIC (I’d say minimum 1-2%).

When it comes to stocks, own the TSX 25. If you’re just starting out, buy them in order, one industry at a time. For example, if you have only $10K, buy the TD Bank (or your bank). With your next $10K, buy Enbridge, and so on until you own them all.

With only a million dollars there’s no need to go international and involve currency risk. We have plenty of good companies here at home. But if you have an international flair, look to the US and Asia.

Young people

Jordan has a good paying job but nothing for savings. He wants to start investing but doesn’t know where to begin. Here’s what I’d suggest.

The first $10K should go into a 5-year, CDIC insured GIC. The next $10K should go into a high-quality corporate bond. The next $10K into the TD Bank, and the next into Enbridge. Along the way, he’ll accumulate some cash. After stage one, his portfolio should look something like this:

  • $ 5K Cash
  • $10K GICs
  • $10K Bonds
  • $10K TD Bank
  • $10K Enbridge

Summary

Being organized relieves the stress of investing. You needn’t experience emotional pain for financial gain. Substitute companies into this list as desired but remember that owning and watching 300 stocks is unmanageable. It’s best to keep things simple. (Besides, getting rich shouldn’t be that complicated.)