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Resist temptation when making investments

September, 2010

What a summer. After two rainy, disappointing summers, we have ourselves a real winner. Hopefully many of you were out there enjoying and doing the things you like.

Typically, summer is a less active time in the market, with trading volumes down and energies focused elsewhere. This summer has seen a very active market with discouraging results. Unemployment is still very high in the United States and is casting a long shadow on economic performance. In addition, housing prices are still under pressure and great uncertainty hangs in the air with no signs of direction.

We will eventually recover, but in the interim, one must be cautious about the investment choices made. Look no farther than the shares of Manulife, which have plummeted over the last six months with no end in sight.

Where is a good place to invest?

Interest rates are at all-time lows, bond yields are low and markets are fraught with risk. I think the key today is to resist temptation. What looks like an attractive investment today could be the next bubble to burst.

Many investors have fled to what they think is the security of corporate bonds, which have delivered solid returns. The problem is that the quality of these bonds may not be as solid as you are led to believe and many experts are calling for an implosion in this sector. Bonds can be a risky asset class and many investors are unaware until it is too late.

Another option frequently recommended are exchange-traded funds, or ETFs.

ETFs can be purchased like a stock and follow the price of a basket of assets. ETFs are widely available on different exchanges and track the price of commodities, equities and bonds. The expectation is that as the commodity price rises, the ETF will follow suit. Unfortunately, this is not what has transpired and investors are shocked when, for example, oil and gas prices rise but their ETFs continue to drop.

The reason for this is the way in which future commodity contracts are bought and sold within the ETF. Futures traders can take advantage of the way this investment is structured. The net result is huge losses for the small investor. There is an excellent article on commodity ETFs in the July 26 issue of Bloomberg Businessweek that explains this phenomenon in much greater detail.

Whatever asset class you elect to invest in, ask questions and read the financial statements. It is important to look at the big picture.

One area of investment that is often overlooked is life insurance. Life insurance carries no risk and has a guaranteed return. Many clients are supplementing their portfolios with an insurance policy to cover losses incurred in the market.

If you do the math, the return to your estate on an insurance policy will exceed the return offered in a fixed income portfolio under today’s rates. For example, a 65-year-old non-smoking male would pay an annual premium of $7,200 to guarantee a payout of $250,000. By contrast, a $7,200 annual investment over 20 years assuming a fixed four-per-cent rate of return would generate $214,000. If we add in taxation each year, the return would be significantly lower. The nice thing about a life insurance policy is that it is totally predictable in how it will perform.

In today’s market, take nothing for granted, especially if you are a passive investor.



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