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Harry Koza

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The Graduate

Harry Koza

 

THE GRADUATE

MR. MCQUIRE
Ben -- I just want to say one word to you -- just one word
BEN
Yes, sir.
MR. MCQUIRE
Are you listening?
BEN
Yes I am.
MR. MCQUIRE
(gravely)
Plastics.

They look at each other for a moment.

BEN
Exactly how do you mean?
MR. MCQUIRE
There is a great future in plastics. Think about it. Will you think about it?
BEN
Yes, I will.
MR. MCQUIRE
Okay. Enough said. That's a deal.

(From the movie, The Graduate)

TORONTO (GlobeinvestorGOLD)—So, Ben (or Benjamina), you're 21, just about to leave university for your first real job. You've got a student loan to pay off, you want to buy a car, get your own place to live, and the world stretches out before you with a panoply of prospects, promise and, yes, pitfalls. Which path should you take?

Back when I was in your shoes, I might have welcomed some advice from a grizzled survivor of the market wars. If I had started to apply when I was your age what I've since learned over the years the hard way, I might be retired on a beach somewhere today, contentedly sipping on a frosty and polishing my Bentley.

Alas, I was an intemperate and insolent whelp at your age (and, for my sins, will likely end my days as a greeter at Wal-Mart). The long haul was, like, way in the future, man. Hell, I wouldn't even be 50 until after the turn of the millennium.

Still, I saved almost every nickel I made working in the mining industry, and pumped it all into the stock market. By the time I was 30, I was a paper millionaire, and was blithely contemplating what colour Porsche I should buy when the bubble burst—as they are wont to do—and by the time I was 31, I had negative net worth.

I won't bore you with that long and depressing story—that's a tale best saved for some long winter's night in front of the fire over a largish single malt or six. Let's just call it an expensive education, sort of a post-grad degree in markets. I was in MBA school at about that time, having come back to the city from the Great White North to learn some new skills, and one day Myron Gordon, our finance professor, asked the class if anyone knew what margin was. I put up my hand, and answered that, "margin is when your stockbroker calls you up and tells you have 24 hours to come up with more money."

Yes, leverage is a powerful thing, but it is a two-edged weapon. Which brings me to the advice I'd like to give you, sort of like Mr. McQuire in The Graduate. So, are you listening?

The rule of 72.

If you divide the return on your investment into 72, you get the length of time in years that it takes for your money to double. For instance, if you earn 10 per cent a year, your investment (ignoring taxes) will double in 7.2 years, at 20 per cent, in 3.6 years. Conversely, if you owe money at 10 per cent, and don't pay the interest, your debt will double in 7.2 years.Try only making the minimum payment on your Visa card for a few months to see this concept in action. The Rule of 72: it's very simple yet very powerful, and there are way too many people who don't understand it yet insist on dabbling in the markets.

At your age, you have a long investment horizon, long enough to let the power of compound interest (the Rule of 72) work for you. Open a self-directed RRSP as soon as you can, and start making regular contributions to it. Pay down your student loan as quickly as you can: paying off the principal on a 6 per cent student loan is the same as earning 9 per cent to 12 per cent (depending on your tax bracket) on an investment, except it is risk-free. Remember those words, "risk-free," because you'll rarely encounter them again in conjunction with the word "investment." When you eventually buy a house, paying down your mortgage quicker will be virtually the best investment you can make (also risk-free).

When you have your student loan paid off, start putting more money into your RRSP. Buy long-dated strip bonds and coupons, as the yield to maturity will be an actual compound rate—no reinvestment risk. Keep at least half your money in strip bonds and other fixed income instruments. For instance, today you could buy Ontario 3/08/33 residuals at a yield of 5.92 per cent. An investment of $1,788.20 will be worth $10,000 at maturity. Or, TransCanada Pipelines 11/20/20 residuals at a yield of 6.966 per cent. An investment of $3,079.60 in those today will be worth $10,000 at maturity.

I know that everyone will tell you that at your age, your risk tolerance is higher than that of an 'alte cocker' like me, and a young buck (or doe) like you should be overweight in equities. The conventional wisdom has it that in the long run, equities always outperform bonds. That's debatable. From 1970 to 2000, equities in Canada yielded a compound total return of 10 per cent. Bonds returned 10.2 per cent, but with only half the standard deviation—only half the variability in returns. Over 30 years, that's a big difference.

Rating risk

Believe me when I say that risk is a highly over-rated financial concept. Bay Street employs legions of financial rocket scientists to hedge risk, to minimize risk, and generally to spread risk around and offload it onto the credulous. This is where Harry's Second Law of Capital Markets—Make the Stupid Pay—comes from.

Think PC: Preservation of Capital. Over the long run, you'll come to appreciate just how difficult it is to accumulate capital, and how smart you were to take steps to hang on to what you managed to generate. To be sure, there will be times when you'll be down at the waterhole with the other young bucks, rubbing the metaphorical velvet off your antlers, and will be drawn to embark on some suitably sporty financial adventure (Nortel at $120 a share springs to mind) and feel compelled to take a punt. What the hell? Some of them work out, though many don't. Never put more money into a speculative investment than you are prepared to kiss goodbye. If it works, great, you made a nice pass. If it doesn't, well, you won't have blown the mortgage money.

For the stocks you do invest in, buy what you know. If you're an electrical engineer, maybe tech stocks will be your thing. If you're a geologist, mining stocks may speak your language. For a doctor: pharmaceuticals, biotech and health care technologies. Every book ever written by any market maven, from Warren Buffett to Peter Lynch, can be boiled down to that simple maxim—Buy What You Know. It doesn't matter if what you know happens to be nanotech or skateboards, Wi-Fi or veterinary science. Make all your investment decisions informed ones.

Never buy a stock or make any investment without first deciding what your pain threshold is. If you had bought Nortel at $120, would you have dumped it at $90? At $65? At $30? At $5? As the old traders always say, your first loss is your best loss. If your investment heads south, cut your losses and live to play another day. Similarly, what's your exit point? Where do you take profits on a trade? My old bond trading mentors always told me that if you didn't have a profit target and a stop-loss point for any trade, then you had no business making it in the first place.

Know your limit

There's no shame in taking a profit. A stock you bought doubles in price? Sell half. Now you have a free ride. The worst you can do is break even. Elsewhere in this edition of Trading by Numbers you'll no doubt find more advice on mutual funds, real estate, stocks and other instruments. Just remember, even the Wealthy Barber took a huge haircut in the tech stock bubble. And as Jane the Impaler, the long Canada trader on the first bond desk I worked at used to say, "the broker you have, the broker you get."

Avoid casinos—the House always wins—they're a tax on the stupid. Stay away from redheads (don't ask). Never play poker with a man called "Doc," and never eat at a restaurant named "Mom's." Never refuse a free option. Never buy securities, gemstones or vacation timeshares from a stranger over the phone. If an investment sounds too good to be true, it is. Learn to read annual reports (hint: all the good stuff is buried in the notes to the financial statements).

Let me leave you with one last piece of advice. In my early days on Bay Street, back in the late 1970s, I once asked Cuffy Dixon, an old Cobalter—and at well into his 80s, likely the oldest working broker on the Street—the secret of his longevity in the markets. He winked, sipped his rum and coke, and told me, "Don't smoke, and only drink tall drinks." Okay. Enough said. That's a deal.

Harry Koza is Senior Analyst in Canadian markets for Thomson Financial/IFR. At various times in his career, Mr. Koza has been a prospector, metallurgist, project manager, engineer, as well as an institutional bond salesman for 15 years. His current area of expertise is in high-yield distressed securities and corporate bonds in general.

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