Why be normal?

Do you remember May? The riot dog?

Athens burned for a while, until Europe’s leaders got together and threw $145 billion at the problem. That fixed things for a few days before the euro crashed and protesters took to the streets again, accompanied by a homeless dog who just keep showing up whenever there was a tasty cop to bite.

But this isn’t about Greece.

Yesterday the Royal Bank got shellacked on the market when profits from its global trading division crapped out. The revenue plunge was Greece’s fault, since that country’s profligate ways and pissy unions caused a credit crisis which gummed up markets, tanked bonds and sent investors to the hills. Everybody knew this was going to happen, just like they knew that trading activity (and bank earnings) would recover in the following months.

Nonetheless, the equity cowboys decided to take a run at the country’s biggest bank, and down she went. The common stock ended the day off over a buck and a half, or 3.4%, to $48.95. A fat 10 million shares changed hands, with traders making money on each transaction. It’s what cowboys do.

But this isn’t about the Royal.

It’s not even about those numbnuts who come to this blog on such days to tell us this is the start of the end. They seem to root for the prospect of a major banking collapse, presumably so their gold wafers and coins will be worth so much that someone is sure to mug them. Of course, there is no bank problem. Nor will there be one in this lifetime – not in Canada. The Royal actually made $1.3 billion in the third quarter, which is $433 million a month, or $100 million a week. That’s not revenue. Just profit.

If you’re scratching your buns and saying — hey if RY was at $62 in April and it’s $49 today, could this be a buying opportunity? – you get it.

But this is not about buying stocks.

Actually I don’t recommend buying any individual stocks unless you have enough money to get a mess of them and achieve diversification. Like a million dollars. Then individual securities can work nicely into a balanced portfolio which also includes fixed income, trusts, preferreds – and no mutual funds.

So the point of this post is to say that anyone who had Royal Bank stock today lost some money (if they sold). But people who owned bank stock ETFs fared better. For example (and it is just an example – I do not endorse any individual securities), the iShares Canadian Financials ETF, which trades under the symbol XFN, was off 1% while Royal was down 3.4%.

This is simply a function of diversification, because sector ETFs like this one give you exposure to all the banks at the same time, which means one of them can have a bad day and you are insulated. It’s the same with ETFs that pace energy companies, gold miners or the entire blue chippers. For people smart enough to be buying into markets as deflation talk rages, debt worries mount and the equity cowboys spank any company they don’t fancy, ETFs are the way to go.

So, what are they?

ETF stands for ‘exchange-traded fund,’ so these are like mutual funds which trade on the stock market, where prices are continuously changing. But unlike mutuals, nobody is driving the bus, so there are no big management fees to suck off your profits. And unlike mutual funds where the fund value is until the end of a trading day, ETFs are totally visible and priced in the open market, minute by minute.

ETFs offer tons of liquidity for that reason. You can jump in or out in moments, which is an absolute necessity in this wonky world. ETFs also pass through dividends from the companies in which they invest, which means you get paid income while you wait for capital gains.

Some ETFs contain shares in every company in an index, like the TSX 60 or the S&P 500, and are therefore called index funds. Some have shares in companies only in a narrow sector, like the banks. Hence, they are sector funds.

ETFs are cheap to own (fees can be as low as one-tenth of a per cent), easy to buy, quick to sell, can give both dividend and capital gain income and offer the small investor the kind of diversification once only available to rich dudes, or through equity mutual funds which make financial advisors rich. I mean, what’s not to like?

The world may look daunting right now, but there are some markers.

  • Residential real estate is one of the most dangerous places possible to have the bulk of your net worth, or to place new capital. Stay back.
  • Bond markets have popped, forcing prices up and yields down, so you missed the big chance I outlined for you months ago. Wait. Things will improve.
  • Preferreds and REITs continue to spin off steady, tax-cheap income. If you want 6% and to sleep at night, bed down with some of these.
  • Cash is fine for the pizza guy, but it’s not an investment strategy. Most people simply do not have enough money that they can afford to hide in an asset class giving a negative return after inflation and taxes.
  • Smart people see the equity markets for what they are. Barometers of human emotion. And when a good company gets spanked for the hell of it, when casual investors are running for cover, and when we all know more economic growth is a slam dunk, why would you stay out?

Danger and opportunity. They’re eternal. Read the news. Then run from the herd.