By Rob Carrick The Globe And Mail Globe Investor RRSPs Tuesday, January 21, 2003

For investors snared by treacherous markets, ROB CARRICK offers golden rules.

Heard about the official investing theme song for 2003?

No, not Money (That's What I Want). It's just this sort of thinking that got us into a three-year bear market.

For 2003, we're adopting a cooler, more skeptical approach best captured by the song Won't Get Fooled Again.

Never mind if you don't know this tune by The Who -- the title is self-explanatory.

How many times have we been fooled in the past five years of stock market history?

Lots of us were fooled into thinking that if some stocks or equity funds were good in a portfolio, more was better.

Lots of us were fooled into thinking stocks can be counted on to go up in any given year.

Lots of us were fooled into thinking that stocks quickly rebound if they do fall.

Lots of us were fooled into thinking that we're more tolerant of risk than we actually are.

If there's anything positive to come out of the stock market downturn, it's that investors have learned lessons that will serve their registered retirement savings plans well during the next market shock, whether it comes from an event like a war in Iraq or a cyclical turn from bull market to bear.

These lessons can be summarized into six golden rules to make sure investors don't get fooled again:

Lesson 1: Have a plan

There are two ways to invest: By following a plan that reflects your objectives, age and risk tolerance and by just winging it on a year-by-year basis.

A proper investing plan looks at your age, life objectives and risk tolerance. It estimates the amount of money you'll need to retire, sets out the rate of return that you'll need to achieve it and then provides a plan for allocating your money to stocks, bonds and cash.

"It's your required rate of return and your objectives more than anything else that really drive what you should be doing in terms of your investing," said Dan Richards.

Sure, you can wing it and you may have passing success.

"A lot of people have believed in the discipline of picking a basket of investments that will outperform this year's market," said Robert Strickland. "But once their plan goes off the rails, what are they using as a guide? The answer is emotion, and this puts them at a lot of risk."

Lesson 2: Stick to your plan

Let's say that, given your personal situation, the right portfolio mix for you is 50 per cent stocks and 50 per cent bonds. Now, imagine we're on the edge of a very bright year for stocks. Should you adjust your mix to take on more equities?

The answer is no. If you're doubtful, try asking anyone who did that three years ago, just as the stock markets were peaking.

"Just because stocks are doing very well does not mean that you can all of a sudden toss out your fixed income and load up on equities," said Adrian Mastracci, president of KCM Wealth Management Inc. in Vancouver. "As we know, things change rather abruptly at times and most people miss the turn."

The bottom line here: change your asset allocation when your personal situation or objectives change, not according to what's happening in financial markets.

Lesson 3: Understand what you buy

There have been a couple of vivid examples over the past several years of people getting into trouble buying what they didn't understand, the most obvious one being tech stocks and funds.

It's a safe bet that many who bought these investments had no idea they were investing in companies with no profits, little in the way of revenue and sky-high stock market valuations.

Mr. Richards said a more recent example of investors not doing their due diligence is structured funds, an equity-like product that promised a yield well in excess of what bonds offer while also offering full return of capital after a period of years.

Many structured products have plunged in price over the past six months because the bear market has caused them to cut the amount of cash they distributed to investors each month.

The latest product investors are getting into without a full understanding is income trusts, Mr. Richards said. Income trusts trade like a stock but offer high yields that are taxed less onerously than interest income.

The problem is that some trusts are less reliable than others in terms of maintaining the monthly or quarterly cash they pay out.

"People have been attracted to income trusts for obvious reasons, without understanding the differences between them and risks associated with them," he said.

Lesson 4: Be tolerant of losers

Over the past couple of years, Nortel Networks Corp. has fallen from a high of just over $120 to a low of 67 cents. There's probably no better lesson out there on how cutting your losses can blunt the damage of a bad stock choice. "A successful investor is someone who has learned to deal with losses," Mr. Mastracci said.

He suggests a proactive approach where you set a maximum tolerable loss and then sell when a stock hits that level. You may sell before a rebound in some cases, but overall, you'll benefit.

Lesson 5: Trim your winners

One of the most galling things about the bear market was the way it vaporized the incredible gains of the late 1990s. Just think what would have happened if you'd taken profits more often on your winning stocks and funds.

One way to do this is through a regular portfolio rebalancing, where you sell or buy more of some holdings to return to your target asset mix. If the stock markets have surged, you'd sell some of your equities. If the markets plunged and bonds were hot, you'd sell some of your fixed-income holdings and buy stocks.

Rebalancing was not a priority in the 1990s because you would have ended up lowering your exposure to equities at a time when they were consistently performing well, Mr. Strickland said. "But if there was ever proof that frequent rebalancing works, it's come over the past few years."

Where speculative stocks or funds are concerned, try the self-half rule suggested by Patrick McKeough.

If your investment doubles in price, sell half to recoup your initial investment.

Mr. McKeough said there's not necessarily a need to worry about selling established blue chips because they can be solid holdings for decades. Same goes for good equity funds.

Lesson 6: Seek dividends

"Dividends are a low-tech way to get a higher-quality investment," Mr. McKeough said.

"Well-established companies will tend to pay a dividend, whereas those that don't pay dividends include all the companies that were accounting shams."

Another point in favour of dividends: Several companies, including some banks, now offer yields well above what shorter-term guaranteed investment certificates offer.

Still another point: Research from Merrill Lynch shows that dividend-paying stocks listed on the Standard & Poor's 500 composite index outperformed non-payers by 12 percentage points in 2002. In down markets, dividend stocks hang tough.

There's an old saying that those who forget the lessons of history are doomed to repeat it. Will the lessons of the bear market be remembered or will investors be fooled again when the bull roars once more?

Mr. Richards likens the experience of investors in the past few years to a child who has touched a hot stove. "I think the lesson will be one that stays with investors for a long time going forward."

NOTE: The information provided above is intended for general informational purposes only. It does not constitute advice for anyone's specific situation. Everyone should always first consult directly with their advisors to determine the appropriateness of any information contained above before taking any action. KCM Wealth Management Inc. assumes no responsibility for any loss or damage arising from the use of, or reliance upon the above information.