This year marks the eighth in a row for the Top 200 tradition which, I’m pleased to say, has been very fruitful. It also happens to be another year in which MoneySense’s Top 200 All-Stars have managed to outperform the market. If you had bought equal amounts of the All-Stars and rolled your gains into the new stocks each year, you’d now be sitting on a 15.5% average annual return over the last seven years, not including dividends. By way of comparison, that’s almost 11 percentage points higher than the annual return of the S&P/TSX Composite (XIC), which climbed 4.6% a year over the same period. This year, you can purchase the list of our new crop of All-Star stocks online as part of our Top 200 Premium Package.

Last year we found that our All-Stars bested every single Canadian equity fund over the prior five years and we were compelled to peek at the numbers again. When we did, we discovered that over the last five years, our All-Stars have beaten more than 95% of Canadian equity funds, in either the pure or focused categories.

We’re pleased as punch with our performance record. If you had split $100,000 equally among our original All-Stars seven years ago, then sold them and rolled your gains into the new batch each year, your portfolio would now be worth $273,000—almost triple your original investment (not including dividends). Still, we want to stress that while we’ve done very well over the last seven years, those kinds of gains don’t come without risk. It’s almost inevitable that we will run into a soft patch. While we believe that our stock picking methodology should work well over the long term, we know—and you should too—that we can’t predict the future. This year’s All-Stars could disappoint.

And despite tough times in America, our U.S. All-Star stocks—those American stocks that combine the best value and growth attributes—have once again beaten the markets. Over the last year our U.S. All-Star team advanced 3.7% over the year, not including dividends. Meanwhile, the S&P 500 (SPY) trailed by 1.2 percentage points, gaining just 2.5% over the same period. Those aren’t huge gains, but they’re not bad considering the state of the markets.

We hope our track record will whet your appetite for this year’s Top 200 and Top 500. As in prior years, we sized up each of the largest companies in each country and graded each one on its investment merit. In our Premium Top 200 Package, we deliver an easy-to-use scorecard festooned with just the sort of information that appeals to most investors. In fact, we think the Top 200 gives you a more objective guide to large Canadian stocks than you’re likely to find from any other single source.

Importantly, the Top 200 and Top 500 offer a logical and consistent approach to selecting stocks that isn’t influenced by feelings or fleeting fads. Instead we take a tip from Mr. Scrooge and apply hard-headed reasoning. We do not rely on gut instincts or nog-induced visions of the future. Our results are based purely on the numbers. Our opinions about a company don’t enter into it.

We begin by identifying the largest 200 companies in Canada and largest 500 in the U.S. by revenue. Using Bloomberg data, we evaluate each stock, first for its attractiveness as a value investment and then on its appeal as a growth investment. (Value investors like profitable stocks that trade at low multiples of book value and pay juicy dividends. Growth investors like companies with expanding earnings and sales.) Our value and growth tests are driven by sophisticated calculations, but in the end we reduce everything about a stock to two grades: one for its value appeal, one for its growth potential.

The grades work just like they did back when you were in school. The best are awarded an A. Solid firms get by with a B or a C. Those in need of improvement go home with a D or even an F. A select group of stocks—those that manage to achieve at least one A and one B on the value and the growth tests—make our All-Star list. Only nine Canadian stocks and 20 U.S. stocks got the honour this year.

Our Premium Top 200 Package includes our list of All-Stars as well as sortable spreadsheets detailing everything investing-savvy investors need to know about Canada’s Top 200 and the America’s Top 500 stocks. As a bonus, we have also included ratings for the next 100 Canadian stocks by revenue (so ratings for the Top 300 Canadian stocks in all), as well as ratings for the next 200 American stocks by revenue (so ratings for the Top 700 U.S. stocks in all). Finally, we threw in a complete copy of the Top 200 and Top 500 stories from MoneySense magazine.

The grades themselves are based entirely on the numbers. We didn’t factor in any personal opinions about a firm. Instead, we scoured the Bloomberg database for detailed financial information starting with Canada’s largest dividend-paying stocks by market capitalization. We then trimmed the initial list to remove candidates that have been around for less than a year or lack the detailed financial data we need for numerical analysis. We then graded the remaining stocks using three primary criteria.

Yield: The more money a firm sends your way, the better. We gave top marks to stocks with high dividend yields. We also reward stocks that have a strong record of dividend growth, because firms that grow their dividends tend to be confident about their future prospects.

Reliability: While a good yield is great, we like it even more when we have some assurance that the dividends will continue to be paid. (Indeed, sometimes an extraordinarily high yield can be a warning sign, which is why we employ a bevy of additional tests.) As a result, we reward stocks that have earned more than they pay out in dividends because stocks that pay dividends that aren’t backed up by earnings will eventually be forced to cut them. We also give additional marks to firms with little debt because balance sheets stuffed to the brim with debt are risky. To measure each firm’s reliance on debt we compare its debt-to-equity ratio against other companies in the same industry.

Value: On the value front we want to be able to buy lots of assets for a low price. As a result, better grades went to companies with moderate-to-low price-to-book value (P/B) ratios. This number compares the market value of a company to how much cash you could raise by selling off the company’s assets (at their balance sheet prices) and paying off the firm’s debts. Low P/B ratios provide some assurance that you’re not paying much more for a stock than its parts are worth. We also prefer profitable stocks with lower price-to-earnings ratios.

Putting all of these factors together we arrived at the final grades for each of Canada’s largest 100 dividend stocks. In total, only six earned an A, but 18 managed a solid B this time around. We believe both A and B stocks are worth your consideration.

You should also keep in mind that the numbers only provide part of the story. Savvy investors look for businesses with unique or intangible features that might not be reflected in the hard numbers. It’s best to use our grades as the foundation for your own research and build from there. Like any screening strategy, the purpose of the Retirement 100 is to help you spot a few good ideas that you can then investigate in more detail.

But Bertie’s carefree lifestyle is the product of inherited wealth and he would be in deep trouble without it. Such is the good fortune of the lucky sperm club. Alas, if you’re like me, you weren’t born with a silver spoon in your mouth and you have to worry about money. But fear not, there is hope for us common folk. A good dollop of thrift and hard work is all that’s required to build up an income portfolio that can generate enough cash to support a comfortable retirement or life of leisure.

When it comes to investing for income, most people should consider adding at least a few good dividend stocks to their portfolio because they can provide a regular, and hopefully growing, series of cash payments. (If you would like to build an entire income portfolio, read “The ultimate income portfolio”for instructions.) In addition to generating an income, companies that pay dividends tend to be large, mature firms that can more easily cope with changing economic circumstances than smaller firms. Their size and relative stability means that dividend stocks are generally easy to hold. Don’t get me wrong—they aren’t without risk, but dividend investors often sleep better at night than those who hold other kinds of stocks. That’s a nice feature for those who want to relax and have fun instead of constantly watching the markets.

In our annual Retirement 100 listing we endeavour to highlight the best dividend stocks in Canada and the results have been highly satisfactory so far. Our A-graded stocks—we call them our Retirement All-Stars—have gained 39.2%, including dividends reinvested annually, since we started four years ago. When you look at the group of stocks that rated either an A or B, the average gain comes in at 20.3%.

Our long-term results far exceed the returns from the markets overall. By way of comparison, the iShares S&P/TSX Composite exchange-traded fund (ETF), which tracks Canadian stocks in general, has advanced a paltry 2.3% since we started. The iShares Canadian Dividend ETF, which tracks 30 of the largest dividend stocks in Canada, climbed only 6.6% over the same period. That means our Retirement All-Stars have beat the overall market by a staggering 36.9 percentage points over four years, while thrashing Canada’s largest dividend ETF by a remarkable 32.6 points.

This year the gains continued to be respectable. Last year’s Retirement All-Stars climbed 8.4%, while the S&P/TSX Composite ETF advanced 4.9% and the Dividend ETF moved 5.9% higher. That’s not bad considering the downturn the market encountered late this summer.

While we’re pleased with these results, we aren’t saying that you’ll make a fortune by buying every A-rated stock. As the past few years have amply demonstrated, the stock market is about as predictable as Bertie on a bender. On occasion the entire market suffers from a nasty hangover and profits dribble away. Even in more buoyant times when most of the market is partying, individual stocks can suffer from indigestion. Nonetheless, we think the A-rated stocks deserve your attention.

Read about How we graded Canada’s largest dividend stocks.

The real question is whether prices are low enough yet. To deduce that, I like to turn to economist Robert Shiller’s price/earnings ratio (P/E) for the S&P 500 to value the general state of U.S. stock markets because it provides a useful long-term guidepost. Shiller’s P/E is the ratio between current prices and average earnings over the last 10 years, the idea being that you can get a better sense of the long-term trend via 10-year average earnings rather than by short-term figures.

The graph to the right shows the history of Shiller’s P/E for the S&P 500. You’ll notice that the ratio is currently 19.7, which is high compared to its historical norm of 16.4. As a result, U.S. stocks could still have farther to fall. The situation in Canada isn’t much better, with Canadian stocks at fairly high levels. Even worse, we tend to be more exposed to downturns, due to the cyclical nature of much of our economy.

Those with a more bullish bent will point out that stocks have traded at far higher levels in the past. Also, the huge earnings collapse of 2008 was unusual—the lower earnings over the last decade might provide an overly bearish reading. As a result, Shiller’s P/E could be somewhat inflated.

Nonetheless, I think stock markets as a whole are not overly cheap. (Thankfully there are still a few bargain stocks to be had.) I also don’t feel nearly fearful enough. As a result, I don’t expect to shift my asset allocation toward stocks at this point. I’ll wait for better valuations and a bit of stark terror before making any dramatic moves.

But when it comes to investing, the possibilities are vast once your portfolio grows beyond $100,000. Problem is, much like Bertie Bott’s Every Flavour Beans (a devilish Harry Potter confection) the investing flavour you choose might wind up tasting like earwax. Alas!

That’s why the advice in Where to invest $10,000 still applies. If you aren’t intensely interested in the markets, you should probably stick with a good low-fee balanced mutual fund. After all, much like grilling a nice steak, if you poke and prod your portfolio too much then you’re likely to obtain less than desirable results.

But if vanilla really isn’t for you, let’s check out some other tasty ways to invest now that you have a more sizeable portfolio.

The lazy way to riches
In the “Where to invest $1,000” story, we introduced the idea of investing using passive index mutual funds such as the TD e-Series Funds, which rise and fall in tandem with the large market indexes. Long-time MoneySense readers will know that we call a portfolio of such funds a “Couch Potato portfolio,” as it’s so easy to execute, you rarely have to haul yourself up from the couch to tend to your investments. The goal is to take the returns the markets give you while keeping your investing costs as low as possible. This allows you to enjoy a big advantage versus high-priced fund managers who, far too often, fail to earn back the fees they charge investors.

Now that your portfolio is larger, we have some good news. You can implement the exact same strategy with a new type of fund that has even lower costs: the exchange-traded fund or ETF. These funds are much like index mutual funds in that they passively follow a market index such as the S&P 500, but instead of being sold like mutual funds, you buy them on the markets, just like a stock. The ETFs you choose depend on your investment goals, your time horizon and your tolerance for risk, but we find that plonking 40% of your money into a good bond fund, and spreading the remaining 60% among Canadian and U.S. stock funds is the simplest way to start. If you do it through ETFs, you can reduce your fees to very low levels. For example, if you use the iShares S&P/TSX60 ETF (XIU), the Vanguard Total Stock Market ETF (VTI), and the iShares DEX Universe Bond ETF (XBB) for the Canadian stock, U.S. stock, and Canadian bond components respectively, then the annual fee on your portfolio will be a minuscule 0.19% a year.

Just remember, because ETFs are traded like stocks, you do get dinged with a brokerage commission when you buy and sell them. The commissions can really add up for small portfolios but, by $100,000, the big Canadian discount brokers usually offer online trades for $9.95 a pop, or less.

Much of the appeal of Couch Potato investing lies in its simplicity, so you don’t want too many funds. Still, if you’re up for it, expanding beyond just U.S. and Canadian stocks is a sensible thing to do. As a result, I suggest the Global Couch Potato variant with international stocks added via the Vanguard FTSE All-World ex-US ETF (VEU). Here you’d put 40% of your portfolio in the XBB bond ETF, 20% in Canadian stocks via XIU, 20% in U.S. stocks via VTI, and the final 20% in international stocks via VEU.

Don’t want to go it alone? If the thought of opening a discount brokerage account and buying ETFs on your own fills you with fear and trepidation, don’t worry. You wouldn’t be the first to feel daunted by the task. I still remember that my first trade, back in the day when you had to phone a real trader, was rather nerve-wracking.

Besides, if you’d like a little guidance you’re in luck: when your portfolio moves above $100,000, advisers will start to take an interest. Problem is, their advice often comes at a steep price. To help you out, I’ve sleuthed out a few ways you can get the basics without spending an arm and a leg. You might not get expensive wine and cheese service, but you will get core asset allocation advice and a friendly hand to help you build a customized portfolio.

One good choice is to enlist the services of investment management firm Phillips, Hager & North. PH&N is the granddaddy in the field and it still represents good value. The firm offers a very broad line of low-fee funds and when you sign up directly with them, you can get a dedicated adviser, portfolio planning, and a long-term investment strategy. All of which is included in the already low cost of their funds.

Another option is Steadyhand, a new entrant run by PH&N alumni Tom Bradley. You get the benefits of his experience, but you also get advisers who are still hungry and thus likely to work harder for you than others who may have had a few too many ice cream cones. Portfolio strategy is included with the low cost of their funds, and Steadyhand’s fees fall as your portfolio grows. At $100,000 you already get a discount and there are more discounts to be had at higher levels. In a break from usual practice, their fees also decline based on how long you’ve held their funds.

Getting started with stocks
At the other end of the spectrum, you might want to take a more active approach and start picking your own stocks. While it might not be the right thing to do for many investors, it would be hypocritical of me if I didn’t say that it can be great for some.

If you’re just starting to buy your own stocks, I suggest moving slowly for the first few years. The experience will likely to be educational and you don’t want to make mistakes with the bulk of your money.

Thus at first you should keep the core part of your portfolio in a good low-fee balanced fund, or a Couch Potato portfolio, and then supplement that with a handful of stocks. Put at least 80% of your money in the core and at most 20% in individual stocks.

Which stocks should you start with? I suggest large Canadian dividend stocks, preferably in different industries. While you can go wrong with big dividend stocks—I’m looking at you Yellow Media—they’re generally less volatile than their smaller brethren. Large businesses with good credit ratings also tend to have more staying power than smaller outfits. To whet your appetite, I’ve highlighted five in 5 great stocks to start out with, which show promise at the moment.

Start slowly when learning the ropes to figure out if buying individual stocks is something you really want to do. As your portfolio and experience level increases, allocating more money directly to stocks becomes reasonable. Just be warned, successfully picking your own stocks is harder than it looks and requires a great deal of patience and discipline. But if you have some aptitude for it, the returns can be most gratifying.

Aside from picking up an infinitesimal amount of calculus, I met a fellow keener in class who had the investing bug. He rattled on and on about odd things called mutual funds and how you could make a potload of money from them. Naturally enough, I promptly forgot about funds for about a decade while exploring calculus a bit more. But I rediscovered them after I had amassed just over $10,000 by playing the part of Beaker to a series of lovable Dr. Honeydews in a variety of laboratories.

At the time, I felt that $10,000 was a tidy sum for a young fellow—enough to think about alternates to a bank account anyway. So after some pondering, I moved my grubstake into mutual funds. If only I knew then what I know now. But you can profit from my experience. Here’s what I’d tell a younger me about investing, if I had the chance.

The importance of fees
To begin with, there are only a few things that you can really control when heading to the market to make your fortune. It is important to realize that the market is just there. It doesn’t care if you make or lose money—and there are many ways to lose money.

That’s why you should launch your offensive for profits from a secure foundation. Instead of immediately seeking the very best opportunities, it can pay to aim to limit your losses. And it shouldn’t come as a surprise that fees are an important source of such losses. To make money from a small base it helps to be thrifty because many financial institutions seem to prey on the middle class and poor these days.

To highlight how important keeping costs down can be, let’s look at the miracle of compounded interest. The notion is simple. If you can grow your money—even at a low rate—over a long period, then you too can be rich as Croesus. More concretely, if you grow your $10,000 nest egg at 4% a year over 30 years, you’d have just over $32,400. Both higher rates of return and longer investment periods would improve your results considerably.

But unfortunately, all too many investors don’t realize that their funds charge annual fees—and the effect of those fees compounds too. A fund’s fee will rarely be highlighted as part of a sales pitch, but you can spot it in the fund’s prospectus, or you can look it up in your fund’s fact sheet online. It’s called a management expense ratio, or MER. Usually, if fees are mentioned, they’ll probably be referred to in some diminutive fashion. Something like: “It’s only 2%, just think about how much money you’ll make.”

It’s true that 2% doesn’t sound like a lot, but let’s say that you hold a mutual fund for 30 years and it earns 4% a year, on average, before fees. That means that almost half of all of your growth will be snatched back from you in fees. As a result, your $10,000 would grow to about $18,100, which is a good deal less than $32,400. That’s why it’s well worth your time to keep an eye on costs—after all, annual fund fees in Canada are often in the 2% to 3% range.

Three enemies of growth
Taxes are another bane to investors. Despite the government’s desperate need to fund new $400-million hockey arenas in Quebec and G8 gazebos in Ontario’s cottage country, I suggest structuring your affairs so as to minimise taxes as far as is both sensible and legal. For most people, the best way to pay less tax over the long run is to hold investments inside a Tax-Free Savings Account (TFSA) or an RRSP. Outside tax-sheltered accounts, taxes can act a bit like a 2% to 3% annual fee on stock returns over the very long term. Interest income from bonds and GICs is taxed at an even higher rate.

I hate to bring it up, but next I must address an even more insidious way that you can lose your hard-earned savings. It is called inflation. That’s the tendency of money to lose purchasing power over time and it is generally caused by the government printing too much currency. Inflation is the reason why ice cream cones cost 10 cents in the distant past whereas now they cost $3. These days inflation is running at 3.1% annually, which means that even if you avoid the risks of the market by stashing your cash under your mattress, you’re still losing 3.1% of your money’s value every year.

There’s one more threat to your growing portfolio: Your own behaviour. Specifically, it’s the tendency we have to buy high and sell low. Most people can sit in a savings account and sleep well at night. But they seem to lose their heads in the stock markets and it’s easy to see why. The markets gyrate and plunge frequently. In early 2009 many investors woke up to discover that their portfolios were only half as big as they were a couple of years earlier. Problem is, very few investors seem to dive in and actually buy low during such downturns. More commonly purchases are made after a good rally, and investments are sold after a big decline. As a result, history has shown that investors lose—very roughly—2% a year over the long term due to such behaviour.

So let’s do a rough summary: Fund fees might reduce your returns by 2.5% a year, taxes another 1%, say inflation nibbles off 3%, and bad timing another 2%. Gulp! Unless your money is earning an annual return of more than 7.5%, your savings could actually be shrinking. How can you avoid this nasty fate? By minimizing taxes, fees and bad timing.

So where should you invest? I’ve already suggested making use of TFSAs and RRSPs to reduce taxes, but what about fees and bad timing? The solution for the vast majority of investors is the humble low-fee balanced fund. It’s the unsung star of the investment world.

Balanced funds are a one-stop shopping experience for portfolios, and they hold a diversified selection of both stocks and bonds. Usually such funds invest about 60% in stocks and 40% in bonds, or equal amounts in both stocks and bonds.

Because balanced funds contain a big dollop of bonds, their returns tend to be much less volatile than those of stock funds. As a result, it is usually much easier to sleep well at night. You might lose a bit during market crashes, but the declines will be more palatable that those from stocks alone. History has shown that most investors handle balanced funds relatively well and don’t suffer too much from the buy-high, sell-low syndrome. That helps to minimize your losses from bad investing behaviour.

Even better, if you look for them, you can find excellent low-fee balanced funds in Canada. Because I know many people like to deal with their bank, I’ve picked a solid low-fee balanced fund for each of the big banks in 8 great funds to stash $10,000 in. I also included a couple of excellent funds from Calgary-based Mawer Investment Management. You can get both Mawer funds with a $5,000 initial investment through a discount broker, or wait until you have $50,000 and invest directly with Mawer to avoid the brokerage fees.

For value I’m going to employ a classic double-barrelled approach that has served me well for many years. Put simply, I’m looking for stocks that are both cheap and relatively safe.

On the cheap side, I want to be able to buy lots of earnings for a low price. That is, I seek stocks with low price-to-earnings ratios. While low-ratio stocks are viewed with disdain in some quarters, studies show that they tend to outperform over the long term.

Turning to the safety side of the equation, debt is critical because a profitable company with little debt is unlikely to go bust. More specifically, I opt for firms whose assets exceed their debts.

Similarly, I also like to keep an eye on interest coverage, which indicates how easy it is for a firm to pay its debts (you can look this number up online at MSN.com). Surprisingly, using interest coverage to gauge a firm’s credit worthiness yields very similar results to those offered up by the big debt rating firms. Roughly speaking, if a large stock has an interest coverage ratio higher than 2 then it probably has a BB, or better, credit rating.

Stocks should also generate healthy amounts of cash flow. Strong cash flows tend to confirm a company’s earnings power and they provide some assurance that the earnings figures haven’t been overly manipulated. It’s not a perfect fraud detector but it is a good thing to double check.

If you think these value requirements sound strict, you’d be right. Only a few Canadian stocks managed to pass all the value tests. But now I’m going to narrow the list even more by using a dollop of wisdom from the world of technical analysis.

More specifically, I want to look for stocks trading near their 52-week highs. The idea being that while we already have cheap stocks, we also want the market to recognise them as showing signs of improvement. That way we get bargains whose prices are already on the mend. (The 52-week-range technique in discussed in more detail in “A crystal ball for stocks”.)

I’ve selected four of the most interesting candidates for your consideration from the few stocks that braved their way through both tests:

Danier Leather (DL) is at the top of my list. It’s a small stock that I hold in my personal account and it is in the sometimes fickle business of selling fashionable leather coats and accessories.

Danier has something of a checkered past and I’ll highlight some of its warts first. Several years ago the company tried to expand its operations into the U.S. but the effort ended in ignoble failure and a hasty retreat. The firm was also plagued by prolonged litigation related to its initial public offering, which was resolved favourably only a few years ago. To cap off the bad news, the economic slowdown of 2008-09 hit the company’s profits hard because Canadians thought twice about buying new leather coats in a recession.

All the sour news pushed Danier’s stock to very low levels. But the company made lemonade out of lemons and began buying back shares by the bucketful at low prices. In doing so the company managed to reduce its share count by almost 30% between 2008 and 2010. Even better, its business perked up, losses turned into profits, and its shares have climbed. The firm now trades at a price-to-earnings ratio of 9.

Breakwater Resources (BWR) is a zinc miner with operations in British Columbia, Chile and Honduras. It’s also developing a new mine in Quebec, which is slated to open in 2012. While zinc is Breakwater’s primary product, it also produces gold, silver, lead, and copper. Now I admit that I’m not a huge fan of resource companies because they have a tendency to gyrate wildly and lack pricing power. But Breakwater may have more than a little room to grow because it’s currently trading at roughly $6, and it wasn’t that long ago that it’s stock was trading for more than $20. At a price-to-earnings ratio of 5, the company should do well, provided commodity prices don’t collapse.

Domtar (UFS), a Fortune 500 pulp and paper firm, has significant operations in both the U.S. and Canada. The company is also the largest of the four selections, it trades at about 6 times earnings, and pays a modest 1% dividend yield.

Goodfellow (GDL) is a Canadian wood distributor hat has been on my radar for several years. Surprisingly, the firm has a reasonably consistent earnings history and has been profitable in each of the last 10 years. That’s a big plus given the tumultuous times we’ve been living through. It also trades at 9 times earnings and provides a dividend yield near 5%, which is mighty fine because I like being paid to wait for better times.

Good luck — and, as always: Do your own due diligence before buying any stock and make sure that it’s a good fit for you and your portfolio.

Such systems usually have a few characteristics in common: They promise to make you rich, they involve lots of complicated graphs and scientific-sounding indicators, and they tend to involve frequent trading. They’re also predicated on the belief that by studying where stock prices have been in the past you can—like the proverbial fortune teller with a crystal ball—predict how things will play out in the future.

These strategies belong to an investing field called technical analysis (as opposed to fundamental analysis which involves looking at the financial health and valuation of the companies themselves). And they’re hugely popular. After all, we humans are glorious pattern finders. It’s evolutionarily useful to be able to quickly spot lions hiding in the bush—and when we do, fast action saves lives. But does it make sense to take our stone-age pattern-spotting propensity and apply it to the modern world?

The surprising answer is—in some cases—yes. But you need to identify the cases where it doesn’t make sense, and they are legion. When someone is trying to sell you such a Pavlovian system, you’ll often find yourself dealing with a tarot card reader of the markets. Like a two-bit fortune teller at the county fair, they’ll serve up a darn good yarn, but their stock analysis will usually fall flat.

Why we love technical analysis
At a very deep level, we’re all suckers for patterns. The problem is, it’s easy to stumble on erroneous patterns in large mounds of data. You can see the result on TV almost every night in the form of new medical breakthroughs. You know, titillating things like the discovery that eating yellow foods decreases the risk of having a heart attack. But after loading up on squash and turning a strange shade of pale, another study might come along that refutes the first and instead points to the cancer causing properties of yellow food. It’s a wonder health-conscious people eat anything all. (Rest assured yellow foodies, these examples are fictitious.) The problem being, just because you’ve spotted a pattern doesn’t mean that it’s predictive or, in math speak, correlation does not prove causation. All too often what the researcher actually uncovered occurred simply by chance.

That doesn’t keep our love of predictable patterns from infiltrating the markets in all sorts of unexpected ways. Even the types of prices you see in the stock market are impacted by it, as some numbers tend to show up in share prices more often than others. For instance, in 2001, stocks on the NYSE traded most often at prices ending in 0 and second most frequently at prices ending with a 5. That is, people liked to trade in five-cent increments with $16.10 being more common than $16.05, and both being more prevalent than $16.12.

Interestingly, traders in China have a slight preference for prices ending in 8, a lucky number for the Chinese, and they tend to avoid those ending in 4, which is viewed as less propitious.

Most investors would say that looking for patterns in raw prices is a waste of time. But when it comes to the overall performance of the markets, it’s hard to find an investor who isn’t looking for patterns on some level. The past is almost always viewed as prologue, despite the common refrain that “past performance is not an indicator of future returns.” Even buy-and-hold types often employ a mild form of technical analysis. After all, when they point to the long-term performance of the stock market as proof that it makes sense to invest in stocks, they are using pricing patterns from the past to try to predict the future.

Indeed, in Canada and the U.S., which have been amongst the best places in the world for stock investors over the last century or so, it’s common for regular families to have a great deal of their retirement savings in stocks. However in places like Japan, where the stock market has been mired in a grinding bear market for many decades, families tend to shy away from stocks.