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Why You Should Avoid Cyclical Stocks With Your RSP Money This Year

For many investors contributing money into a retirement savings plan (RSP) account, there is a normal tendency to want to take more risk to achieve a higher return. One way to accomplish this feat would be to invest in companies that are highly cyclical instead of defensive.

As many investors are aware, cyclical companies are characterized by large swings in revenues, profits, and returns on equity (ROE) during bull markets (good times) vs. bear markets (bad times).

While investors are often excited about the idea of obtaining higher returns by purchasing a cyclical stock at what they believe is the bottom of the market cycle, the situation is often much different than what is hoped for.

In many cases, the slowdown is often deeper than expected, or a one-time write-off comes later on and shares fall further. In other cases, the realization of revenues and profits returning to the previous peak instead of the previous average begins to set in only once the stock has been purchased and an investor is holding a bag of bad grapes.

Investors much too often buy with the optimism seen through rose-coloured glasses. After all, the RSP contribution has been made for the year; this is just the part where an investor gets to prove how smart they really are.

One investment which comes to mind is Finning International Inc. (TSX:FTT). Although this company may have a significant upswing coming, the reality is that the current share price is trading just shy of a rolling 65 times earnings and is yielding less than 3%. At a current price of just over $25, there is an argument to be made that the risk/reward is simply not worth taking.

Looking to the past 10 years, the security has returned a total of approximately negative 5% in total price depreciation while offering a small dividend, which got investors back into the positive.

Within that same period, there have been five separate 12-month rolling periods in which investors could have received a return close to 50% or more.

Clearly, when investing, this is what we hope to get caught up in.

Looking to the past 10 years, 2008 and early 2009 have come to be known as the Great Recession, while the years which followed have been spent, in large part, rebuilding what was lost. Only in the past few years has the stock market experienced returns that could make others jealous.

At the present time, there are clearly areas of the market that have performed very well and may be on the precipice about to take the next step. The result for investors may be very painful.

As experienced investors are aware, understanding the vicissitudes of the market is key to be able to benefit from the positives which come from them.

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Fool contributor Ryan Goldsman has no position in any stocks mentioned. Finning is a recommendation of Stock Advisor Canada.

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