When markets plummet or soar, even seasoned investors question the logic of diversifying our investment portfolios. During these times, emotions regularly compel us to reposition our investments so that we concentrate on either what’s safe, or what’s exceeding expectations. Sadly, this is not a winning a strategy if we want a favorable outcome over the long term.
Being disciplined is not always easy. Diversification is not a guarantee of the best possible performance, or the avoidance of any loss. Instead, it’s about long-term success: reaching your financial goals within the level of risk and time horizon specific to you.
So what does diversification involve? For most of us, we first think about a mix of stocks, bonds and cash.
Stocks include large, medium and small size companies, diversified amongst different types of industries, and located in different geographic areas. Be aware that many companies, including Multinationals, may not derive all or any of their income in the country they reside.
Stock selections can include both growth and value companies, or be chosen for their stable or growing dividend payouts.
Bonds include government (federal, provincial, municipal), corporate, and high yield debt of different investment grades (risks), with issuers in different geographic locations, denominated in different currencies, with extra features such as real return (inflation protection) or floating rate interest. Their term to maturity will dictate their sensitivity to inflation and interest rates, so while varying maturity dates can make sense long term, short term this can make them more volatile.
Other investment options include real estate, real estate investment trusts (REITS), ETFs, alternative strategy funds, commodities, etc. and are becoming more commonplace. You can also decide whether to hedge your portfolio against currency risk, or focus on income producing investments that can either be paid to you, or reinvested for higher compound returns.
To reduce risk, have a broad number of different holdings within each type of asset. No one investment should ever represent more than 5% of your portfolio, and if you work in that same industry or for that company, having your employment income, pension/RSP, and nest egg exposed to all the same risk factors is rarely prudent.
Building and maintaining a portfolio that incorporates all the above is complex and time consuming. Using professionally managed portfolios such as mutual funds, segregated funds, and private pools can be a great strategy. There’s nothing like delegating your research and ongoing monitoring to disciplined investment professionals who have better access to current information and will work 24/7 while you enjoy life.
And, always consider your net returns when considering both tax and fees. It’s not how much you earn or pay; it what’s left in your pocket that’s important.
With this ever-growing emphasis on low costs, don’t forget the insight and truth of this wise saying: “Value, Price, Service. Pick two.”
Many find that using a trusted financial advisor to review your specific goals, time horizon, and risk tolerance helps determine the right mix of assets (and right managed portfolios) for your situation. Regular reviews (at least annually) then ensures that market value changes, or lifestyle changes (to health, employment, family) have not resulted in a portfolio that’s no longer appropriate for your current situation.
Lastly, never try to time getting in or out of the market. You may luck out and get it right on the odd occasion, but over time, statistics prove that investors miss far more opportunities, and experience significantly lower returns, than if they simply stuck to their plan. Regular interval investing (dollar cost averaging) takes ‘timing’ out of the equation, and most often results in better returns over the long term.