Diversifying your portfolio
It just makes sense to ensure your investment eggs aren’t all in one basket. Everyone agrees diversification is essential, so it’s not surprising how few people actually achieve genuine diversification in their holdings.
The standard formula for diversification is well known, and all too frequently accepted at face value. It calls for an asset split that’s 60% stocks and 40% bonds.
Equities
Yet, even within this very limited view of diversification, it’s surprising how narrowly focused some portfolios can become. In Calgary, we frequently see portfolios containing many different equities – all drawn from the oil and gas sector – because that’s an area of expertise and therefore a comfort zone for people from that industry. But the ability to pick excellent energy stocks doesn’t shield investors from the notorious volatility of that entire sector in periods when supply exceeds demand.
Others seek diversification in an array of mutual funds. But while each of these funds may be individually diversified to a certain degree, as a group they frequently show alarming overlap in their holdings.
Tax Efficiency
Another frequent weakness seen in many portfolios is that certain assets are held so as to maximize tax exposure rather than minimize it. Usually, this mistake is seen when assets generating dividends or capital gains are held within registered retirement savings plans.
When money is taken out of an RRSP, it is treated by Revenue Canada as interest income, taxable at the highest marginal rate for that investor. This means that dividends and capital gains from investments held within an RRSP lose their tax-advantaged status.
Bonds
Bonds are the traditional counterweight to equities in every portfolio, because bonds are seen as the secure refuge that protects capital investments when equity markets decline. As a direct result, bonds tend to rise when stock markets fall, and bonds pay a guaranteed rate of return.
This is all good, as far as it goes. But in the current low-interest environment, bonds purchased today can easily be overtaken by tomorrow’s rising inflation rates.
Real Estate
All of these considerations can help to provide better balance to any investment portfolio, but the key item missing from most wealth management plans is real estate. It’s a cornerstone of nearly all of the world’s great fortunes and for many good reasons. Most importantly, directly-owned real estate has a very low correlation with equity markets and therefore tends to remain stable when markets are not.
Like bonds, real estate can provide long-term security of capital, plus monthly income. But unlike bonds, it can offer a rate of return between 6 and 11 percent on average, making it far less vulnerable to inflation.
First Mortgages
First mortgages are another play on the real estate market rarely seen in the portfolios of average investors. First mortgage pools make loans to real estate development projects, generating monthly income for investors, with principle secured by first claim on the value of the underlying real estate.
Beyond 60/40
WealthCo includes these investment vehicles in a plan that takes clients beyond the traditional 60/40, stocks-and-bonds approach to wealth management. Instead, we advocate a truly diversified approach that can insulate our clients from market volatility.
An example of a genuinely diversified portfolio might include:
25 percent equities;
15 percent bonds;
25 percent real estate;
20 percent first mortgages;
15 percent other investments, such as flow-through shares, stock options, REITs and raw land.
If you're tired of the roller coaster ride and want a diversified portfolio, call us at 403-537-5853, or email info@wealthco.ca
