Balance
Life is all about balance. How much time you spend working needs to be balanced against the time you give towards family, your own personal endeavours and the community around you. It goes without saying that your investment strategy must also be balanced.
When we talk about balance, we are not only referring to a “balanced portfolio” but a balance between an individual’s appetite for risk and that person’s expectations of investment returns or growth. In other words, an investment strategy must begin with a realistic assessment of how much return can be generated for a given degree of risk. When an investor has an extremely low tolerance for market swings, suggesting a bias towards less-risky securities like government bonds, then it is unrealistic to assume double-digit annual returns over the long-term. For this reason, we believe there is no such thing as spending too much time with a client to explain the risk-reward trade-offs associated with every type of investment being considered, and to ensure that the strategy we put in place matches the client’s own risk tolerance.
Diversification
Studies have shown that roughly 90% of a portfolio’s volatility can be accounted for by how the assets in the portfolio are allocated. The more diversified the portfolio, the less risk there should be. Some believe that this means having the right mix of stocks and bonds; however, we must also make sure that there is diversification within the equity and bond segments of your portfolio as well as in the holdings of bonds. For example, just as an individual shouldn’t have too much weighting in a particular stock market sector or company, the bond portfolio should also be diversified across federal, provincial and municipal governments, as well as corporate bonds. And this diversification should also be across countries and regions as well.
At the same time, investors should realize that there comes a point where simply adding securities and investments to the portfolio, for the sake of diversification, doesn’t achieve any material increase in diversification. One of the biggest mistakes made by retail investors is having an excessive number of mutual funds in their portfolios. For those funds that invest in blue chip Canadian companies, there will be a huge amount of overlap. Therefore, we not only take the time to ensure that our clients’ portfolios are diversified, but that they are efficient and not complicated.
Discipline
It is fairly easy to produce a diversified portfolio when a client’s account is opened for the first time, but as time goes by the movements of various markets will change the relative values of the portfolio’s holdings. For example, if you started out with 60% in stocks and 40% in bonds and the equity market experiences a prolonged rally, then it’s quite possible that the portfolio will now have more than 60% in stocks and less than 40% in bonds. Of course, the opposite may hold true as well. Just consider what happened from 2000 to 2002, when the TSX index suffered through a major correction, while bonds outperformed, and did so again in 2008.
A disciplined investment philosophy solves this problem by constantly reviewing the portfolio and rebalancing when necessary. What this means is that we simply return the allocations of the portfolio back to their desired weightings. This has two benefits. First, it keeps the investment strategy intact and your portfolio structured in a manner consistent with your objectives. Second, the process of rebalancing implies ‘selling high’ and ‘buying low’. If one market or sector outperforms another for an extended period of time, the rebalancing takes profits from that sector (where the value is probably higher than what fundamentals suggest) and puts them to use in buying those sectors where values have declined relative to fundamentals.
For a tax-sheltered account (such as an RRSP), the rebalancing can be performed on a very frequent basis, with very slim thresholds of how far a particular market or sector gets away from the desired allocation. In taxable accounts, a greater degree of discretion is taken, meaning longer periods in between rebalancing and perhaps larger deviation thresholds. Again, the key point here is discipline. |
