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Get the balance right

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Can we simplify asset allocation?

Yes, we can.

While there may be more to asset allocation than just stocks and bonds, stocks and bonds are the best starting points for most investors. Anyone can become an investor through mutual funds or ETFs.

What have most investors heard about stocks?

• Stocks usually outperform bonds over long periods of time

Ok, now, in this hypothetical, let’s imagine that stocks take longer than average for that outperformance to take place. What can we do to bolster our portfolios?

If we find ourselves in a period where equities take longer to outperform than average, we can arrive at two conclusions:

• Fixed income positions (bonds) are even more important

• Rebalancing is even more important


Because, although a 100 per cent portfolio of stocks should statistically outperform over the long-term, most investors are more human than they are instruments of logic. People are emotional.  Since they’re emotional, what is theoretically true about investing may not hold true in real life.

Volatility takes its toll. Big market drops herald big investor reactions. When bad news reaches a fever pitch about stock markets, many investors start to feel ill. Investors start abandoning strategy and discipline.

After all, there’s Europe, a potential recession, inflated house prices in Canada, and a blue sky that’s sure to fall. (Never mind that equities haven’t been this cheap in quite a while.)

The only things that have really changed are the names of the crises. Not to belittle the difficulties we face economically – these are challenging times – but we’ve always faced difficulties economically. With market corrections, and, with prudent planning, difficulties become opportunities.

Seeing the opportunity in today’s markets may be better than running around screaming the sky is falling.

If your portfolio has a good allocation to fixed income products – if you have a mix you’re comfortable with – and you have a disciplined rebalancing strategy, you should benefit. There are times when stocks and bonds move up or down at the same time, but usually, stocks and bonds move in opposite directions.

If your allocation is 65 per cent equity (stocks) and 35 per cent fixed income (bonds), then when your allocation drifts, let’s say to 70 per cent equity and 30 per cent fixed income, it’s time to rebalance.

What do you need to do? Sell some stocks and buy some bonds. Sell the asset class that has outperformed, and buy the asset class that has underperformed.

Sell high. Buy low.

Everyone knows that, right? But it takes great discipline to do. You have to automate the process.

Some investors worry that they’ll impede portfolio performance by selling stocks when they seem to be doing nothing but going up. True. This happens. Your allocation may change early in a bull market. But many investors struggle seeing future benefit in the face of the madness of crowds. The “noise” affects their focus and their resolve. It can make investors buy at the wrong time or sell at the wrong time. In down markets, too many investors only see current losses or declines.

What might be the best rebalancing schedule theoretically, may not work for the average investor struggling to cope with “noise” during a market correction, especially, if it’s a severe correction like 2008-2009.

While the financial crisis may have caused some grey hair, it was one of the best times in recent memory to test out your portfolio. Recent weeks also put some pressure on investor nerves while squeezing portfolio integrity.

It’s times like 2008 – 2009 that make people happy to own bonds. Bonds performed very well as stocks declined.  Stocks usually outperform bonds over the long-term, but bonds add some insurance to your portfolio.

As the market began the steepest part of its recent decline, we can see that bonds once again outperformed as investors positioned themselves for safety. The steady income from bonds and the hedge they provide against market drops often make them fund manager favourites.

Why should the average investor be any different?

Bonds providing a hedge during recent market correction

Part Two is here.

Don’t panic

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In the face of the typhoon (market correction), bend like bamboo

What is it about market corrections? Wise, rational people can become wide-eyed pessimists and conduits of fear in the face of steep market drops. Can you remember a time when you sold investments during a market correction and it turned out to be a wise move?

Investors ruled by a forest fire of emotions, fanned by the media looking to report the latest, most sensational story, rarely make wise decisions. Often, when the market is hitting new record after new record, they’re buying. But when the market turns the other way, and suddenly high quality companies are on sale and can be bought at excellent discounts, emotion-ridden investors are running for the hills or putting their heads in the sand.

Here are some facts that you’d do well to pay attention to. The study tells the sad tale of how investors, suffering from a bad dose of “Oh, no! The world’s going to end!”, make some classic mistakes while investing. In fact, what may be the most important aspect of your investment plan, after asset allocation, is dealing with the forces of rampant negativity that rear their ugly heads every time there’s a market correction.

Glued to the media, wide-eyed and beset with your worst fears for the economic future? It’s time to go for a walk. Fund managers wait for corrections to go out bargain hunting. Wouldn’t you be happy if the suit or new pair of shoes you wanted to buy were now on sale? Because that’s exactly what’s going on now: high quality, dividend-paying companies are on sale.

Investors need to do themselves a favour:

  • Develop a thicker skin
  • Stop dwelling on the investment media during corrections
  • Stop chasing investment returns
  • Ask yourself: since everybody’s talking about gold bullion (or whatever the flavour of the month is) right now, do I really want to buy it?
  • Get a sound investment plan
  • Stick to your plan
  • Buy or sell investments when your asset allocation veers away from your planned allocation, and do it regularly
  • Remind yourself that great, stable companies are not going to disappear

Further considerations that you should bear in mind:

  • Remind yourself that Warren Buffett (and other smart money managers) are looking for bargains rather than making rash, panic-fuelled decisions
  • Aren’t all the companies you wanted to buy when they were more expensive, cheaper now?
  • The economy’s gone through corrections dozens of times before – this won’t be the last time (e.g., Latin American bonds, the Asian Crisis, the Tech bubble, 9/11, [Remember when people were talking about the Canadian peso?], the financial crisis, etc.)
  • If you’re buying in the midst of this correction, or any, remember, you don’t need to throw all your money in at one time – you can also buy gradually, giving you a cushion and better prices should the market go down further
  • There’s a place in your portfolio for bonds – do you have any?
  • Revisit your plan yearly

If you’re still spooked after a hard, meditative look at your investments, maybe your asset allocation is too aggressive. Should you reduce your equity holdings somewhat? Reducing stock holdings amidst any correction is tricky. You’re probably going to be selling at the worst of possible times – maybe you should revisit your asset allocation model when things calm down a bit? (Have I mentioned stick with your plan and re-evaluate your plan regularly?)

The time for strategic thinking is before a correction and during one. When it seems that investment losses are falling out of the sky, too many investors forget their planning. Many have heard Warren Buffett’s “Be greedy when others are fearful” philosophy – slowing down and taking a breath during the bad news feeding frenzy will help give you some perspective on where you’ve been, where you’re at now and where you want to be.

RESPs for the educated mind

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The kids are all right

Strategy. Strategy. Strategy.

You have watched your child grow and develop. You can’t believe it, but your little bundle of joy has grown up, has her own opinions and philosophies and is now ready to embark on one of her greatest adventures. Higher education. Goodbye high school. Hello post-secondary education.

Remember your own first year in university or college? Everything looked so big … How could you possibly get from one end of the campus to the other in five minutes? The excitement … The feeling of learning and collaborating … And now, it’s your own child ready to swing the door open to a whole world of possibilities. Immensely proud, you have some small, nagging worries about your child getting a great education and a smooth path into the future.

You have planned for this, though. Long ago, you established a Registered Education Savings Plan (RESP). And now, that long-term thinking is about to pay off. You might think your financial planning and strategy for you child’s education is done …

Think again.

Did you know that the way money is withdrawn from an RESP is enormously important? Strategizing doesn’t end now – it evolves.

Just like that little baby that grew into a teenager ready to take on the world.

  • Limit withdrawals – Remember the government … The government limits the withdrawal of RESP income and Canada Education Savings Grant funds including the CES Grant. Government restrictions on a maximum of $5,000 in the first 13 weeks of your child’s program, might leave you searching for extra funds, tempting you to grab some extra cash from the RESP to add to the $5,000. Avoid this redemption, if possible. Think long-term. Investing is often about deferring tax. Redeeming early undermines a registered plan’s tax-deferred growth potential just as leaving college or university early may limit your child’s future possibilities. Even worse, if the program doesn’t qualify, you’ll have to repay a portion or the entire CES grant!

Wait a minute … Didn’t you start this plan to give your child an advantage?

Yes. And knowledge will help you graduate RESP complexities with honours.

  • Get permission for an early withdrawal – And get it in writing. You can exceed the $5,000 limit on the withdrawal of RESP earnings by requesting permission in writing from the Minister of Human Resources. Avoid withdrawing plan capital (and a repayment of CESG funds), but make your request early. By making the request as soon as you can, you’ll get a timely response and be able to determine if this plan works for you before school begins.

The government could request a payback …

  • Strategic withdrawals avoid paybacks The government may ask you to pay them back the CESG grant money if they see earnings remaining in the plan after your child graduates or leaves school. Avoid the potential CESG payback, be sure to use the plan’s earnings before withdrawing contributions.

Part Two is here.

Gold riot

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Warren Buffett’s thoughts on gold or how looking at the return on gold might reduce the glitter

The riot over gold has calmed down a little, however, there is still significant interest in the metal. An interesting perspective on gold comes by way of value investor par excellence, Warren Buffet.

Will all the gold that glitters glitter less?

There is no denying gold has had a great run. What people forget when gold performs spectacularly is that it has often caused investors an enormous amount of pain as well. Gold is volatile. It soars, but it has also come down very hard throughout its history – part of the reason that most recommendations limit gold to about 5 per cent of a portfolio (in order to smooth out volatility).

Gold has performed very well this year and over the last few. The S&P/TSX Global Gold Index has doubled the S&P/TSX 60 this year. But gold’s performance comes with a lot more volatility. The fact that gold is such a big sector within the Canadian stock market has been advantageous this year. Gold often kept the Canadian market buoyant when other stocks turned downward. It acted as kind of a built in hedge. However, should gold turn south in a significant way, it will also hold the Canadian market back because of its large weighting. In fact, by just holding an index fund or ETF tracking the S&P/TSX 60, you have about 20 per cent exposure to the materials sector, and, a large portion of that is in gold. The broad Canadian market has a lot of gold exposure already.

Unfortunately, gold is on everyone’s tongue lately.

But what does Buffett say about gold?

Gold just sits there

Buffet has become wealthy by being a value investor. He believes in goods and services and buying the undervalued companies that deal in them.

If you don’t listen to Warren Buffett at some level, you’re odd. Whether pundits agree with him or not, his opinion is focused on and respected. Buffett says there is no place for gold in his portfolio – intriguing, because, unlike Canadian investors who have seen appreciation in their currency, Americans have been dealing with a declining dollar, resulting in the rush to gold as a hedge against devaluation. Throw in the troubles in the world economy, the devaluation of the Euro, etcetera, etcetera, and the rush to gold isn’t exactly surprising.

Buffett’s logic on the metal is definitely interesting. He thinks gold is useless.

That’s right. Useless.

Buffet on gold:

“(Gold) gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

Ah, the Ziggy Stardust gold analysis …

In Fortune, Buffett recently said:

“You could take all the gold that’s ever been mined, and it would fill a cube 67 feet in each direction. For what that’s worth at current gold prices, you could buy all — not some — all of the farmland in the United States,” Buffett said. “Plus, you could buy 10 Exxon Mobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?”

A very, very interesting illustration …

Buffett has stayed consistent with his messaging on gold.

  • Expensive to store
  • Has no practical use
  • Doesn’t generate income

Of course, some of the large players that mine gold do generate income, but Buffet’s talking more about buying the metal itself.

The S&P/TSX Gold Index has done very well in the last ten years. It has returned about four times the S&P/TSX 60. However, during the dog days of the financial crisis, it collapsed along with everything else, and that collapse wiped out all gains since about 2002. Gold has recovered spectacularly since then though not without some equally spectacular volatility. Without a doubt, placing a big bet on gold increases risk immensely. If you’re looking to steer away from volatility, putting more than 5% of your portfolio into gold could leave you with a nasty surprise.

Gold stocks, because of their leveraged positions with respect to gold perform even better than the metal, generally, yet that outperformance goes the other way in a hurry at times. So, gold stocks can be a great hedge, but they also have some explosive volatility built into them – volatility which can go either way faster than most people can monitor.

The big question is which way will gold go in the near future? And, how much has the risk premium for holding gold increased?

For Canadian investors, this question doesn’t hinge on a declining currency. Our market has a huge piece of gold already. If you own the broad market, you’re already exposed to gold. That can be a good thing or a bad thing. In the last ten years, it’s been a great thing, but all good things come to an end. Are we closer to the end of gold’s aggressive increases or is there still room to shine?

For the average Canadian investor, if you just own the broad market you have exposure to gold and its advantages. At the same time, should gold have a significant correction, you’ll feel it.

Buffett’s comments on holding gold bullion (even though it’s easier to do with ETFs now) bear some thought. Expensive to store. No practical use. No income.

Looking for value makes one a big fan of dividend-paying investments. Canadians already have exposure to gold. Would you take a flyer on gold at these prices? Such an idea may have lost its sheen.

If you are a trader, that’s one thing, but if you are an investor, polishing gold may leave less of a glimmer lately.

Now, if there were a significant correction in gold, that would change things, but right now gold looks like its bumping its head on a ceiling. Whether that will be temporary or longer lasting depends on many different interconnected moving parts within the economy.

The questions it’s prudent to ask yourself with every investment are:

  • Am I likely to get the same return on my investment next year?
  • Will I get even half of that return?
  • Am I using sensible portfolio approaches regarding the construction of my investment portfolio?

A portfolio of gold stocks I was looking at recently has returned over 70 per cent year-over-year. The broad market has returned less than a third of that. Over 50 per cent of that return has come in the last six months. Recently, this portfolio has pulled back 6 per cent – and it is a broad portfolio that has increased over 800 per cent over the last ten years.

Is it cheap? Does a correction of 6 per cent add much value? …

Not exactly a huge pullback.

Every Canadian investor who holds the broad market holds gold. Loading up on gold may not be the best of all portfolio moves. At this point in time, Canadian investors find themselves in a different situation compared to their American counterparts.

The gold rush may not be over but there certainly are a lot of people panning in the stream.


For an update on gold stocks, gold bullion and dividend-paying stocks click here.

Asset allocation: Diversification is king

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The king and you

Invest in different asset classes, across geographies, sectors and styles, and the impact of any one investment on your portfolio is diminished. Most investors, especially new investors, worry about poor performance but forget about the importance of diversification.

For example, if your only investment is your house, then you’re not very diversified. Ask anyone who was overloaded in U.S. residential real estate about how lack of diversification can negatively affect your portfolio.

These days diversifying is easier than ever. You can invest in real estate, international stock and bond markets, emerging markets and commodities. You don’t have to simply depend on domestic stock and bond markets as much as investors once did.

But what is important is considering the risk/reward features of these asset classes. You don’t want to invest too little or too much in any one asset.

The challenge of asset selection

The number of investments available today is truly staggering. Individual stocks and bonds, mutual funds, ETFs and managed accounts are only a few of the types of investment options. If you want to manage risk well, you have to evaluate how each investment will impact your portfolio.

Benchmark indices help financial professionals gauge the performance of their assets under management. Some investments are designed to very nearly track these indices. Many exchange-traded funds seek to offer investors nearly the same performance as indices.

Individual securities or actively managed funds hold out the potential to outperform the indices they are based on. However, these investments rarely do outperform. And they often carry higher risk and higher management fees that are a detriment to an investor’s overall portfolio depending on the extent of an investors understanding of markets, and the level of advice she may need.

Determining the level of risk you are comfortable with is crucial. Mixing index and active investments into your portfolio will benefit you when it comes to the end result of achieving your objectives.


Rebalancing your investments is key. Periodically, investors should review their portfolios and re-assess their investments and long-term goals. Often, this requires selling your best-performing investments along with the discipline to execute your plan.

“Buy low and sell high” may be the mantra investors want to follow, but for many, it’s easier said than done. Risk management best practices suggest that an investor must pay just as much attention to selling high as buying low. Getting overly greedy after a good run in the markets is dangerous to your portfolio.

By rebalancing, you can stay on track. Proper asset allocation helps you stick to your risk/return objectives. Although this sounds easy on paper, it’s not. Systematizing the rebalancing process is one of the most important processes of a sound investment plan.

How to be a smarter investor

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Most people obsess about investment performance. While tracking the performance of your investments is without a doubt important, are you considering risk?

Investors generally understand risk. For example, not meeting investment goals stands out as a hazard when it comes to portfolios. But without risk, there is no return. You have to take some risk to earn better-than-average returns.

So, how should you consider risk? How does risk fit into your portfolio? If risk and reward are so heavily correlated, how much should you be taking? How can you manage risk properly?

Understand risk

What is risk, anyway?

You can’t control everything. The recent market meltdown was out of investors’ control. But how you organize your portfolio is within your control. And that’s empowering.

Most Americans investing in residential real estate didn’t think they were taking on a lot of risk. Yet U.S. residential real estate dropped by about 50 per cent from its peak. You definitely increase your risk with all your eggs in one basket. But you can manage risk. You can create less uncertainty and the stronger probability of meeting your investment goals.

Are you taking on too much risk? Is there overlap in the securities or funds you hold? You think you’re well-diversified, but are you really? On the other hand, if you’ve been holding only low-risk, low-return investments like GICs over the last ten years, you might feel sorry. Why? Because if you held a basket of Canadian financials (even with two major stock market corrections), you would still come out ahead. Yes, risk offers the potential for higher returns. However, you need to determine what the appropriate amount of risk in your portfolio is.

In order to create an intelligent investment plan, you need to evaluate your risk tolerance. You need to ask yourself questions like … How much risk are you willing to take? Is a very conservative strategy going to allow you to achieve your investment goals? Research shows that being too conservative also entails risk when it comes to achieving portfolio goals. Risk is not only about aggressive investments. Conservative investments carry risk, too.

Risk, by any other name, is still risk

Risk can take many shapes and forms. Do you have the right investments? Are you being too aggressive? Or maybe you’re not being aggressive enough? The best way to consider risk is by having a sound investment plan.

Considerations for your investment plan

• Asset allocation

• Choosing assets that will make up your allocation

• Rebalancing your portfolio

In an upcoming post, I will discuss the above fundamentals.

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