Two Tools
to Help You Manage Risk & Volatility
Asset Allocation: Putting Your Eggs in the Right Baskets
Asset allocation is a fancy term for how much money you put into each of the three major buckets, or asset classes, you hold in your portfolio, i.e., stocks, bonds, and cash.
More technically, Investopedia defines asset allocation as “an investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance and investment horizon.”
For long-term investing, i.e., investing over 10, 20 or more years, a very large allocation to equities or, if you are comfortable with the volatility that will occur, (i.e., occasional stock market drops of up to 30%-50% or more), an all-equity portfolio will provide the best long term returns.
About five years before you need to draw on your investments, you can begin to decrease your allocation to equities and increase your allocation to fixed income investments, i.e., bonds, GICs, and preferred shares.
Diversification: How Many Baskets You Use
Diversification strives to smooth out unsystematic risk events in a portfolio so that the positive performance of some investments will neutralize the negative performance of others.
Within the equity portion of a portfolio, diversification is required both geographically, i.e., owning equities in various global markets, as well as in terms of economic sector, i.e., owning equities across various sectors such as Finance, Consumer, Industrial, Utilities, Real Estate, Technology, Health Care, etc..
Asset Allocation, Diversification and You
In the context of long-term investing, given that you have 10, 20 or more years to invest, TheAnswerIs supports an initial allocation of all or mostly all of your assets into equities, increasing your allocation to fixed income when you are five years away from the time when you will need to draw on your investments.
With respect to an ETF-only portfolio, it is possible to obtain global diversification and industry sector diversification with a low cost portfolio of six ETFs.
TheAnswerIs.ca supports you having a stock portfolio that has industry weightings that are different than the TSX industry weightings. It also means that your portfolio may outperform or underperform the TSX.
More specifically, TheAnswerIs supports diversifying a portfolio with industry weightings in Consumer, Finance, Utilities, Real Estate, Manufacturing, and Resources, (i.e., energy and raw materials) that is more balanced than the Toronto Stock Exchange index.
