Business: Get your portfolio mix right | #Toronto #realestate #finance

Business

Get your portfolio mix right

You should think of your portfolio strategy as a blender that mixes investments to your own unique taste.

 

You should think of your portfolio strategy as a blender that mixes investments to your own unique taste.

The asset classes of cash, bonds and equities are the basic ingredients. What you are really blending, however, is the distinctive return and risk profiles of these assets and how they interrelate to each other.

Cash investments such as treasury bills are commonly viewed as riskless. Not so. Sure, they don’t drop in value but they contain massive reinvestment risk — the possibility that future proceeds will have to be reinvested at lower interest rates. According to the Bank of Canada, the 30-day treasury bill rate fell from 4.3% in August 2007 to a rock bottom 0.1% two years later. Even today, the rate is 0.5%. Try funding your retirement on that return.

Bonds offer the opportunity for higher yields but they introduce new risks into the blender. Short-term bonds have reinvestment risk, but as the maturity date is extended, interest-rate risk replaces reinvestment risk. Bonds that offer a fixed rate of interest will fall in value when interest rates rise — in general, the longer the term of the bond the greater its interest-rate risk.

Today, worries about deflation and falling interest rates have made long-term bonds a winner, but inflation and rising rates may lurk on the horizon. The last time inflation seeped into the economy after the Second World War, bonds became an underperforming investment for more than three decades. Courtesy of interest-rate risk, long-term bonds in Canada had a negative return (net of inflation) from 1948 through 1981. So much for the common wisdom that bonds are always a safe refuge for the conservative investor!

Bonds, particularly corporate bonds, also possess default risk. A promise to pay is not a guarantee of payment. Ask a bondholder of Lehman Brothers or Chrysler LLC. And today, the gargantuan debts of many developed nations, including the United States, are introducing the spectre of default risk into these bonds. Fortunately, Canada’s fiscal prudence has kept default risk at bay, at least for now.

Equities bring stock market risk into the portfolio. As the inevitable swing of the business cycle lifts and erodes corporate profitability, equities rise and fall in value. This inherent volatility is amplified by the herd behaviour of investors who can drive prices to delusional heights during manias and extremely depressed levels in busts.

Investors demand compensation for greater risk so the higher volatility of equities historically has resulted in a return premium to treasury bills and bonds. Over the long run, equities have averaged an annual return about 6% higher than treasury bills and 4% or so to bonds. But the long run can be a very long time: Over a 10-year period, stocks still underperform bonds about 15% to 20% of the time.

More unusual ingredients are available. Real estate and commodities have different return and risk profiles than equities. The higher return and riskiness of small company stocks can spice up any portfolio. Exotic flavours are available from hedge fund strategies that can bring the risks of shorting, leverage, illiquidity and derivatives into a portfolio.

Mixing these assets into an optimal blend suited to the taste of a particular investor is one of key challenges of portfolio management. Most investors do this the old-fashioned way using rules of thumb. Increasingly, however, high-net-worth families are emulating institutional investors by hiring advisors who use fancy blenders such as optimization and asset-liability models to craft more precisely diversified portfolios. They know that their investment success depends on getting the recipe right.

Financial Post

* Michael Nairne, CFP, RFP, CFA is the president of Tacita Capital Inc., a private family office and investment counselling firm in Toronto.

 

 

 

 

Advertisements

About Tariq Sultan
Dear Readers, I am a dedicated Toronto, Ontario based real estate professional who has been successfully meeting and exceeding the needs of his clients for past several years. I am actively involved in the insurance, financing, and mortgage industry. Real estate is not only my career – it is my passion. I strive to continuously provide my clients with exceptional service to ensure they are fully satisfied when it comes to their real estate needs. For any real estate related inquires contact me today, I will be happy to assist you. Best wishes, Tariq Sultan

2 Responses to Business: Get your portfolio mix right | #Toronto #realestate #finance

  1. But the long run can be a very long time: Over a 10-year period, stocks still underperform bonds about 15% to 20% of the time.

    • Tariq Sultan says:

      @türkh web tasarım: Thanks for your input! It think you could be right, but it largely depends on several different factors affecting performance of stocks vs. bonds in the long-run. Whatever the portfolio mix be, it’s best to say that it differs from individual to individual, and ultimate responsibility lies on the investor(s) to educate themselves about their investment portfolios. The more you know, the better.

      Best,
      Sana

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: