My youngest son would eat the same thing every day if we would let him.
Like many kids, he is resistant to stepping outside his comfort zone and does not realize, despite mom and dad's best efforts, that eating different foods provides numerous health benefits.
Humans are creatures of habit. We often gravitate to what we know and avoid what we don’t. This often is the case when it comes to investing. According to a recent article from The Vanguard Group, the S&P/TSX Composite Index only accounts for 4% of the world stock market; however, the average Canadian investor has 60% of their portfolio in Canada. By contrast, according to the Canada Pension Plan web site, they invest only 16% in Canada.
Diversification allows you to participate in the growth of investments that are doing well, limit downside risk and smooth out the highs and lows associated with individual investments.
Diversification aims to maximize return by investing in different areas that would each react differently to the same event. Many investment professionals agree that diversification is the most important component of reaching long-range financial goals while minimizing risk.
Below are seven strategies that we employ to reduce risk in our portfolios:
1. Asset Class: Number one for a reason, asset class, also referred to as asset allocation, can account for up to 90% of an investor's return. It refers to the portion of a portfolio that is allocated traditionally between stocks, bonds and cash. Everyone's asset allocation will differ based on his or her investment objectives, risk tolerance and unique circumstances.
2. Geography: We believe that investing only in Canada leaves your portfolio under-represented in the world market. Most of the things we own in our home are made globally. Ninety-six per cent of investment opportunities lie outside of Canada. The U.S. stock market is the largest, accounting for 54% of the world.
3. Style: There are several investment styles, but the two most common are value and growth. A value approach tends to focus on price, fundamental strength of the company and if it is over/under valued. Banks, pipelines and railroads tend to be value investments. A growth investor tends to focus on the growth prospects of the company and competitive advantages. The tech sector is a growth industry with some notable names, such as Amazon and Google.
4. Size: Different-sized companies can have significantly different returns in various market conditions. Smaller companies tend to see more growth when the economy is doing well and expanding. Mature and larger companies tend to hold up better when the economy slows or drops.
5. Sector: Markets are typically broken down into 11 sectors. The Canadian stock market is dominated by two sectors as financial and energy companies comprise roughly 42% of the market. Both financials and energy have struggled through the COVID pandemic, while other sectors, such as technology and health care — which are underrepresented in the TSX— have fared far better.
6. Currency: Investing outside of Canada adds a layer of risk dealing with currency exposure. Large swings in currency can either add or detract from a portfolio. The options are to hedge out currency in part, altogether or let it ride. Many investment vehicles offer a hedged version that removes the currency component to international investing.
7. Non-Traditional Assets: With increased globalization, we are seeing increased instances of different stock markets moving in the same direction, also called positive correlation. The goal of non-traditional assets is to find investments that act independently of the main markets. Hedge funds, private debt and commodities are a few examples.
These are some of the most common and effective ways to diversify your portfolio and help you achieve your investing goals. As always, we encourage you to consult with a professional before making any changes to your portfolio.
Until next time, Invest Well. Live Well.
Written by Keith Davis. This document was prepared by Eric Davis, vice-president, portfolio manager and investment advisor, and Keith Davis, investment advisor, for informational purposes only and is subject to change. The contents of this document are not endorsed by TD Wealth Private Investment Advice, a division of TD Waterhouse Canada Inc.-Member of the Canadian Investor Protection Fund. All insurance products and services are offered by life licensed advisors of TD Waterhouse Insurance Services Inc., a member of TD Bank Group. For more information, call 250-314-5124 or email Keith.firstname.lastname@example.org.