Why are the best-tasting foods—cake, pizza, beer—always the worst for your waistline? Meanwhile, dreary stuff like broccoli, wheat germ and anything labelled omega-3 is ridiculously healthy for you. The good news is you can have your cake and eat it too: the odd indulgence isn’t going to harm you if taken in moderation. If you regularly load your dinner plate with veggies, grains and lean protein, it’s OK to chow down on something gooey and decadent from time to time. It’s all about moderation and balance.
Finding the right balance is also important in your portfolio. You’ve got to find the appropriate mix of exciting stocks and boring fixed income (bonds and GICs). Equities can grow your portfolio more rapidly, but they also carry the risk of big losses. Bonds are more stable, but don’t have the same potential for a big payoff.
A traditional balanced portfolio—suitable for investors seeking moderate growth without too much volatility—holds about 60% equities and 40% fixed income. But you can adjust that mix to suit your own situation.
One of the important factors is your age. Just as teenagers can eat more beer and pizza without gaining weight, younger investors can afford to gorge on more equities, since they have a long time horizon and can ride out the inevitable ups and downs. As you get older, you need to rethink your portfolio’s balance. With less time to recover from stock market declines, you should scale back on equities and pile your plate with more bonds and GICs. A useful rule of thumb is that your portfolio’s fixed-income allocation should equal your age—so, 60% bonds if you’re 60 years old.
You should strive for balance within your equity holdings, too. Investors tend to keep most of their stocks in their own country, and Canadians are no exception. But it makes more sense to diversify globally, with roughly equal amounts of Canadian, U.S. and international equities (including both developed and emerging markets).
When it comes to settling on the right asset mix there are no hard and fast rules. Scott Gailfus, a 39-year-old petroleum engineer in Calgary, has 65% of his portfolio in equities and is considering increasing that even more because he’s concerned a bond-heavy mix won’t get the returns he needs to build a retirement portfolio. “Am I playing it too safe with 35% in fixed income?” he wonders.
“Finding the right balance is a somewhat personal decision,” notes fee-only planner Ian Black of Macdonald, Shymko and Company in Vancouver. Part of it comes down to how well you can handle volatility, but it’s also important to figure out how much money you want in retirement, Black says. You then need to calculate your portfolio’s target rate of return to ensure you’re on track to meet that goal. Once you’ve established those targets—and ensured your expectations are realistic—you can determine the asset allocation that will get you there.
For example, if Gailfus determined—based on his current portfolio size and annual savings rate—that he needs a 7% return to reach retirement comfortably, he may indeed need to tilt his portfolio more toward equities. But if he can get there with just 3%, he doesn’t need to take on additional risk.
This kind of big-picture thinking helps you avoid getting distracted by the current climate for stocks and bonds. “I try to get clients to focus on their whole portfolio, not just individual components,” says Black.