Why you need to spread your money around - MoneySense

Why you need to spread your money around

Diversification can be your investments’ best friend

M A K I N G   B A N K

golden eggs in basket

Be careful of putting all your eggs in one basket.

You’re probably over-exposed to Canada. I know I am. Well, here is a word you need to get a handle on: Diversification.

You’ve probably heard the term ‘don’t put all your eggs in one basket’ before. What does it mean and why am I talking about it? If you’re new to investing you might be slightly confused. Here’s where I’m going with this: if you put all your eggs (i.e. all your money or investments) into one basket (say, the agriculture sector) then you’re at risk because if a clumsy hen tips over your basket (or there’s a calamitous agriculture sector market crash) then all of your eggs are smashed (all your money is gone) and in both scenarios, you have nothing with which to make delicious omelettes because your eggs are kaput and you’re broke.

Make sense? Uh, yeah, I guess you still don’t know where I’m going with this. Here’s the thing. If you’re a new investor and have just put your money into the market but might not know a tonne about what you’re supposed to do with it, there’s an important factor to take into consideration. Don’t put all your investment eggs in one basket. Make sure your money is spread out across various sectors and different types of investment products to make sure you’re comfortable with the risk you’re taking on.

Here’s another fact about if you’re a new investor in Canada. You’re probably woefully overexposed to the Canadian stock market. You might be in mutual funds that invest in Canadian stocks. Or ETFs that follow Canadian-based indices. And if you’re enrolled in a workplace pension plan or a stock plan, boy, forget about it. Most of your precious eggs are in the warm, cozy and seemingly safe Canadian basket. We invest in what we know, and while sometimes it can get us in trouble, like when Canada’s oil sector crashed a few years ago, for the most part it means that you’re missing out on better returns elsewhere.

Canada’s market is minuscule when it comes to the global markets. You say you’re investing in THE stock market. But the Canadian market makes up about 4 per cent of the global stock market. So if 75% of your investments are in Canadian-focused stocks or products, then you’re shunning the sweet, sweet returns that can be found in emerging markets, for example.

Now, what can you, a young, newbie investor, a stumbling chick who for some reason has tons of eggs to spread out across baskets, do?

This all sounds fairly complicated, I know. Here’s the first, simple thing you should do to offset any diversification issues you might have in your young, burgeoning portfolio. Just look at what percentage of your portfolio is invested in stocks versus bonds, says Heath. There are plenty of technical things you can learn about this topic, but understanding where your portfolio stands in equities versus fixed income is the most practical thing you can do at this point. Your asset allocation may be different depending on your goals but if you were to go the tried and true Classic Couch Potato route, you should be in 60% equities (spread out across stocks, ETFs and mutual funds) and 30% in fixed income like bonds.

Then, look at your geographic exposure, says Heath. “If you’re a do-it-yourself investor, I would caution against the common mistake to just load up on Canadian banks, for example. There are probably worse companies you could overweight in a portfolio, but diversification is a real important recipe for investment success and risk minimization.” So, an example of a good split between geographical regions is 30 per cent Canadian equities, and 30 per cent U.S. equities and another 30 per cent in foreign investments.

This is just a starting point and a call to evaluate where your eggs are right now. You don’t want to be unaware when that basket tips and you realize you’ve lost most of your money—or if 20 years from now you’re lamenting the fact that you could’ve had way, way more eggs.

Bottomline, you set yourself up for stronger returns. And, even more important, you set yourself up for less RISK.