I am sure you recall your parents telling you as a child to eat your vegetables before you can have dessert. You may also remember seeing Health Canada’s nutritional food guide listing the recommended servings for every food category.
To have a healthy diet typically requires you to eat a variety of foods that will allow you to obtain the nutrients necessary to keep your body functioning at its optimal capacity. It is not without reason that your parents wanted you to have your vegetables!
You may be wondering, “Why in the world is he speaking about nutrition? I thought this was about finance!”
The fact is the concept of a well-balanced investment portfolio closely mirrors that of a healthy diet.
The key to building an optimal portfolio is diversification. This should be done through multiple asset classes as well as across different regions. Many Canadians suffer from a home bias, by having a diet that is particularly rich in Canadian assets. It is nice to support your country, but what if this was a detriment to your portfolio?
Let’s take a look at some of the global index returns for 2013.
Although many Canadian investors enjoyed seeing the Toronto stock exchange increase by 9.56% in 2013, if your portfolio was not properly diversified across international equities you missed out on some even more satisfying returns.
To put it in perspective, the TSX significantly lagged some of the global leading indexes. Our neighbor’s index, the DOW Jones industrial gained a hefty 26.5% in 2013. Even some of the European indexes outperformed the TSX with London’s FTSE and the Frankfurt DAX increasing by 14.43% and 25.48% respectively. One of the best performing markets last year was Japan’s Nikkei with an impeccable return of 56.72%.
As seen above, a portfolio that is well diversified across markets would have yielded a much higher return than one which simply invested in Canadian stocks. Adding global exposure to your portfolio can usually help you capitalize on higher returns by accessing developing countries that are experiencing much higher growth than our own. To properly diversify you need to look towards other markets in order to invest across all types of sectors. By doing so, you are minimizing return deviations as different economic cycles will impact every sector differently. For example, when an economy is growing rapidly, the technology and retail sector will perform strongly, however in a downturn these sectors may be the hardest hit. On the other hand, consumer staples and utilities will remain the least volatile in poor economic situations as they prove to be necessities with more stable earnings and higher payout ratios.
Of course, much like a diet, depending on your age you will have to adapt the way you eat as well as the way you allocate your investments. At a younger age, time is on your side and risk is less of an issue. It is often recommended to have a larger portion of equity exposure with a healthy weighing of international stocks to take advantage of higher long term expected returns. As you age you will likely throw a little more fixed income securities on your plate to lower the return variations and increase the consistency of income.
Formulating the proper asset allocation for a portfolio can be impacted by many varying factors other than the age of an investor and is specific to each individual. From risk tolerance to the expected use of the funds, many variables must be considered. To find the proper balance for your portfolio it is always wise to sit down with a qualified financial planner to tailor an investment strategy that is specific to your needs.