Feb 2, 2018
Personal Investor: Minimize risk and maximize opportunity through diversification
By Dale Jackson
To make the case for diversification you must understand risk. That’s not an easy sell for investors wanting to knock every investment out of the park. The fact is, circumstances beyond our control can turn the brightest idea into dark regret.
That’s why it’s important for long-term investors to minimize that risk while opening their portfolios up to as many opportunities as possible by diversifying.
The advantages of diversification have been proven through several studies since the Second World War. Portfolio samples have been sliced and diced over different periods of time and asset classes, but in the end, the process is subjective. It basically comes down to which investments have the lowest correlation, how much to hold, and how often to rebalance when some go up and some go down.
Investment advisors often point to the "Brinson, Hood, .Beebower” study done with pension funds in the 1970s and 1980s. It concluded that over 90 per cent of the variance in investment returns is explained by asset allocation decisions. In other words: on a risk-return basis, the whole of a portfolio is much more effective than the sum of its parts.
Here are some ways to diversify a portfolio:
Asset classes: the basic asset classes are equities, bonds, cash and real estate (that includes your home if you own it).
Economic regions: Canada, U.S., Europe, Far East and emerging markets.
Currencies: if you’re a Snowbird with plans to winter in the United States, it’s good to have a supply of U.S. dollars regardless of how they are valued against the loonie.
Time to maturity: Fixed income rates are low but they are reliable. You can get the most out of bonds by staggering maturities.
Type of investments: In addition to stocks, mutual funds and exchange traded funds can be diversified themselves.
Management style: Some active funds will employ a growth strategy seeking out the best returns. Some will have a value strategy focused on fundamentals such as earnings.
Sector emphasis: Investments in the resource sector can be offset against investments in the technology, retail or industrial sectors.
Market cap: Small, mid or large caps – take your pick.
