Excerpts from the Book – Preserving Wealth – written by Jack Lumsden, MBA, CFP®
How do you Develop a Diversified Portfolio?
“So how do you actually develop a diversified portfolio?” asked Sally. “I understand the basics between bonds and equities, and clearly I haven’t been doing as much research and reading as Alice. How do we put it all together?”
“From my experience,” Uncle Wayne continued, “there are six key factors to developing a globally diversified portfolio, and they are:
- strategic asset allocation tactical asset allocation
- specific Investments and/or money managers
- risk management
“Whole books have been written about this subject; however, I will attempt to simplify this. Strategic asset allocation is basically what we have reviewed, and it’s your long-term allocation between bonds and equities. This also includes how much you would invest in Canada, the US, and internationally for both bonds and stocks.”
Alice commented. “Is one of the reasons that we should invest outside of Canada because different country’s economies and companies do well at different times, so by investing outside of Canada, we can reduce our risk?”
“Yup, that’s it,” Uncle Wayne said with a smile.
“So then tactical asset allocation,” Sally added,” would be shorter term allocation changes based on market conditions?”
“Correct,” continued Uncle Wayne. “It could be a decision to increase your allocation slightly to Canadian equities or increase an allocation to international bonds.”
“I’ve been doing some reading,” I mentioned. “So for the actual investments, we could pick the stocks or bonds ourselves or use mutual funds, exchange-traded funds (ETFs), index funds, and/or use a managed money approach using a professional portfolio manager. I’ve been wondering, though. What are ETFs and index funds exactly?”
“Well,” Uncle Wayne continued, “ETFs are similar to mutual funds in that they can be a basket of securities, such as stocks and bonds; however, they’re traded directly on a stock exchange , which means they’re bought and sold like stock. Many track the performance of a specific stock market index and/or asset class. These are often referred to as index funds. For example, at the most basic level, you can buy an ETF or index fund that follows the performance of the Toronto Stock Exchange (TSX), so you would get exposure to all the companies in the TSX. Today, some ETFs are wrapped in a mutual fund as well. It can get very confusing, and as a result it can be difficult and/or time consuming to select and monitor your own investments over time, but we’ll talk about that in a minute.
“Let’s finish the last three factors first. I had mentioned risk management, and these are techniques that professional money managers use to reduce the risk of a portfolio. An example would be to use a currency hedge to protect returns. When you invest outside of Canada, your investment is valued normally in the home country’s currency. To protect your investment from dramatic swings in the currency of another country versus the Canadian dollar, professional money managers can use a hedging strategy.”
“Is this used because our portfolio is valued in Canadian Dollars, and investments outside of Canada are converted back to Canadian Dollars?” asked Mark.
“Bingo!” Uncle Wayne continued. “After risk management, another factor is fees. These would be the fees you would pay your financial advisor for their advice, and the fees for the investments themselves. Like all things in life, you must get value for the fees you pay. You could invest yourself and save on the fees, or you could hire a professional. It really depends on what you’re looking for and your own money management expertise.
“The last key factor is taxation. You’ll want your investments to be held in a tax effective manner, and you also want to organize your investments in a way to reduce the amount of taxes you have to pay”
“This is a lot of stuff to know,” said Mark. “I’m glad we have you to help us!”
“While I can provide a good general overview, you either must hire an advisor yourself, or really do a lot of reading and research. Jack asked about what type of investments to select. I recommend the use of a globally diversified portfolio, and I’d suggest using a professional money manager using a portfolio approach. The specific investments could be individual stocks and bonds, mutual funds, ETFs, index funds, or a combination of them all.”
For more information you can refer to Chapter 3: Protecting and Preserving your Wealth from the book Preserving Wealth: The Next Generation – The definitive guide to protecting, investing, and transferring wealth by Jack Lumsden, MBA, CFP®
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This material is provided for general information and is subject to change without notice. Every effort has been made to compile this material from reliable sources however no warranty can be made as to its accuracy or completeness. Before acting on any of the above, please make sure to see me for individual financial advice based on your personal circumstances. The information provided is for illustrative purposes only. Commissions, trailing commissions, management fees and expenses, may all be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated. Please read the Fund Facts and consult your Assante Advisor before investing.