Remember this one key principle of investing
When you’re relaxing at the beach or cottage, or doing the grand tour somewhere, you don’t want to spend much time fretting about your investments. If you’re continually worried that stock markets are on the verge of a major correction, you’re doing something wrong. Here’s how to stop fretting and start relaxing.
Markets will fluctuate…
Markets fluctuate and regularly experience periods of volatility. Except recently they haven’t. Over the past few months, stock markets have in fact touched record highs. And that’s got a lot of market watchers predicting imminent catastrophe. They point out that stock markets have risen since May 2012 without a major correction – that’s a broad market slide of at least 10%.
They also point out that volatility has been low – the markets just haven’t been swinging up and down as much or as frequently as they have in the past. And this has happened despite all sorts of troubles around the world, including the assorted crises in the Middle East and the Ukraine, slower growth in China, as well as lukewarm economic recovery in the eurozone. All this, they say, adds up to the potential for a fall. They just don’t know when.
…We just don’t know when
This sounds a lot like the “even a stopped clock is right twice a day” argument. Eventually the doomsayers will be right. Eventually, the markets will pull back. They always do! And we never know when they will. This essential truth is at the heart of my money management philosophy at Castlemark Wealth Management. Once you understand that, and accept it, everything else falls into place.
The key is to ensure that your investment portfolio aligns with your tolerance for risk. Even after years in this business, I’m still amazed at the number of new clients who come to me with a wildly inflated sense of their tolerance for risk.
How much can you stand to lose?
They’ll often ask me, “Why not a portfolio allocated 100% to stocks? Markets are on a high. I can live with the risk.” But can you really? A high net worth portfolio of, say $500,000, invested in a broad equity index ETF would plunge by $60,000 dollars if the market sustains a 12% correction. Your portfolio would have to climb 13.6% just to get back to breakeven. Could you live with that?
Instead of committing your portfolio to assets based on what you’ve heard or read in the news on any given day, it’s far more prudent to accept the reality of financial markets (they fluctuate unpredictably) and allocate assets in a way that aligns with your real tolerance for risk.
So, for example, with a moderate risk tolerance, your portfolio would likely be weighted 60% equity and 40% fixed income. The equity component is designed to generate growth (and perhaps some dividend income); the fixed income component is designed for safety and a regular income stream.
A moderate-risk approach
If you are looking to make your portfolio more defensive against the possibility of a stock market correction, you can deploy two strategies. First, in the fixed-income component, look to a strategy using fixed-income funds that have a common goal of generating steady income while maintaining safety of principal.
This can be achieved by investing in Canadian bond funds (I would recommend only short-term funds, given the current state of the market), high yield bond funds (investment grade only), Canadian mortgage bond funds, or Canadian income trust funds.
To bolster income though the equity component of your portfolio, look to Canadian dividend equity income funds and real estate investment trust funds, which are also inherently defensive equity assets. I’d focus on low-MER passive, exchange-traded funds to keep overall costs down.
Keep calm, and stay educated
Remember, this is only a broad-brush example I’ve used to illustrate a principle. Investing takes knowledge and patience. Be calm, stay educated, and make decisions only when you have weighed the pros and cons and are ready to be accountable for the outcome. If you are not sure you are holding the right asset mix, consult a qualified advisor. And then enjoy your vacation.
© 2014 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited.