No one outsmarts the financial markets.
So stick to the basic rules of portfolio building and fight the urge to make fine adjustments. Overweighting this, underweighting that and fiddling with your holdings in stocks and bonds to suit your expectations of what’s to come are just guesswork for most investors.
The Japan catastrophe proves this. All the talk about the dangers of government bonds, the wonders of commodities, the bright outlook for the Canadian dollar and the tenacity of the two-year stock market rally went out the window - at least temporarily - this week.
Let’s review some portfolio-building ideas that will allow your portfolio to prosper in good times and limit the damage in down markets.
First, it’s the correct mix of investments for you personally that rules how much exposure you have to stocks and bonds, not your market outlook for the year or your response to events like the disaster in Japan.
Review your mix once or twice a year. If your stock or bond holdings are below your target – 50:50 for example – then sell some of what’s been rising and buy more of what has fallen. The process is called rebalancing and it’s the best way to avoid reacting to emotions that tell you to avoid stocks when they’re down and jump in when they’re up. In fact, that’s the opposite of what you should do.
“People who were focused on their asset mix and their long-term plan would have been adding to their stock position last summer, when markets were correcting,” said Murray Leith, vice-president and director of investment research at Odlum Brown in Vancouver. “And, if anything, they should have treated the recent market rally as an opportunity to rebalance out of stocks and into cash or fixed income.”
But, wait, aren’t bonds vulnerable to the rise in interest rates we’ve long been expecting? True, but you still need bonds, notably government bonds, as portfolio insurance. In times of high stress for the stock markets, money flows into the safety of government bonds. We saw that in 2008-09, and we’ve seen that as stocks tanked on the news out of Japan.
If you’re worried about your bonds or bond funds falling in price as interest rates rise, play it conservative by holding only bonds that mature in five years or less. On the chance that global economic growth disappoints, maybe because of Japan’s troubles, Mr. Leith suggests you keep some longer-term bonds around as well.
For the portion of your investments made up of stocks, put strict limits on your exposure to any one company or sector. While it’s tempting to let your winners ride, you can be vulnerable to the kind of sharp, sudden setbacks that uranium stocks experienced on Monday as investors began to appreciate the risk of nuclear power-plant meltdowns in Japan. Shares of Cameco Corp., the world’s largest publicly owned uranium company, fell almost 13 per cent that day alone.
“Obviously, if you had 25 per cent of your holdings in uranium stocks on Monday, you were in worse shape than someone who had 3 per cent in uranium stocks,” said David Baskin, president of Baskin Financial Services. “Our rule of thumb is not to have more than 5 per cent in any one name, and no more than 15 per cent in one sector.”
If you’ve taken a look lately at the sector weightings of the S&P/TSX composite index, you’ll find that energy and materials (mostly mining) add up to about 50 per cent of the total and financial stocks add another 29 per cent. Exchange-traded funds that track the Canadian market will be similarly dominated by these sectors, and many mutual funds will be as well.
