The stock market was unexpectedly excellent in 2016. Enjoy the buzz and then get to work preparing for the year ahead. Here are seven do's and don'ts to consider for your portfolio.
1. Do hold onto your January account statement.
New rules requiring the investment industry to up the ante in reporting fees and returns to clients took effect last summer, but most people won't see the impact until account statements for 2016 are received. If you habitually skip reading your statements or scan them haphazardly, pay closer attention.
Expect to see personal total-percentage returns for the past year and for longer time frames going back to when the account was started. We have seen the last of those junk statements that simply compared your latest portfolio value to three months earlier. On fees, you'll see commissions and fees paid to your adviser expressed in dollar terms, a dramatic shift from the current use of percentages. You may know you're paying your adviser a fee of 1.5 per cent – now you'll know the actual amount. Use this fee and return information to assess your relationship with your adviser. I'll have some suggestions on how to do that early in the new year.
2. Don't have a tantrum if your 2016 results lag the S&P/TSX composite index.
A lot of money managers couldn't keep up with the surging Canadian stock market this year. The market was powered by energy and mining stocks, a marked departure from the more conservative dividend blue chips that led in previous years. Missing this pivot cost you returns in 2016.
Do not be the kind of short-sighted investor that goes looking for blood after one year lagging the index. A three-year slice of time is better for judging returns, and five years is better still. Something I can tell you from personal experience is that the most consistently succesful money managers often fall short in a hard-charging bull market. But when you tally up their long-term results, they compare very well.
3. Do rebalance, even if you think bonds are toast and stocks are golden.
Rebalancing means selling some of your best-performing holdings and buying more of your losers. Practically speaking, you will probably find yourself selling Canadians stocks to buy bonds. This will be painful.
Many bond funds eked out small gains for the year through mid-December, but results over the past few months have frequently been dismal. The U.S. Federal Reserve just pushed its benchmark rate higher, and this raises the possibility that the United States is moving into a period of stronger growth, resurgent inflation and higher rates. If this happens, there will be a trickle-down effect in Canada in the form of downward pressure on the price of bonds and bond funds.
Your aim should be to get your bond exposure back more or less to the target weighting you set when putting your portfolio together. Bonds will cushion your portfolio if the economy stalls and if stocks crash. Ditch bonds only if you're sure neither of those things will happen.
4. Don't start remaking your portfolio based on what Donald Trump might do as U.S. president.
Guessing the stock market sectors that would benefit under a Trump administration has become something of a pastime for stock pundits. But it's a pointless exercise because there's so much we don't know about both his policies and his ability to implement them.
Consider an exchange-traded fund covering the broad U.S. market instead. Unlike the S&P/TSX composite index, the big U.S. indexes are well diversified and offer meaningful exposure to virtually all sectors. At the same time, you're not over exposed to any one sector. Here in Canada, the S&P/TSX composite index is roughly two-thirds weighted to financials, energy and materials.
5. Do be aware that your conservative dividend stocks are going to continue to lag if the stock market keeps its momentum.
As already noted, the current stock-market rally is a being led by growth-oriented stocks, notably those in the resource sector. The conservative blue chips that powered the market for a good stretch after the last stock-market crash have finally been superseded. Don't stop owning them, but do consider adding some more aggressive stock-market exposure. What to buy? With its one-third weighting in resource stocks, a broad Canadian stock-market ETF will do fine.
Another investment category set to underperform is the relatively new but highly popular low-volatility ETF. By holding stocks that don't move up and down in price as much as big stock-market indexes, these funds have generated excellent returns for a few years now. They're also a classic example of an investment likely to lag in the kind of market conditions we're seeing now. Again, the answer is to diversify your low-volatility ETFs with more aggressive stocks or funds.
6. Don't keep hanging onto large cash allocations.
Five per cent sounds like a reasonable cash weighting for the average portfolio. Seniors managing their registered retirement-income fund accounts should have enough cash to cover at least one year's mandatory withdrawal and probably two. Beyond that, cash is portfolio dead weight.
If you are earning 1 per cent on your cash holdings, you're doing well by current market standards. But inflation, even at today's subdued levels, is running at 1.5 per cent or so. Cash is actually costing you.
Trust me, the moment to get your cash into the market will pass without you noticing. In fact, the time to deploy cash was last January, when the stock market was tanking. If you didn't pounce then, why would you recognize the next opportunity?
A way to put your cash to work and contain the stress of being caught in a sudden market pullback is to divide your cash into four chunks and invest them one at a time on a quarterly basis starting first thing in 2017.
7. Do be realistic about investment returns.
There's something close to a consensus among investing strategists that we are looking at subdued returns in the years ahead. An aging population and slower economic growth are the reasons.
This outlook does not square with recent returns, but the rationale for low returns remains sound. Based on a survey of strategists a while back, I suggest you figure on annualized 5 per cent returns after fees for a balanced portfolio.