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GlobeCampus.ca: a NASA handout of NGC 6240, which contains two merging black holes. Work at CERN's Large Hadron Collider could provide glimpses into the beginning of this universe. (HO)
GlobeCampus.ca: a NASA handout of NGC 6240, which contains two merging black holes. Work at CERN's Large Hadron Collider could provide glimpses into the beginning of this universe. (HO)

Financial Planning

Is there a black hole in your investment portfolio? Add to ...

If your investments carry interest rate risk and will return very little in the next year, that's like having a black hole of lost opportunity in your portfolio.

Taking a look at where we are at in the investment cycle, now's a good time to switch up your "safe" investments.

I am a big believer in human nature and history when it comes to investing. Human nature ensures that we constantly shift on a pendulum from fear to greed and back. History supports this pendulum theory, and the world market continues to grow.

As a result, the general market trend is always up (over time), and after a period of market weakness, it rarely takes more than three years to overtake the previous peak. For those who disagree, I say "look it up." I base this on the post-war period that covers the past 65 years.

As a result, I recoil a little when people say, "This time it's different." Unless human nature has changed, then this time isn't different.

Having said that, there is the pendulum to think about. When fear is at its highest point, it is time to boost your stock weighting, and when greed is at its highest, it is time to shift some weighting back to safety. Sounds easy, but it's actually very difficult to do.

I would suggest that we are now at a stage where much of the fear has subsided. The greed part has not yet emerged in a major way, but we are starting to see "green shoots" of greed. I believe we are getting close to an equilibrium. If that is true, we have a period of time where greed will build, but that is usually a good time for stock markets.

There is a portion of the market that many people consider to be the safety zone: long-term GICs, short-term bonds, and government bonds. Right now, returns are very low for such investments, and outside of short-term bonds, you face some interest rate risks and opportunity costs. This is what I think of as the black hole.

The question is what do you do if you believe that the "safe" portion of your portfolio is not ideal? My suggestion is that you take a little more risk than normal, but temper it by adding to high-interest cash accounts or high-interest cash savings funds.

As an example, if you believe you should normally hold 30 per cent of your portfolio in "safer" bonds, you might take 10 per cent of this money and hold it in cash (high-interest savings, high-interest funds), and invest 20 per cent in convertible debentures and utility stocks. The rationale is that you don't simply want to shift your safe bonds to stocks because that will meaningfully increase the risk of your portfolio. I do believe that now is the right time to have more growth than average in a portfolio, but it is a matter of 10-per-cent or 15-per-cent shifts, not 30 per cent. Today, it just doesn't make sense to leave 30 per cent in underperforming short-term bonds and government bonds that still face likely downside pressure from interest rate hikes.

There are conservative companies with good dividend yields that pay out higher than any safe short-term to mid-term bond counterparts. BCE, Fortis and Enbridge are good examples.

Convertible debentures are another good way to add a notch of risk from traditional bonds. They are essentially a bond, usually with a higher than average coupon rate. Today that might be 6 per cent. They also usually have a term to maturity of no more than seven years, but often no more than five.

The other possible benefit of a convertible debenture is that if the underlying stock moves up past a particular price, you have the ability to convert the bond to the stock. This is the "icing on the cake." You don't buy a convertible debenture for this purpose, but if you are able to convert, it means that you have probably made good capital appreciation on the investment in addition to the coupon payments. A decent example might be TransForce 6%, November 30, 2015. TransForce is a mid-sized trucking firm with good cash flow. It comes due in less than five years and pays a 6-per-cent coupon. It costs a little more than when it came out, but should provide a yield to maturity of about 5.5 per cent.

When it comes to your investments, there are periods of the cycle in which it is time to think a little differently and make some changes. Now is one of those times.

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