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Rules for tying the (financial) knot

Wednesday, March 09, 2011

After a pretty poor decade on the investing front, with the possible exception of Natural Resources and Precious Metals, you have to wonder where we go from here. How do we take advantage of the performance shift from West to East, developed world to emerging world? How do we do it in way that doesn’t push our portfolios too far up on the risk scale?

Take a look at the following comparative tables of the best- and worst-performing fund categories as of January 31, 2011. The five-year average annual compounded return is shown:

Best-performing categories 5-Year Return %
Precious Metals Equity 14.77
Miscellaneous - Commodity 12.97
Greater China Equity 10.61
Miscellaneous - Geographic Equity 8.02
Asia Pacific ex-Japan Equity 7.36
Canadian Income Trust Equity 6.46
Natural Resources Equity 6.34
Alternative Strategies 5.94
Emerging Markets Equity 5.63
High Yield Fixed Income 4.98
Worst-performing categories 5-Yr. Return %
Japanese Equity -9.00
Financial Services Equity -5.66
Retail Venture Capital -4.46
U.S. Equity -2.76
International Equity -2.30
European Equity -1.12
Global Equity -1.11
U.S. Small or Mid Cap Equity -0.84
Health Care Equity -0.07

What’s notable here is that the top-tier categories have a heavy concentration in emerging markets. Even the resources and precious metals categories are highly influenced by red-hot growth in emerging economies. The strong performance of the Alternative Strategies category also demonstrates that although this is not as heavily influenced by growth in emerging economies, it also represents a non-traditional investment strategy that is paying off for those in the space.

Categories that represent investment in developed economies are few and far between in the top-tier list.

It will come as no surprise, then, that categories in the bottom tier represent investments that focus predominantly on developed Western economies. This still may shock some people, but it clearly shows that the performance lead of developed economies has given way to the stronger emerging markets. These emerging economies have little debt as whole, younger populations, and are growing at a rapid pace.

Core and explore option reviewed

So how does this translate into a “big picture” investment strategy?

I am in the camp that favours placing 80% to 85% of your assets in traditional investments that form the core of your portfolio. These might consist of Canadian, U.S., and International Equities along with a good percentage of fixed income to mitigate some stock market volatility risk.

This strategy also works to stop excessive principal erosion that makes it difficult to get back to where you were in the event of a market correction or bear market.

The remaining 15% to 20% should be used to “explore” areas that might give your portfolio a return boost while diversifying your portfolio to reduce overall risk.

Precious Metals, Alternative Strategies, and Real Estate are three categories that have traditionally not been closely correlated with general stock market movement. “Correlation” is simply the term used to measure the degree to which different asset classes move together.

Ideally, you want to structure your portfolio so not everything is moving up or down at the same time. This works to stabilize your portfolio by minimizing (not eliminating) large movements down during a correction and getting you back to your pre-correction state more quickly.

Emerging Markets, China, Natural Resources and Small Cap categories are all potentially more volatile owing to exposure to less developed markets and financial systems. But all can be used to boost returns by giving you exposure to areas of potentially strong future growth.

We can’t invest in the past. We must invest for the future, because retirement planning can have a 40-year time horizon (or more). Many analysts now believe that emerging markets may not be any more volatile than developed markets, because their economies have less debt, younger populations, and faster growth.

You can reduce your volatility further by investing in these potentially more volatile areas by investing on a monthly basis to “dollar cost average” your investments, taking advantage of corrections to buy on weakness.

Some financial advisors also recommend selling a portion of your “explore” position after several years of very good returns (so you don’t unintentionally give back your gain) and moving back to “core” positions.



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Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the simplified prospectus before investing. Mutual funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated.

Personal Opinions & Recommendations Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. However, please call the author to discuss your particular circumstances.