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By Sharon Adams
Vancouver Sun
RRSP Extra
Thursday, February 15, 2007
"Divide your fortune into four equal parts: stocks, real estate, bonds and gold coins. Be prepared to lose on one of them most of the time. During inflation, you will lose on bonds and win on gold and real estate. During deflation, you lose on real estate and win on bonds . . . Stocks will see you through both periods, though in a mixed fashion. Whenever performance differences cause a major imbalance, rebalance your fortunes back to the four equal parts."
—Jacob Fugger the Rich, 1459-1525
Bob Affleck knows why it's important to diversify your registered retirement savings plan.
"I went through the tech crash," in the early years of this decade, he said, "and because I wasn't diversified, I lost a lot of money."
Adrian Mastracci, fee-only portfolio manager at
KCM Wealth Management in Vancouver, says,
"Although the tools available to investors have changed over time, the fundamentals of growing wealth have not changed for hundreds of years."
A human resource manager with Spectra Energy in Prince George, Affleck has now adjusted his RRSP portfolio to spread the risk.
It's common sense to diversify your investments to better weather economic storms.
When one sector of the economy falters, investments in another sector will compensate.
But many investors, like Affleck, would be surprised to learn that although they have several different mutual funds, they are not diversified.
"People might have 10 funds in RSPs and think they're diversified, but when they look at the funds they are all highly correlated," says Bob Thompson, senior investment adviser.
That was Affleck's downfall.
"I had diversified into different sectors of the technology industry -- in hardware, software and storage," instead of diversifying into completely different sectors.
So in the dot-com meltdown his whole portfolio lost value.
"Emotions drive people's investment decisions," says Thompson. Instead of taking the long view and planning for gain over time, investors like to put their money into what's hot at the moment or has done well in the past couple of years.
Instead, they should look at their investments as a portfolio that needs adjusting both in response to economic changes and to the stages of the investor's life.
Although the tools available to investors have changed over time, says Adrian Mastracci, a private client portfolio manager at KCM Wealth Management Inc. in Vancouver, the fundamentals of growing wealth have not changed for hundreds of years.
About 500 years ago Jacob Fugger the Rich advised investors to divide their portfolios among stocks, bonds, real estate and gold -- although modern-day investors might consider another commodity, like black gold (oil), says Mastracci.
Such a strategy can be adopted at any time, but it will pay off best if the planning is done when setting up the portfolio.
"If you say, for example, 'I want 10 per cent in gold, 30 per cent in foreign equities and the remainder in Canadian equities,' now you can make a proper decision when things change," says Thompson. "If gold doubles in price but the rest of the investments stay flat, you'll end up with 20 per cent in gold. The target was 10 per cent, so take the profits from gold and redeploy it to bring the portfolio back into balance."
"The key is to rebalance regularly," says Thompson. "But I've been in the business 12 years now, and in my experience, few people do it."
He advises investors "sit down early with their advisers and arrive at a figure for their target mix," including gold (or other commodities), stocks, bonds and real estate. For most people, the biggest real estate investment will be outside their investment portfolio, in the family home.
Plan to adjust the mix as time goes by.
"The life cycle approach is constructive," he says.
"Stocks stand out as beating inflation and rising taxes over time," says Thompson, "but the problem is volatility."
Splitting the portfolio between stocks and bonds moderates the risk, and the target percentages can be adjusted over time to become more conservative.
Investors in their 30s might want to put a larger percentage of their portfolios in stocks, because they have longer to recover if there's a market downturn.
But investors in their 50s likely want more stability as they near retirement, and may want more of their investment in bonds.
"You want to tweak the percentages, maybe 10 per cent per decade,'' says Thompson.
So investors in their 30s, as an example, might want to target 30 per cent of their portfolio for bonds, up it to 40 per cent in their 40s, and to 50 per cent in their 50s.
Once the targets have been set, the investor needs to stay on target.
"Once a year, make sure the target allocation is right," says Thompson. "Ask why things are in the portfolio, how they help meet the target. You'll end up rebalancing by selling what's gone up a lot, and buying into what's gone down.
"Now," he says, "you're managing a portfolio, instead of looking at what's going to be hot in the next six months."
Since deciding to diversify, Affleck's been careful to rebalance his portfolio regularly.
Investors who did this during the dot-com meltdown hedged their investments -- moving money as they made it into other investments poised to rise as tech stocks collapsed.
This type of portfolio management makes it easy for the inexperienced investor to sell high and buy low, and avoid a permanent loss of capital, says Thompson.
That's not to say investors will avoid all risk, but diversification reduces the risk.
"I have a lot of volatile assets in my own RSP," says Thompson. "But each one is volatile in a different direction. When some things zig, others zag, so the whole portfolio is stable."
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