David F. Andrews B Comm CFP CLU TEP |
"The only investors who shouldn't diversify are those who are right 100% of the time." - Sir John Templeton.
One of the first steps that people take when they enter a new investment relationship with an advisor is to complete a risk profile. When speaking of risk in the sense of an investment portfolio we tend to think in terms of market volatility as opposed to an absolute loss of your capital.
Risk is mitigated through DIVERSIFICATION of Asset Class. Debt instruments, Equity Investments with Geographical, industry, Investment style and market capitalization features. Different investments do better in different market conditions. Is there some way we can tell?
Measuring Market Performance
Market Indices (Index) are often described as the measure of the performance of a group of similar investments, without any expense structure attached. As such, investment managers are often measured against the index and beating the index becomes a measure of manager value added. No system is perfect and every investor needs to be aware of issues. Indices are not always the best measure of prudent investing. Recall the Canadian experience when one stock became approximately 35% of the index and it was subsequently shown to have little value.
Maximum Efficiency Frontier
Despite this concern, indices are still the best general measure of market performance and much analysis has been done in terms of average rates of return and risk (volatility). By analyzing various combinations of asset classes, a series of "portfolio" combinations have emerged that represent the best rate of return for the risk assumed. When plotted on a graph, we call this the Maximum efficiency frontier and it forms the basis on which recommendations are made when you complete a risk profile. In a recent comment from Manulife Investments, research shows that 90% of your potential returns are based on asset mix (stocks-bonds-money market) while market timing constitutes 1.8% and stock selection 4.6%. By having money invested in a variety of assets which respond differently to market conditions -you stand a better chance of maximizing growth and minimizing the impact of market ups and downs.
The greatest influence of risk, is the allocation of fixed income versus equity, but few risk profiles if any can take into account your emotional reaction to declining markets. As a result, some people have to adjust their approach to risk management and your best approach to this is to continue to work with your advisor, adjusting for FUTURE market conditions, not necessarily immediate changes for today's market.
Your Portfolio Design
Now that we have a decision on how much fixed income versus equity we wish to hold, the design process comes into play. What are the choices. Starting with do-it-yourself, we can work our way up through several levels of sophistication to the point where we receive an institutional like investment approach. If you have read the High Net Worth Paradox, you will see that this is the solution most desired by people with larger sums of money.
Typically this intuitional (or pension style) approach is heavily weighted towards risk adjusted returns. You can always find someone who can do better ...today.... But investing is like baseball. Would you rather have a player who can hit a home run sometimes, or one who gets to 2nd or 3rd base every time at bat...Steady progress is better.
David Andrews, Investment Representative
Jed Ziegler, Investment Representative
