One of the big turnoffs about investing is the way that even the simplest concepts can suddenly turn wickedly complex on you.
Example: In my last blog post, I talked about the concept of asset allocation or the blending of stocks, bonds and cash in proportions to suit a particular investor’s needs. Sounds simple, right? Unfortunately, the level of complexity jumps as soon as you try to put this into action.
What, exactly, do we mean when we say stocks? Canadian stocks? U.S. stocks? Global stocks? International stocks? Emerging market stocks? Large-capitalization stocks? Small-cap stocks?
As for bonds, there’s almost as many sub-categories – short- and long-term bonds, government bonds, investment-grade corporate bonds, high-yield corporate bonds, real-return bonds (a.k.a. inflation-protected bonds)… OK, I’ll stop now because my point is made. When building an investment portfolio, the choice of components is huge.
This is the world the investment industry has created for us out of a desire to offer new and interesting products that attract customers. You don’t have to live in this world, though. Many of the stock and bond categories mentioned here are in no way essential. Leave them to investing pros who have reams of analysis to use in judging the best opportunities in the market. For civilian investors, simplicity rules.
Here’s how we might build a simple portfolio for a 35-year-old:
|Canadian stocks||40%||Government bonds||20%|
|U.S. stocks||15%||Corporate bonds||10%|
If you’re using mutual funds or exchange-traded funds (index-tracking funds that trade on the stock market), then building on this blueprint would simply be a matter of selecting good funds in each of the categories mentioned just above. For bonds, you should be able to find a diversified bond mutual fund or ETF that mixes government and corporate bonds in a single product.
There is nothing wrong with further diversifying this portfolio with things like emerging market stocks or high-yield bonds (issued by companies that have less than ideal financial stability and thus must pay higher interest rates to investors). A weighting of 5 percentage points is a good rule of thumb when adding exposure to particular sectors or market niches, but you don’t have to. Simple portfolios require less upkeep and can work well.
Now for a quick primer to help you understand what those various portfolio options are all about:
- Global stocks: Include all countries, including Canada
- International stocks: Countries outside North America
- Emerging market stocks: From less developed economies, notably Brazil, Russia, India and China, commonly bundled together in the BRIC group.
- Large capitalization: The biggest companies as measured by their share price multiplied by total number of shares outstanding.
- Small capitalization: Small companies as measured the same way as above.
In my next blog post, we’ll look at the risk profile of all these portfolio components. Risk is one of the most common terms in investing, but what does it actually mean?