A well balanced diet helps keep you healthy. A similar notion holds true for getting the right asset mix in your investment portfolio.
Asset mix is a fundamental principle of portfolio construction. But like leading a healthy lifestyle, it’s often easier to talk the talk than walk the walk, according to portfolio manager Darren Coleman.
Despite knowing what’s good for us, we are often attracted to “junk food” investments.
“Everybody wants to own the hot investment,” said the Toronto-based financial planner with Raymond James and author of Recalculating: Find Financial Success and Never Feel Lost Again.
That’s until that investment goes cold, and then everyone wishes they hadn’t put most of their eggs into that one basket.
Indeed spreading investment eggs around cuts to the heart of the asset mix discussion.
The big three
At its simplest, a diversified asset mix breaks down into three basic classes: cash, fixed income (bonds) and equities (stocks).
“Every combination of these three results (creates) different levels of risk and return over time,” said Winnipeg-based portfolio manager Doug Nelson, author of Master Your Retirement: How to Fulfill your Dreams.
“Basically the greater the portion of equities, the greater the return you could earn, but also the greater the risk that you may have to endure to achieve this higher return.”
At the other end of the spectrum is cash. You won’t lose money, but you will lose buying power over time to inflation. Bonds offer the middle ground: modest returns on investment while protecting your capital, for the most part.
Ideally, all three should be mixed together to complement one another to best suit your needs. For example, bonds typically do well when stocks don’t.
Owning both assets in tandem helps reduce the ups and downs in your portfolio (volatility), which can spur you to sell in a fit of panic during a market meltdown, Coleman added.
At the same time, cash is handy if you need money in the near-term for the unexpected – like losing your job – because you’d rather not sell those other assets, especially if they’re down in value.
More diversity is best
But asset mix involves more than the aforementioned basics.
Within the equity portion of the portfolio, for example, investors should hold different stocks across several industrial sectors and geographies like Canada, the U.S. and emerging markets like China.
Even within those sectors, it’s important to own many different stocks to avoid risks specific to any one company.
Outside help
All this can be a tall order for investors to do on their own, Coleman said. That’s where professional advisors can help, providing know-how backed by advanced software to build a well-diversified portfolio to suit your needs.
Do-it-yourself investors can build their own diversified portfolio, however, with exchange traded funds or mutual funds.
The services of robo advisors also offer automated professional portfolio construction and management at low cost.
“Regardless of what you choose, find a good, one-stop shop … to build a diversified portfolio,” Coleman said.
You can then cross “asset mix” off your list of concerns – and just worry about finding the money to put in your portfolio.
