The media and the financial services’ marketing teams have done a good job preaching the virtues of "diversification" or, not putting all your eggs into one basket. By holding investments across different asset classes, different countries and different investment styles you can reduce the volatility in your portfolio (volatility is just another word for "risk").
But far too often I will see people’s portfolios with large concentrations in the Canadian stock market. Now, this is a tricky subject to broach because as you know the Canadian stock market has been one of the best performing stock markets for the last 5 years globally.
However, if you do believe in diversification then you would have a tendency to spread your money around a little bit more. One fact that gets tossed around often is that the Canadian stock market represents approximately 3% of the world’s total equity. So for people who ONLY invest in Canada, but then tell me they have diversified across all 10 subsectors of the TSX I have to wonder if they have missed the point… While they are investing across the different major industry categories, they are still limiting their investment universe to 3% of the total spectrum!
Investing in the Canadian index is not that great when you consider that the top 3 subsectors (Financials, Materials and Energy) represent 75% of the TSX! Our stock market is not a very well diversified one to say the least. Healthcare stocks make up around 1% of the TSX so if you want any meaningful exposure to healthcare you would have to go south or overseas to Europe.
It has been proven time and time again, that if you expose yourself a little more to foreign equities (even though they may be more volatile), they tend to have different up/down cycles than Canadian equities. Adding these riskier asset classes to your portfolio in moderation can actually serve to DECREASE your overall portfolio volatility while increasing returns.
Given that the Canadian stock market has had double digit positive returns for the last 4 calendar years and perhaps heading to a 5th, you know that when we have a strong over-performance above the long term average, eventually something has got to give! Currently, many institutional asset allocation services do not hold more than 30% of their portfolios in Canadian equities. Food for thought…
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Interesting. Thinking about this I may want to change my contribution instructions to my company RRSP/DPSP plan. They have an awesome plan where they match 6% of your income, but their investment options are patheticly limited. We actually only have 5 funds to choose from, A money market, a fixed income, a balanced, a Canadian equity, and a global equity.
So far I figured since I’m making 100% on my money I have everything going 60/40 in to the Canadian and Global Equity. The global equity asset mix chart simply shows the countries that they invest in, the largest is the USA which is 44% of the funds makeup. That puts 60% of my assets in Canada and 44% of 40% in the USA, or 17.6%.
Perhaps I should instead use a 75/25 mix in the global equity at 75%. That would put 25% of my funds in Canada, 33% in the USA and the rest around the world in small portions.
I originally opened the plan to buy a house since both the company match and my contribution are instantly vested and available for use, I figured if I can make the cash of the company match the house will get to me that much faster. Now that I am in a house I’ve been looking at it more like a retirement fund and not a house fund. Since I’m only 27 I figure the equity funds were the only way to go out of our HUGE 5 fund choice.
Do you think this is a prudent move to change my contribution instructions to better spread over the world (Both funds are listed having the same fees as far as I can tell)?
I would agree that investing in a broader Canadian index (i.e., ETFs such as XIC or XIU) does emphasize the sectors you mention (financial, materials, energy). Diversifying in emerging markets can be appropriate for some portfolios, particularly where there is a long term investment horizon.
However, many emerging markets share the same cyclical natural resource industries as Canada, and some analysts have observed that emerging and Canadian market indices have tracking characteristics when there are global impacts to that sector. In view of that, it’s important to be aware of the risks and the nature of foreign exposure in a fund (mutual fund or exchange traded fund). Emerging market ETFs such as EEM or EFA are good starts (other emerging market ETFs such as Vanguard’s have an even lower MER). If the reader doesn’t have an online brokerage account to purchase ETFs, then research into mutual funds’ (easily done using Globefund.com) holdings, MER, and fund managers, and/or discussing the merits of funds with an adviser is recommended.
Traciatim: You may actually want to increase your fixed income exposure if you are planning on using the money for a short term goal. I may be a bit of an extremist but when people approach me for investment portfolios with a time horizon of less than 5 years GICs and 5 year bonds look pretty good! The reason for this I hope is obvious in that equities are much more volatile over the short run and it is quite possible that you will have less money after 5 years than your original investment – ESPECIALLY with the 75%/25% split you mention.
If your company’s Group RRSP has someone you can talk to, perhaps you can give them a ring for some advice – and make sure to mention that your money will be withdrawn in the near term for a house down payment.
Certainly there is a trade-off to be made here. But I would strongly urge you to consider increasing the fixed income portion of your portfolio and to even use the money market fund.
I realize you are probably thinking that a money market fund is the lowest yielding option you have, but even your bond fund can have negative returns. So the question you have to ask yourself is whether you want a guaranteed slight increase in your possible down payment versus a 50/50 chance of a substantially higher or substantially lower down payment with all possible combinations in between.
I have an option for you nonetheless. Many people who have immediately vesting employer contributions will transfer their Group RRSP to an RRSP at a financial institution and advisor with a broader product selection. They make annual transfers so they can keep collecting their employer-matching but open up their investment options substantially. If you look into this, you will find that you can find a advisor you can talk to for more specific planning and investment advice.
Hope this helps. Please feel free to email me, or post here, before making any final decisions if you have any questions or if you want another second opinion.
Preet
Hi Leslie! Thanks for your additional insight. Yes, it is worth noting that certain markets and economies ride in similar waves. If we extrapolate the analysis of systematic versus non-systematic risk within a market out to the global landscape then the addition of foreign market exposure would serve to reduce the non-systematic risk of a global portfolio, but you would still have the gyrations associated with systematic risk.
For those who are interested, here is the link to the article I wrote on Systematic Risk vs. Non-Systematic risk – it is an important one.
Hey Preet,
Thanks for the advice, but I think you misunderstood my post. I originally opened the account to buy a house a couple years back. I recently (in March) drained it and did in fact buy a house. I never bothered to stop my payments because I can’t stand the thought of losing out one the free money, and I’m looking at a 42 year timeline (assuming 65 retirement). Before buying the house I was in a less aggressive stance, probably too aggressive, but it worked out for the best anyway.
My apologies, it’s been a hectic day at work and I totally missed that part in your original post! :P
Well, in that case, good for you on not stopping your payments – why turn down the free money? I would still recommend finding an advisor that you can work with on a personalized level and transfer your Group RRSP over every year to his/her management if you want to increase your product choice.
Which reminds me, I have to post on the different types of products available to different types of advisors – thanks for the reminder through your comment! :)
One thing you need to look into is if there are any "transfer-out" fees from your Group RRSP and if they are worth paying every year. Transfer out fees range from $50 + GST to $125 + GST – but they are normally $125 of course. Sometimes there are none with Group RRSP’s though.
Now is a great time to have a financial plan drawn up – find a good advisor and have one drawn up. If you look on the search function on this website – you can enter in "financial plan" and find the post that has a link to download a sample financial plan – you can use that as a reference as to what you should be looking for.
Also, ask to see any sample work they may have.
Cheers,
Preet