Knowing your current asset mix on an ongoing basis is important because it indicates to you your portfolio’s “risk budget” in terms of volatility. Cash and bonds have less volatility than stocks. Therefore the more cash and bonds you have, the more conservative your portfolio is and vis versa. The asset mix for you is the one designed through Steps 1-3. you do not need to be perfectly on it every quarter. However its a good idea to be close to it and monitor that you are as outlined in Step 3.
Recap on Asset Mix Terms
“Cash” is any short term debt instrument that matures in one year or less:
• GICs that are redeemable in one year or less
• Bank accounts
• Treasury Bills issued by governments
• Bankers’ Acceptance “BAs” issued by banks
• Commercial Paper "CP" issued by corporations
“Bonds” are debt instruments that mature in more than one year. Typically two to 30 years is the time horizon of a bond:
• GICs that mature in more than one year
• Government bonds
• Investment Grade bonds issued corporations that are rated between AAA and BBB
• Below Investment Grade bonds issued by corporations that are rated below BBB
“Canadian Stocks” are issued by Canadian corporations for investors to hold equity in these corporations. Small, medium and large corporations issue stock. This stock is generally traded on Canadian stock markets like the Toronto Stock Exchange TSX.
“Foreign Stocks” for Canadians are issued by corporations outside of Canada for investors to own equity in these corporations. There are regions within foreign equity that I believe are important to look at. As well, some markets are more liquid and have lower trading costs among other differences. The larger, more liquid, less expensive trading cost markets are considered “developed” and the less liquid and at times more expensive trading costs markets are called “developing”. Developing markets are often referred to as emerging or frontier markets:
• United States is a developed market
• Europe – Western European countries are developed markets and Eastern European countries are developing markets
• Asia – Australia, New Zealand, Japan and Singapore are considered developed while China, India, South Korea and other countries are considered developing
• Emerging and Frontier markets include the developing markets listed above as well as South America, Russia and South Africa as emerging markets and the rest of Africa as frontier markets.
“Hedge Funds” are pools where you buy units in that pool and the manager invests in a variety of strategies. There are many different kinds of hedge fund strategies which I will address in another blog. What they all have in common for purposes here:
• They will use leverage, options and other derivatives
• They will charge a management fee as well as a performance fee
• You are typically locked in for at least one year and it usually takes 30-180 days to redeem if and when you’d like to.
Hedge Funds should be classified as a risky asset like stocks even if they invest in bonds. More on that later in the blog to come.
“Private Equity” is where you own stock in a company however that company is private and does not trade on any stock exchange. Typically investors own private equity directly with the corporation or through a private equity manager in a limited partnership “LP”.
“Real Estate” is any land or building you own that is not your primary residence. Typically I consider real estate from a risk standpoint to be half like bonds and half like stocks. Reason being there is often income like bonds and price movement like stocks.
Naming of Asset Classes
In the investment industry you can find more than one name for any asset or region. For example, I often use the term “global equity” which for me means all developed stock markets outside of Canada. Others call that “international equity”. Some people refer to global equity as all markets around the globe including Canada.
What is important is to really look at what your manager, broker, mutual funds or pools are holding. Do not use the name as the name of a fund can also be misleading by accident.
For example most “balanced” funds in Canada have bonds, Canadian stocks, US stock, European stocks and Asian stocks while some other balanced funds only invest in Canadian bonds and stocks.
Understand what you are investing in so that each investment compliments the others and does not duplicate.
Determining your Asset Mix
Copy your current portfolio from the Portfolio Position spreadsheet to the Calculating Current Asset Mix spreadsheet in column C. Like the other spreadsheets there is an example sheet and a sheet for you to fill in. Then add the dollar amounts that that investment has in each asset class (columns E, G etc) where there are yellow highlights. Column X should be 100% for each investment if you have allocated numbers that add up to the total amount of the account – which is an indication that the allocation is correct. If it does not add to 100%, you have made a mistake - check your numbers.
On line 27 you will find your portfolio’s total asset mix. Cell H30 shows you your portfolio’s allocation to conservative assets stocks and bonds and if you have real estate cell H31 shows this value plus ½ of the Real Estate allocation.
You can use this sheet to know where you are today for Step 3 section C; every time you make a change to your portfolio; and every quarter or six months to continue to monitor your asset mix.
Keeping track of your Asset Mix
It is important to monitor this through positive and negative markets so that your portfolio strategy is never caught offside. That is why doing it on a quarterly basis makes sense. If a particular area is 5-10% away from its target, discuss this with your broker/advisor/managers to determine whether it makes sense to rebalance. Remember if something has done really well, it may have become too big in your portfolio - it may be time to take a profit and trim this position.