Diversification and Your Investment Portfolio

Jennifer Kirby, BA(Hon),CFP,RHU,CLU Kirby Financial Group Inc.  Jennifer is a Certified Financial Planner and is the principal of Kirby Financial Group in Calgary. 

The expression "don't put all your eggs in one basket" applies to many things in life, especially when it comes to investing. Diversification is one of the most important principles to keep in mind when constructing an investment portfolio.

Diversification allows you to take advantage of many different types of investments that may perform differently from year to year. Franklin Templeton Investments has a great diversification presentation that shows that no single asset class has been a top performer for more than a few consecutive years.  Statistically, the odds of one asset class performing consistently better than another year over year is unlikely. Check out http://www.franklintempleton.ca/ and click on "why diversify".

For example, in 2002 Canadian Bonds performed the best out of any asset class for an overall return of 8.7% (as measured by the Scotia Capital Universe Bond Total Return Index). Investors were thrilled with the bonds in their portfolio because other asset classes had performed so poorly. However, one year later, in 2003, Canadian bonds were the 2^nd worst performing asset class at 6.7%.  People who owned bonds that year likely dumped them for Canadian stocks since they performed the best in 2003.

Since it is impossible to predict which asset class will perform the best in any given year, diversification can give investors the opportunity to take part in the "hot" sectors of the economy while protecting their portfolio when the market declines. A diversified portfolio should contain different asset classes, investment styles, mixture of stocks and assets from different geographic regions. 

Asset classes

The first type of asset class includes cash and guaranteed investments – the class that provides investors the certainty that their money will be there when they need it. This would include savings accounts, GICs, and fixed income funds such as money market funds.

The next type of asset class is equities or stocks.  Although the value of stocks can fluctuate over time, historically, investors will achieve a higher rate of return if they are in equities vs. fixed income or guaranteed investments. 

The most speculative asset classes are real estate, commodities, gold, collectibles and gems. These asset classes can produce the highest return, however, they also have the most risk because of the unpredictability of the return. Investors with a high-risk tolerance and a good base of other investments are best suited for these types of investments.

Investment styles

Investment managers choose investments in a variety of different ways. Having several management styles also provides diversification. "Top down" fund managers look at the overall economy and then identify sectors that they think will outperform. "Bottom up" managers focus on individual company fundamentals and focus less on how the economy is doing as a whole. 

Investment styles can also be classified as value and growth. A growth manager will look for companies with an expectation of strong continued growth. A value manager would look for companies with a low stock price relative to its market value. 

Stock Mix

Once the asset classes have been selected, investors should select individual stocks to make up their portfolio.  An investor may be interested in Company A vs. Company B because they think that Company A has the ability to grow their company and increase profits over time. 

Geographic regions

Geography is also important when diversifying an investor's portfolio. Many Canadians are primarily invested in Canada; but since the Canadian market represents about 3% of the world financial markets, investors may be missing out on great opportunities in other regions. A good portfolio mix may include Canadian, US, and international companies. 

With so many investment options and products on the market today, investors are often overwhelmed and left wondering if they are in a portfolio that is right for them. A good financial advisor can help determine your risk tolerance and the most appropriate investment mix given your financial goals. 

Check out http://www.franklintemplton.ca and click on "why diversify".