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Good advice in volatile times: ‘Keep it simple’

Overcomplexity can breed portfolio overlap, which is not good diversification

By: GUY DIXON

Date: April 14, 2015

When it comes to money, “stupid” can be a good thing.

Clarity and simplicity in investing are key, as investment hall-of-famers Warren Buffett and Peter Lynch say with their axiom, “Keep it simple, stupid.” But the broad array of investment products out there can make keeping it simple seem naive, not sufficiently diversified and therefore risky.

Don’t be swayed, advisers say. Overcomplexity can breed overlap, and that’s not good diversification. It may also not be the best bet tax-wise. Here is some advice from the pros about keeping investments solid and simple.

Bev Moir, associate director and veteran wealth and investment adviser, ScotiaMcLeod, Toronto

People equate diversification with having a lot of different funds or a lot of different stocks, Ms. Moir said. But “there’s so much correlation and overlap between all the different mutual funds.”

The trick is to whittle away investments that move up or down in unison, even if that paring down can seem counter to the premise ingrained in so many investors that diversity generally means a greater variety of holdings.

“It’s actually possible to have one very good-quality, balanced mutual fund that could give someone adequate diversification,” Ms. Moir said. “Now, it may have a thousand different things in it,” she joked, “but what I’m looking at when I’m trying to streamline and simplify is to prevent duplication and overlap.”

A simplified portfolio should cover many bases, she said, ranging from cash, domestic and global bonds, and North American and global equities to perhaps investments in infrastructure projects and real estate investment trusts.

Of course one fund isn’t going to cover all of these effectively. So “there could be a core investment and some satellites, smaller positions to provide some of the specialization. A satellite could be having a little bit of cash that is never going to fluctuate, or having some bonds or GICs.”

Jennifer Black, certified financial planner, Dedicated Financial Solutions, Mississauga, Ont.

Ms. Black’s advice is somewhat different. Instead of one main fund or two, with satellite investments, Ms. Black prefers at least two Canadian equity funds and two global funds, and they should be somewhat specialized in differing economic sectors.

She likes the use of global funds “because they have the flexibility to go anywhere in the world where they see value.” Having a heavy position in Canadian equities is fine, “just not fully Canadian.”

Of course, all good advisers emphasize that individual investors should follow their own goals. But Ms. Black likes the idea that 10 to 15 per cent of a fund’s holdings should specialize in one sector, such as health care, say, while another fund might focus more on consumer goods.

“They should be focused. When you start getting into funds that have 200 holdings, not only does the diversification get watered down, but the manager can’t possibly know that many companies,” Ms. Black said. “So, from my perspective, they’re not offering the best management that they can.”

Investors who are building simple portfolios should also keep tax efficiency in mind, Ms. Black said. They need to understand how income from their investments will be taxed.

Relying on investments that earn interest income isn’t the smartest option because they are fully taxable, she said. Instead, capital gains that are taxed at half that rate can be better, she said.

Rob Wells, senior vice-president and investment adviser, TD Wealth Private Investment Advice, White Rock, B.C.

“The longer I go in the business, the more I realize how having things simpler is better,” Mr. Wells said. “I would say there are different levels of simple. Firstly, have as few accounts as possible.”

Some are inescapable, he said. Investors should have a registered retirement savings plan (RRSP) or a retirement investment fund (RIF) and a tax-free savings account (TFSA). And if they have children, they should have a registered education savings plan (RESP), he said.

If they have money to invest beyond those, it’s best to have a joint investment account with a spouse to take advantage of taxes, he said.

When investing, forget about buying individual stocks. It would take 40 or 50 stocks to be properly diversified, and there’s no simplicity in that, Mr. Wells said.

Instead, consider mutual funds, or exchange-traded funds (ETFs), which provide broad diversification at a low cost. “But the downside is that you have the same risk as the market, and you can never outperform the market with the ETFs.”

Of course one way to simplify is to hire an adviser to do the work. But look for one who has an overarching strategy and process for investing simply, Mr. Wells says. Advisers who try to do too much can give you more work, approving and monitoring the many investment decisions.

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