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Smart strategies to diversify a portfolio

Diversification can mitigate risk while paying off long-term. Here’s how to diversify with an eye towards retirement

By: PAUL BRENT

Date: January 19, 2016

Ask most investment professionals how to achieve long-term financial goals while minimizing risk and the answer will likely be: diversification.

With the memory of the 2008-2009 financial crisis still fresh, the merits of a well-diversified portfolio should be top of mind for financial advisors and their clients, says Michael Banham, vice-president of wealth distribution with Sun Life Financial.

“These relatively recent events have made investors more wary of investing in stocks,” says Mr. Banham.

That wariness is clearly illustrated in the findings of the 2014 Sun Life Canadian Unretirement Index – an online survey of 3400 Canadians conducted by Ipsos Reid. The survey found that nearly four out of 10 (38 per cent) Canadians are taking less risk with their portfolios following the financial crisis in 2008, with only six per cent reporting that they are taking more risk.

Fortunately, as more and more products become available to investors, “there are so many ways to diversify a portfolio today,” says Mr. Banham.

According to Mr. Banham, diversification is best achieved in several different ways. First, investors can diversify through investment type: cash (low risk), bonds (medium risk), equity funds/stocks (higher risk). They can also diversify by investment regions: Canada, U.S. or global. Then there’s diversification by industry: financial services (insurance companies, banks), health care, consumer staples (supermarkets, drug stores), technology, utilities, mining, energy (oil and gas) and many more. Lastly, diversification can be achieved by management style, such as active or passive.

A dedicated investor willing to put in the time and effort can build a diversified portfolio with all these different elements. But why not simplify the process? Mr. Banham suggests investors consider managed solutions. “Think of them as a self-contained, fully diversified portfolio within a single investment, such as a mutual fund.” An advisor can help investors choose a managed solution suiting their goals, risk tolerance and time horizon.

Mr. Banham is also a big believer in dollar cost averaging (DCA) as “one of the simplest ways to accumulate savings over time. This method forces disciplined investing and doesn’t try to time the market.” Rather than purchasing the same number of units or shares every given period, DCA involves buying the same dollar amount of investments at regular intervals. When the unit/share price is up, their dollar buys fewer units or shares, but when the unit/share price is down, each dollar buys more units or shares. DCA reduces the average share cost and spreads the investment risk over time. Investors are more likely to own more shares at lower prices than if they bought them all at once.

“While dollar cost averaging won't eliminate market risk or guarantee a profit, it's an investment strategy that makes sense for the patient, long-term investor concerned with managing price risk,” he says.

Beyond securities, investors and their advisors should consider vehicles such as segregated fund products, which are insurance contracts that can provide unique advantages such as death benefit, maturity and income guarantees. They also offer named beneficiary options, potential creditor protection, and avoiding probate. “They first came into popularity over 20 years ago, when interest rates began to fall and conservative investors turned to them as an alternative to GICs (guaranteed investment certificates),” explains Mr. Banham.

A life annuity can provide a source of guaranteed lifetime income, typically for retirement, supplementing other sources of guaranteed lifetime income such as Canada Pension Plan (CPP), Old Age Security (OAS) or a defined benefit pension from an employer.

“Diversification is a good thing, simply because it mitigates your risk,” says Bruce Sellery, a personal finance expert and author of The Moolala Guide to Rockin’ Your RRSP. “We do it in lot of different areas of our life – we buy insurance for our car, our house, for our life.”

The Toronto-based author and speaker notes that it is easier and less expensive than ever to diversify an investment. “Most people can diversify with really just four products. Maybe those are mutual funds, maybe those are exchange-traded funds (ETFs), but you can buy a basket on the cheap that is going to give you pretty good diversification and low complexity.”

Keeping the elements of an investment portfolio simple is something that Mr. Sellery believes people overlook far too often. “What is the super simplest way to do it so that it actually gets done? Because the best plan is not the best plan on paper, the best plan is the one that gets executed.”

For the average investor, he is a big fan of the “couch potato” portfolio approach, which is basically a minimalist, hands-off strategy with little day-to-day or month-to-month adjustment. Managed solutions take the work out of an investor’s hands by giving professional money managers the responsibility of analyzing and choosing investments.

“What you do is set yourself up in a diversified way right from the beginning and then you rebalance one a year, twice a year, and add new money in a way that rebalances as a matter of course,” says Mr. Sellery. “If you are working with an advisor, you want to make sure that is the kind of service that they are providing you with – that there is diversification and regular rebalancing.”

Finally, Mr. Sellery cautions against the all-too natural tendency to incorporate new investment vehicles into a portfolio simply because they are new. “That is not, in my view, a reason to add something to your portfolio.”

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