Where the Experts Say to Invest Your Portfolio Now

The holy grail of investing is to get maximum return with minimum risk. Wise investors not only know this is impossible but in fact risk and reward share a contrary relationship. The higher the risk the higher the potential reward; low risk equals low reward. Since each investment type has a range of risk versus reward profiles how can one find an ideal mix of investments that offers the best chance for reward while reducing risk?

Diversification – the Ideal Plan

The classic answer has been to diversify. Index funds provide maximum diversification by following a stock index. Exchange traded funds take that diversification a step further. They take a global approach and the diversification isn’t limited to domestic (U.S.) stocks alone, but includes international stocks as well as safe bonds.

Exchange Traded Funds

Exchange traded funds are the product of countless academic studies by prominent financial experts. Here’s what the studies have consistently proven when it comes diversification and risk reduction:

• Portfolio Size and Make Up

  A portfolio of at least 50 equal sized and well diversified U.S. stocks reduces risk by over 60 percent. Further increase in stock holding won’t produce much more risk reduction. In other words the remaining 40% of the stock market holdings simply don’t carry enough weight to significantly alter the returns one can expect from an all stock portfolio.

• International Stocks

  To further reduce risk international stocks are added to the portfolio since global markets aren’t always synchronous with the U.S. economy. Studies suggest the magic number is about 17% international stocks.

• Bonds?

  The third major holding for index style funds is safe bonds. The percentage of bond holdings is often used to control volatility which plays on investors emotions. Typically a conservative fund will have up to 40% bonds and a higher risk fund would have only 20% bonds.

• Domestic Stocks

  A blend of domestic stock holdings (both Canada and U.S.), international holdings and bonds is the optimum strategy to reduce risk and aim for optimal return in the long term. It’s a truly global portfolio.

• But What Percentage?

  The percentages of these three key holdings will depend on the actual fund itself.

• Universal Strategy

  There is no universal diversification strategy that will consistently eliminate risk. During times of economic crisis (2008 and 2020) all markets can fall in unison. However over a long term of at least 10 years these funds consistently perform well.

• Management?

  Since the percentage holdings in index funds are rigidly fixed these funds require little active management which results in record low fees (as little as 0.2%)

• Rebalancing

  These funds are periodically rebalanced when the percentage holdings begin to stray from the rigid guidelines. Rebalancing on a regular basis (typically yearly) is a proven strategy to play the master game of buy low and sell high.

Examples of Index Funds

When purchasing a fund people usually become overwhelmed by the number of choices. Using Ishares as an example here are the allocations for XBAL (60% stocks 40% bonds), and XGRO (80% stocks 20% bonds).

Similar Products?

Note that both Vanguard and Bank of Montreal (BMO) currently offer similar products. Do your homework and insist on a global mix of stocks and safe bonds. The sad truth is these funds will beat actively managed funds overwhelmingly and are a safe long term strategy to reduce risk and optimize returns at industry leading low fees.

In my E-books (“Water Barrel” and “The Balance”) I discuss simple methods to live sensibly for today, take charge of your financial affairs, and invest safely for the long term. For more information please visit David Penna Amazon.

Disclaimer for ManageYourMoney.ca

The information provided on ManageYourMoney.ca is intended for educational and informational purposes only. It should not be taken as financial advice. The opinions shared are those of the authors and are meant to encourage sensible financial habits and decision-making. We recommend that you do your own research or consult a certified financial advisor before making any financial or investment decisions. All investments come with risks, and there is no guarantee of success. Past performance is not a reliable indicator of future results. Always consider your personal financial situation and risk tolerance before pursuing any investment opportunities.

As always, we are not a qualified financial advisors. We just relate financial management to our own experience which may not resemble yours at all. Advice is frequently worth exactly what you paid for it. Most of ours came from expensive experiences.

Please share your thoughts in the comment section below.