Recent economic and political events which have affected the stability of world markets should serve as a reminder of the potential volatility these markets hold for investors. Whether it is concern over the uncertainty of the European or Chinese economies, the political situation in the US or the decline in the Canadian Dollar, these factors can put unprotected investors at risk. While some try to time the markets to better protect themselves, historically these strategies have a poor rate of success because no one can accurately predict the future.
You can protect your investment portfolio against market volatility and downturns by utilizing a long term asset allocation strategy. This involves allocating your portfolio into a number of different asset classes as well as geographical regions to avoid having all your investment eggs in one basket. The appropriate asset and geographical weighting is dependent on a number of factors including your age, risk tolerance and when the funds will be needed. To be successful, the asset allocation approach to investing needs to be viewed as a long term strategy. Studies have clearly proven this strategy effective in reducing the overall risk and increasing the overall rate of return on your portfolio. Studies have also shown the importance of proper allocation: it is responsible for over 90 per cent of your portfolio's return.
Asset allocation reduces risk because not all of your investment assets increase and decrease in value at the same rate or at the same time. Since the different asset classes grow at different rates, your future portfolio allocation may end up quite different from the original mix established in your plan. To ensure the continuing profitability of your portfolio and to avoid putting yourself at risk in the event of a major market change, it is imperative that you implement a formal re-balancing program on at least an annual basis.
A properly structured program of asset allocation within your RRSP portfolio provides a disciplined approach to investing. Investments are sold that have risen in value and those that are on sale are bought. One word of caution: if the investment vehicle you want to realize profit on is a mutual fund, a deferred sales charge may be incurred if you are switching between fund families. However, these redemption charges will usually apply only if the amount re-allocated exceeds 10 per cent of the value of your investment. In the long term this strategy will help to balance the overall performance of your portfolio and lower the chance of significant loss when declines in certain asset classes occur. When re-balancing your non-registered investments, additional implications such as taxes incurred need to be considered. In tax deferred investments such as equity funds, you do not realize the profits you have made until you redeem your investment. The realization of those gains upon sale increases your tax liability, the extent of which is dependent on the amount your investment has appreciated and your tax bracket.
The key to long term investing success is to create and implement an investment plan based on proper asset allocation, review and re-balancing on a regular basis. This ensures you will maximize the returns on your portfolio over the long term while minimizing the amount of risk your portfolio is exposed to.
The use of a financial professional is recommended. Darryl Prociuk CFP, R.F.P., CLU, TEP is a Registered Financial Planner and may be contacted at [email protected]
