My Portfolio – Detailed Asset Allocation for Equities

Today I’ll talk about the equities portion of our portfolio which represents 75% of our entire portfolio. This section of the portfolio is a combination of low cost mutual funds, ETFs or exchange traded funds and one stock.

The breakdown for equities by type is as follows:

The first number is as a percentage of equities portion, the second number in brackets is a percentage of the total portfolio:

Canadian equity 20% (15%)

US equity 33% (25%)

International equity 33% (25%)

Emerging Mkt 8% (6%)

Reits 5% (4%)

How did I come up with this allocation? Good question…

Canadian equity: My Canadian equity portion has gone from about 90% before last year to around 30% last fall and now goes down to 20%. The reality is that for Canadians to be diversified they need to limit their Canadian exposure which is tough to do when you spend Canadian dollars and tend to think that your home country is a lot more economically important than it really is. I’m not too concerned about currency fluctuations since my investment time horizon is fairly long so I can handle currency swings. The Canadian dollar is at a 30 year high so maybe loading up on Canadian dollars is not the greatest thing at the moment.

US equity: As a percentage of the world equity, I believe US equity is around 45%, in my portfolio it’s only 33% of the equity portion. I don’t have any good explanation for the amount I choose except to say that it’s “a lot more than I had before”. Perhaps along the lines that it’s hard to reduce your home country holdings, it’s also hard to put 45% of your equities into another one country. US equity returns have been hampered by the rising Canadian dollar but according to Bernstein the best time to buy is when things look their worst. Feel free to convince me I should have more (or less) US equities!

International equity: This is Europe + Asia – this portion should be 33% according to Martingale, so I have the proper allocation according to it’s world equity weighting.

REITs: I’ve chosen 5% for this. As mentioned in an earlier post, this asset class has a low correlation with other types of investments, namely equities. I’ve only looked at Canadian REITs but I will also be considering US (such as VNQ) and international REITs as well. I really have no idea how much I should have in real estate but I’ve heard anywhere from 5% to 20% of your portfolio should be in real estate. Anyone have any input on this one? Should I increase this amount?

Emerging Markets: The global market capitalization is 9% and I have 8% so that’s pretty close. This section makes me nervous for two reasons, the emerging markets have had a great run over the last few years and although it could continue for quite some time, it could also come crashing down in a hurry. Another thing is the China factor, it’s really hard to believe that this market will not hit a brick wall at some point and if that happens, all other emerging markets will get hammered as well.

Another aspect of emerging markets that I’m not keen on is that the long term returns don’t seem to match up with the incredible risk levels involved. One of the tenets of Bernstein’s Four Pillars (and many other books) is that increased risk leads to increased returns over the long term but I’m not sure if that’s true in this case. I have a separate post for this issue.


Market Timing?

I thought I would take a break from the exciting portfolio building series and write about market timing. This post was inspired by one of my favourite Globe & Mail writers, John Heinzl who wrote this morning about market timing and why you shouldn’t do it. Although he manages to contain himself in that article, he has a very funny sarcastic wit – check out his Saturday Stars & Dogs column sometime to see what I mean.

I used to be an avid market timer, when the markets went down I would switch my equity mutual funds to money market. When the market went back up, I would switch back to equity. I realize in retrospect that I probably could have just stayed invested in the money market fund the whole time and achieved the same return with less risk and stress.

Part of my new investment strategy which I’ve been developing over the past year or so is to avoid market timing since I’ve established that I can’t do it successfully. In his article, Heinzl talks about how last June, the markets had tanked and it really looked like a great time to adopt a more defensive portfolio approach but since then the Canadian market has gone up 30% which is an incredible run.

I’m not suggesting the Canadian market will go up another 30% over the next year but Heinzl’s point is that nobody knows what it will do which means that any moves based on predictions are useless.


My Portfolio – Asset Allocation for Fixed Income

Today I’ll talk about the fixed income or bonds portion of our portfolio which represents 25% of the entire portfolio. This section of the portfolio is a combination of GICs, real return bonds ETF (iShares XRB), short term bond ETF (iShares XSB), and a bond mutual fund.
The 25% bond portion is made up of 20% bonds (see detail list below) and 5% real return bonds. Note – real return bonds are referred to as treasury inflation-protected securities in the US.  I don’t know if the real return bond allocation is high enough so if anyone has any thoughts then feel free to let me know. According to Bernstein and this from Canadian Capitalist, long term bonds are not worth owning because they don’t give a return that matches their risk (historically at least). With this in mind, I’m planning to buy the XSB ETF (short term bond – duration 2.56 years) in order to lower the average duration of our bond portfolio to an estimated 3.5 years. I could lower it further by owning less of the bond mutual fund and buying more of the ETF but this is what I have for now.

These are the weightings of each security as a percentage of the entire portfolio:

GICs – five years or less – 7%

Bond mutual fund duration 6 years MER = 0.65% , 5%

Short term bond ETF duration 2.56 years, MER = 0.25%, 8%

Real return bond ETF – MER = 0.35%, 5%

In case you’re wondering why we own GICs, a mutual fund and an ETF for the non-real return portion of our fixed income, the GICs are my wife’s, the mutual fund is very useful for rebalancing, and the ETF has a low duration and a low cost.

One other thing I learned recently about fixed income – when buying or renewing GICs you can negotiate the rate and can often get a quarter or half percent more.


My Portfolio – Asset Classes

In this post I want to outline the basic asset classes that make up my portfolio and also to give some extra information on two classes (REITs (such as VNQ), and real return bonds) which I’m not as familiar with.


In the bonds area I have various bond products (ETF, mutual fund, GIC) and a real return bonds ETF.  Note – real return bonds are referred to as treasury inflation-protected securities in the US.


My equities are divided up into Canadian, US, international (Europe, Asia and Far East), emerging market and REITs. I’ll be posting soon about my exact proportions of these different areas.



REITs – Real Estate Investment Trusts


These are considered a separate asset class since real estate has a low correlation with other types of investments.

These securities are trusts that purchase properties and pay out a high percentage of their income in the form of dividends. This group was the only type of income trusts to be excluded from last year’s income trust tax change so investors have to be aware that government tax policy on REITs could change at any time. An example of a REIT is VNQ which trades on the AMEX and is run by Vanguard.

Canadian REITs trade on the TSX so they can be bought individually but I’m buying the iShares ETF XRE which represents the TSX Capped REIT Index.


This site has some great info on REITs.



Real Return Bonds


These are Government of Canada bonds that pay you a rate of return that is adjusted for inflation. Unlike regular bonds, this feature assures that your purchasing power is maintained regardless of the future rate of inflation.

These bonds can be purchased individually through any broker but I’ll be buying the iShares ETF XRB which represents the Scotia Capital Real Return Bond Index.


Bylo has a lot more details on these bonds.


Other Stuff


I noticed today that Middle Class Millionaire has a series on asset allocation as well – I thought it would be interesting to list some bloggers and their equity asset allocation along with their ages for comparison. This would have been better in yesterday’s post but better late than never! Please note that I’m including cash as part of the bond portion.


Middle Class Millionaire – age 27 – 95% to 100% equity

Outroupistache – mid 50’s – 70%

Canadian Capitalist – early 30’s – 80%

Moi – late 30’s – 75%

I’d love to hear from anyone else about what kind of asset allocation they have?



My Portfolio – An Asset Allocation Decision

Last fall I sat down for the first time ever (after 13 years of owning mutual funds) and looked at all our investments and did an analysis to determine what our asset allocation was. As I recall we had over 90% equity and a good portion of that equity was in Canada. At that time I decided to make the equity/bond split to be 80%/20%. This was chosen somewhat arbitrarily although it seemed to be a good mix for a fairly aggressive portfolio with a long investment time horizon. I also changed the country mix in order to reduce the Canadian holdings down to about 30% of the equity portion.

At this point in time I will be revamping my portfolio once again since I decided to move about two thirds of our rrsp to a broker (Questrade) in order to convert it to ETFs. The remainder will stay in low cost mutual funds and GICs. I’ll be discussing some of the specific investments in future posts but I plan to start with the asset allocation since that’s the most important decision in my opinion.

The first asset allocation decision was to lower the equity portion of the portfolio down to 75% from 80% and to raise the bond portion up to 25%. I decided to do this mainly based on the research of William Bernstein (Four Pillars of Investing) which showed that having an equity portion of a portfolio higher than 25% wasn’t worth the extra risk since it usually didn’t result in a significantly higher return and of course results in more ups and downs with the market.

Interestingly enough Bernstein says that although 75% equity should be the maximum for an investment portfolio, 50% should be the minimum regardless of your age. The reason for this is that if you are retired and have a more conservative portfolio ( less than 50% equity ) then inflation is a bigger risk. Another great point he makes about asset allocation is that you should have a more conservative portfolio if you’re not sure if you can handle the volatility in a downturn. If you sell equities every time the market drops and then wait until it goes up before buying in again, then you are better off in a more conservative portfolio (ie 50/50) if that allows you to stay invested during the downturns.


Why I Chose A Five Year Term For My Mortgage

Last year I felt a lot of stress from being financially over-extended in the form of a mortgage that was too large. One of the obvious remedies to this problem was to concentrate on lowering that debt, which we’ve done with some success. The other significant thing we did was to lock in our mortgage for five years. I realize that studies like the one done by Moshe Milevsky show that shorter terms are cheaper in the long run for mortgages, but in our current situation, the peace of mind of not having to worry about the possibility of increased interest rates is well worth any extra cost that locking for five years might end up causing.

The reason the mortgage payment is such a concern is because our budget is too tight to handle a big increase in payments if interest rates jump up. By locking in, we don’t have to worry about that for five years, at which time the mortgage will be low enough, we’ll be able to handle higher interest rates if need be.

I can’t predict if interest rates are going to go up or down in the future, but I can accurately predict that with the longer term mortgage, I will sleep better at night.

Personal Finance

Mortgage Renewal Time

My mortgage is coming due at the end of July and I decided to shop around to get the best rate I could. In the past few years I’ve been renewing with one year terms at TD Canada Trust where my mortgage guy always gave me reasonable rates which I verified by talking to other people I knew who were mortgage shopping. ING Direct website is also a good indicator of competitive mortgage rates. Last year I didn’t think I got a competitive renewal rate but I renewed anyways because of extenuating financial circumstances – 2 mortgages, maxed out line of credits, baby was due same week as the mortgage etc etc. This year I’m down to one mortgage and the LOCs are paid off so it’s time to go shopping!

I used a mortgage broker who was recommended by two different friends of mine. She gave us a quote of 5.19% for 5 years for a $190k mortgage with a LOC up to $250k. The LOC requires a lawyer to setup and there is a $500 cash back for the legal fee so I don’t have to pay it. I also asked if she would cover the $270 fee that TD is charging for allowing me the privilege of not renewing my mortgage with them and she agreed (sometimes you just have to ask). By way of comparison ING Direct had 5.24% for their fixed five year mortgage and TD (my current bank) offered a whopping 5.49% for five years. Almost a third of a percent is a steep price to pay for the convenience of staying with TD.

I feel good about putting in a proper effort to get a good mortgage rate. I wasn’t that concerned about what the exact value of the best rate, since there is nothing I can do about that, but I really didn’t want to sign up for a mortgage thinking that there was a better deal out there if only I had searched a bit harder.


Rebalancing With A One Stop ETF?

I’ve been doing a lot of research recently on ETFs and what’s in them because I’m about to convert a good chunk of my rrsp over to ETFs. One of the new ETFs I’ve been looking at is VEU – Vanguard world equity minus the US. This ETF would replace three ETFs I was planning to buy: VKG – Vanguard European, VPL – Vanguard Pacific and VWO – Vanguard Emerging Market. At first this ETF seemed like a great idea because it would save on transaction costs and would make the portfolio a bit simpler.

Today, however it occurred to me that since that part of my investment strategy is to rebalance on a regular basis, combining different geographical and economic regions into less ETFs might reduce the benefit I can get from rebalancing. The emerging market area is one particular class that is very volatile and as a percentage of your portfolio can easily double or half depending on the markets and is a great candidate for portfolio rebalancing. According to this article by MartinGale the portion of world equity of emerging markets is around 9%. If they keep up their torrid pace then this percentage could climb quite a bit. On the other hand, they could get reduced significantly as well. With the VEU ETF I won’t be able to do anything about it except go along for the ride.

Another benefit with having more specific ETFs is that you can better control the risk level of your portfolio. For example I am thinking of only having about 6% of my equity portfolio in emerging markets since I don’t want the risk involved with the proper weighting of 9%. Another investor might want to go overweight and have 10-15% in emerging markets. Either way you can’t overweight or underweight emerging markets with VEU.

On the other hand, if someone comes out with a world equity ETF which happens to have the underlying weightings that I’m looking for…I would be tempted to buy it and be a completely passive investor.