I recently received an email from a twenty-something investor asking for my opinion on the following asset allocation:
Developed Markets - EFA - 52.5%
Emerging Markets - VWO - 22.2%
Corporate Bonds - XCB - 7.8%
Materials - XMA - 17.4%
Usually, I am unable to offer an opinion on someone’s asset allocation because I don’t know enough about their ability and willingness to take risks. In this instance though, it is easy to notice that US equity markets are totally left out and developed and emerging markets are significantly over weighted. I also don’t know the rationale behind adding exposure to corporate bonds at the expense of short-term government bonds and a narrow sector like materials instead of a broad-market fund. My suspicion is that there is an element of performance chasing because these asset classes have posted excellent near-term returns.
ETFs and index funds are a good thing only if used properly. If you don’t have a proper asset allocation or if you chase performance or if you don’t invest for the long-term, indexing could end up being as harmful as active management.
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7 responses so far ↓
1 FourPillars // Jun 12, 2007 at 10:57 pm
This is an extremely risky portfolio - although the returns for the past year or two would have been absolutely phenomenal.
I suspect you’re right about the performance chasing.
I would suggest he do some research about asset allocation with particular regard to how much risk he’s willing to handle. This is a portfolio that is capable of some huge drops and if that happened, would probably turn him off of investing for quite a while.
Check out this website’s sleepy portfolio and also Canadian Business couch potato portfolio. That will be a good start and then he can decide for himself what to do.
Mike
2 Phil S // Jun 13, 2007 at 7:37 am
I wouldn’t put any money into a bond fund of any stripe, especially in a rising interest rate environment like the one we’re in… The bonds in the bond fund are all marked to market, so the value of the fund is likely to go down. For the fixed income portion of the portfolio, they should stick to simple GICs or T-Bills in order to guarantee their return of capital.
If the individual is Canadian, I would suggest some domestic investments in order to balance out all of the foreign risk. If you’re Canadian, then all your living expenses are Canadian and some portion of your portfolio should be unaffected in the worst case scenario such as if the loonie shoots for the stars!
3 The Financial Blogger // Jun 13, 2007 at 7:39 am
Whoa! I call this kind of portfolio a roller coaster. As Mike said, he sure made good money from the past two years. However, it could fall down by 20% in a week and I wouldn’t be surprised.
Having said that, it is good to see different portfolios. This one seems to be too aggressive for nothing. A little bit of diversification among US and CDN market wouldn’t hurt either.
Cheers,
FB.
4 Canadian Capitalist // Jun 13, 2007 at 7:57 am
Phil: I take the opposite approach. With interest rates at 5-year highs, this is a good time to initiate a position in short-term bonds. Yes, they might fall even further but then again they may not. Wish I had a crystal ball.
I’ll second Mike’s suggestion. You may want to search for “sleepy portfolio” or “lazy portfolio” to learn more about constructing a well-diversified portfolio.
5 GIV // Jun 13, 2007 at 10:29 am
the weirdest part, to me, is nearly 20% to materials. I mean, find me an asset allocation that advocates that much cash to something as specific as one particular sector. Never mind one based on commodities.
6 Phil S // Jun 13, 2007 at 11:44 am
CC. I think we may be talking about the same thing but different approaches. Most people buy bonds for capital preservation. But all I’m saying is that bond funds (regardless of whether it’s an index fund or ETF) means the bonds are marked to market with no maturity date where you’re guaranteed the return of your original capital. I agree that he should buy short term bonds (or GICs or T-Bills in my particular suggestion) but to buy the actual bond, not a bond fund.
My personal favourite over the past year has been cashable GICs. I believe that we’re in for a stock market correction, but I’m NOT confident enough about it to short the index. I am confident enough about a correction to sit in cashable GICs making roughly 4%, as I think a 4% return may beat the index in the short term. Obviously the reason why I chose a cashable GIC is to deploy the money back into equity markets when I think it has “bottomed out”.
7 ThickenMyWallet // Jun 13, 2007 at 12:19 pm
As pure conjecture, it sounds like someone suggested to him (I’ll assume its a him) that he’s young and can take a lot of risk so his portfolio is slanted to aggressive stock plays.
Given that the largest growing consumer base/demand for materials is emerging/developing markets, he’s really got all his eggs in one basket given the growing correlation between emerging markets and the materials sector.
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