When I started the Sleepy Portfolio, I intended to track it as my personal portfolio benchmark and as such the portfolio allocations reflect my personal investment goals and risk tolerance. I am frequently asked how an investor should tailor this model portfolio to suit their investment goals. In this post, I’ll try and answer some of the questions that frequently arise:

Aggressive Asset Allocation

I started the Sleepy Portfolio in my early thirties and allocating 20% to bonds and 5% to cash is not unreasonable for a young investor. In fact, some would consider the allocation too conservative. Older investors can dial up the “sleep-at-night” quotient by increasing the allocation to bonds. Keeping the age in bonds is a good thumb rule to start with. The bond allocation should then be adjusted for the need, capacity and willingness to assume risk.

Too much allocation to Foreign Stocks

Once an investor has decided how much to allocate to fixed income, the next question is how much to allocate to Canadian stocks. The Sleepy Portfolio allocates 28% of the equity portion to Canadian stocks. Some may consider that too much, others too little (See this post on Portfolio Allocation to Canadian Stocks for some interesting comments). Dan Solin, author of The Smartest Investment Book You’ll Ever Read allocates just 10% to Canadian stocks in his model portfolios based on the belief that investors should hold globally diversified portfolios. Others such as money manager Leith Wheeler say that Canadian investors can get most of the global diversification by allocating half their portfolio in foreign stocks. It is clear that adding some foreign stocks to a portfolio reduces overall risk. Exactly how much is a matter of much debate.

Providing a value and small-cap tilt to the portfolio

The Sleepy Portfolio keeps it simple by holding broad-market, capitalization-weighted indices. There is a large body of evidence that show that investors would have earned a premium for holding small-cap stocks and value stocks in the past. Opinions are divided on whether investors should expect the small-cap and value premiums to exist in the future. I chose to keep it simple in my own portfolios but it is not unreasonable to choose to slice-and-dice equity holdings based on size and value.

The bottom line is that while the Sleepy Portfolio is well thought out (even if I say so myself!), there are not many right and wrong answers in investing. Should you allocate 28% or 35% of your equities to Canadian stocks? Pick one and stick to it. It is impossible to say in advance which option would turn out to be the best answer.

This article has 13 comments

  1. I think the point of “sleepy” is that you do what you’re comfortable with and then you just let ‘er go. Hence, it is sleepy. When you age 5, 10 years you think about asset allocation re-balancing. I wish I was so laid-back / dedicated.

  2. Asset allocation is fundamental. However, advisors integrity in the selection of securities or funds within each class is more important. This is especially true for long term bonds. In order to increase return, many advisors purchase or recommend fixed income traded above par to get higher short term return. This without considering the objectives and constraints of their client. A sure way to create capital loss in the future and over the years paying too much tax for investors that do not need the cash flow.

  3. The Blunt Bean Counter

    CC: Do you make any attempt to account for currency fluctuations (ie: If $US appears to be on upward or downward trajectory- some still think the day of reckoning has not come for the US and its dollar ) or is F/X risk just part and parcel of your foreign holdings and your global diversification accounts for portfolio allocation and exchange risk?

  4. The selection of canadian securities (vs other countries’securities) should be done for tax purpose or for risk management purpose (exchange rate). Companies compete on a global basis and deregulations have decrease country specific allocation in most cases. Investors should remember that the weight of the benchmarks in many countries are often concentrated in a few sectors or a few companies.

  5. The selection of canadian securities  should be done predominantly for tax purposes or for risk management purpose (exchange rate). Companies compete on a global basis. Deregulations  have decrease the importance of country specific allocation in most instances.  But investors should also consider that benchmarks in many countries are often concentrated in a few sectors or in a few companies. The notion of risk-return expectations  and expected volatility should be a better way to build portfolios.

  6. @Sustainable PF: I’ll admit that it’s not easy being ‘sleepy’. But I’ve moved away from individual stocks and it’s working very well so far.

    @patrick: Good points. Thanks for your input.

    @Mark: I think that direct f/x unhedged holdings provide important diversification benefits. Investors wanting to avoid f/x risk have two unappetizing options: dial up their Canadian equity exposure and miss some important sectors (such as health care & technology) or currency-hedge their investments. Currency-hedging sounds good in theory but tracking errors have been atrocious in the past.

    http://www.canadiancapitalist.com/category/currency-hedging/

  7. When investing in fixed income, if the intention is for “capital preservation”, then isn’t it better to buy individual bonds with a fixed interest rate (based upon the purchase price of the bond) and a fixed maturity date? Bond funds are marked to market each trading day and do not mature as they continuously roll over, so you’re not “guaranteed” your original principal. So, if your intention is to preserve capital, you can lose your shirt in a rising interest rate environment.

    If you’re looking for a short term trade on bond prices, then I completely agree that bond funds would be the easiest choice… If you’re looking for capital preservation, then you’re going to want to hold the individual security, in my humble opinion.

    For disclosure, just like how I’m a stock picker on the equities side of my portfolio – I also buy individual bonds, coupons and GICs in my fixed income portfolio.

  8. @Phil S: The idea that individual bonds are less vulnerable to rising interest rates is an illusion. You may not see the decline in the value of your bond, but it happens anyway. Here’s a good article on the issue:
    http://moneywatch.bnet.com/investing/blog/irrational-investor/bonds-or-bond-funds-an-easy-choice/873/

    The other problem with buying individual bonds is that retail investors get terrible prices from most brokerages.

  9. CC, you say the passive portfolio has been working so far. Do you actually have direct evidence for this? or is it indirect? (e.g. your personal rate of return has been better over the past year years while you indexed, compared to if you didn’t)

    I suppose if you did some bad stock picking early and got burned, that it only makes sense that a passive portfolio would be doing better, especially if the market is rising overall.

    Curious to know how you would do if you went back to picking stocks. I recall you picked bottoms for RIM and SC over at the money forum.

  10. @Couch Potato. That article’s argument is pretty weak. If you do “dollar cost averaging” strategy in a rising interest rate environment that you can lose money on the original bond but make more money by buying more of the same bond? Weak. Face it – you lost money that you’ll never get back, just like a bad trade. Don’t pour any more money in it unless you feel that it can recover strongly. And for that, you can ride out an individual fixed income security to maturity and get your cash back. In comparison, the fund doesn’t mature so if you cash out, the money is lost forever.

    I suspect that the writer is a bond fund manager and is probably trying to protect his turf. Like I said, if you figure interest rates are going down, then the bond fund is a good vehicle for a short term trade and for that purpose it is a far better vehicle than an individual bond. But I maintain that if your goal is capital preservation, then buy an individual security like a GIC.

    As far as the brokerage fees, you get killed regardless of whether you buy a fund or an individual security. That’s a flaw inherent in our bond trading system, which really isn’t a system at all.

  11. @Phil S: As Canadian Couch Potato says, holding bonds directly doesn’t mean there is no volatility; it’s just that we don’t see it. Since I hold bonds for diversification purposes and lowering the volatility of a portfolio and not to address a financial liability at a certain point in the future, I’m okay with holding a bond ETF. A GIC ladder doesn’t work that well for me because I need liquidity in case I need to rebalance the portfolio. I suppose an investor could sacrifice some liquidity for a higher rate and put part of their fixed income portion in GICs.

    Another reason, I chose XSB here is because it makes up just 15% of the portfolio. To build a short-term bond ladder, I would need at least $25,000.

    @Sampson: I started switching to an all-ETF portfolio around 2007. Until then, I was invested in a mix of individual stocks. When I looked at my past picks, my Canadian stock picks trailed the markets by a few percentage points (early picks included Nortel, JSDU, Bombardier etc.) and US stock picks beat the market by a few percentage points. Overall, before taking taxes into account, it was a bit of a wash and my portfolios essentially performed in-line with the markets.

    It turned out that my timing of moving to an indexed portfolio was fortuitous because I did own names such as AIG, E*Trade, GE, Nokia that would have dragged down returns significantly. That’s why I think a passive portfolio is likely working better for me.

    Yes, I do put stocks in a watch list and follow them. But it’s just for fun. I don’t put money in my picks. I think RIM would have been a good pick in the low 50s considering it is in the mid-60s now. I don’t think SC was such a great pick. You could have made just as much or maybe even more with XIU. If you measure these things accurately, you might as well get a chimp to throw darts at the stock pages.

  12. @CC – even watching stocks for fun, are you ever tempted to get back into owning stocks?

    I do agree, with the equity runup of late, you could have made just as much or maybe even more with XIU. I like that one myself over XIC.

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