Recently the Financial Post featured a couple who are excellent savers but have experienced quite poor returns as investors in its Family Finance column (High savers need to enjoy the present, July 25, 2010). Despite arriving in Canada just two decades back with little to their name apart from their training and education, they have achieved a substantial measure of financial security. But though they’ve saved substantial sums (excluding both their defined-benefit pensions), they are disappointed with their investments. The reasons are not hard to find:

Too many mutual funds

The couple own 40 mutual funds between them. Talk about diworsification! With that many funds, it is very hard to determine their current asset allocation, let alone tracking and monitoring their portfolio. Five to ten funds should be plenty for most investors.

Incorrect asset location

The column notes that the couple hold the bulk of their assets in the form of GICs and cash in the most terrible place possible — their taxable accounts. The best locations for GICs and bonds are tax-sheltered accounts such as RRSPs and TFSAs. If both these accounts are maxed out, long-term investors should seriously consider taking on more risk and holding Canadian stocks in taxable accounts as the return from GICs in taxable accounts after taxes and inflation is likely to be negative.

It is not enough to establish a good savings habit. It is just as important to grow those savings through intelligent investing.

This article has 14 comments

  1. Despite my personal feelings about Kevin O’Leary, one of his mantras which I’ve adopted is that you shouldn’t let any one investment or one name represent more than 5% of your total portfolio size. So, even if you hold nothing but GICs, for example, you should still diversify and have GICs issued by different institutions, just in case one issuer goes into receivership. If you follow this rule, then there should be at least 20 different investments in your portfolio.

    I’m not a fan of mutual funds, but I won’t bore anybody with any diatribe on that subject here.

    Warren Buffett, on the other hand, says that it’s OK to have all your eggs in one basket – provided that you watch that basket VERY VERY closely. So, there you go, you have two talking heads advocating different approaches.

  2. I see one short coming to the suggested ‘new’ approach, and that is the risk in the sequence of returns. I think it’s fine to use an average ROR of 5.25% on the new portfolio and new contributions if the time horizon is long enough, however, the couple are needing the cash flow and growth of investments to pay off in the very near future. It seems like there is a lot of risk of the couple not attaining their goals by the prescribed timeline.

    I personally haven’t begun considering this for my own financial planning, but all the retirement goals are easily 15+ years ahead so I do feel comfortable using an average ROR for projections. I would guess that when the clock ticks down to 10 years or less, I would want to use much much more conservative estimates, say plus or minus 10-15% on the portfolio.

  3. Oh, and it’s always that damned egg management fee. Gets everyone in the end.

  4. @Phil S: Presumably O’Leary’s 5% limit relates to one stock or one bond issue. If “one investment” means an ETF or index fund that holds hundreds or even thousands of names, this doesn’t apply. Neither does it make sense to limit each GIC to 5% of your portfolio. Unless you’re investing more than $100,000 in GICs, there’s no reason to hold them with different financial institutions. CDIC covers $100K per issuer, so there is no reason to “diversify” in this way.

  5. Canadian Capitalist

    @Phil S: If we talking about stocks and individual corporate bonds, then I concur that it is best not to under diversify. However, with Government bonds, GICs (within the $100K CDIC limit), mutual funds and ETFs, it is not necessary to limit to 5% of the portfolio. XIU holds 60 stocks and even if I put 60% of my portfolio in it, it’s just 1% per stock.

    @Sampson: Agree that sequence of returns is an issue for those closer to retirement. I personally have 20 years or so to go as well, so I’m not worried about it just yet. But even with sequence of returns risk, if I had no room left in RRSPs or TFSAs, I’d seriously consider cutting back on fixed income if the only place to hold it is taxable accounts. Especially, these days when you can get 2.5% dividend yield on Canadian stocks, which is only slightly less than interest on bonds.

    @Canadian Couch Potato: I agree. I wouldn’t bother diversifying with ETFs, mutual funds due to their trust structure and with GICs as long as they stay within the CDIC limits.

  6. Great investing (with conservative capital preservation) is a great way to save. After all, if you can preserve capital with the possibility of increasing your invested capital, you’ll be ahead of the “under the mattress” individual whose money is eaten away by inflation… even our low inflation rates today!

  7. That was a great article in the Financial Post. An excellent example of how successful personal finances is a combination of saving AND a plan for managing those savings.

    The good news is that fixing the investment planning is likely much easier than changing a person’s savings behaviour.

  8. Wow, 40 funds. Agreed, if they stay in funds, keep at very, very most 10 between them. Better still, put all their RRSPs in a few ETFs like XIU, XIC, CDZ or XBB, CLF, CBO. Just sit back and enjoy.

  9. I have seen a few statement that had 20+ mutual funds, I personally see no need for more then 5 or 6.
    Can Equity, US Equity, Int’l Equity and a Bond fund would make a well balance portfolio and although I would not personally recommend it, one or two more holdings if you wanted higher exposure to a specific region or industry, (ie emerging markets or technology).

    I also saw a RRSP statement once that had 109 GICs all between $500 and $1500 all issue by the same company. The guy was recieving maturity notices in the mail every couple days.

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  11. When you have 40 mutual funds, your gain defaults to the market return less the MERs ranging from 2% to 3%. Better to get a few broad market ETFs and get market return less 0.1% to 0.2%. Over time, it adds up.

  12. This is”Investment Adviser’s”(M F salesperson) wet dream….i will bet they all have a 5% s.c. and 1% dsc

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