A New Way to Think about Risk

There are too many investment options out there, so I thought I'd take a step back to look at some excellent places you can park money. I also want to introduce a new way to think about risk tolerance.


They keys to success in what I'm about to show you are:

• Make regular contributions (even if they are small)
• Invest according to your risk tolerance
• Average into the market if you have a lump sum to invest
• Re-balance your portfolio at least once or twice per year

For those of you who have less than $100,000 invested, here's my recommendation. Before I give it, note that I am not a professional financial adviser, and I am not a money manager. I am just a person who has made his own way to finding success with simple investment strategies. Year over year, I am up over 50%. Using Dow theory, I chose not to touch my money and kept investing. The result was a winning year.

If you are already seeing success in your investment strategy, don't change your approach just because you read something here that sounded like a good plan. If, however, your strategy isn't working, and you are losing money hand over fist like I was a few years ago, or have been barely squeaking gains out of your investments, please consider what I'm about to say.

There are basically two levels of investors I will be speaking to: those with less than 100k, and those with more than 100k.

Index Mutual Funds vs ETFs

If you have less than 100k to invest, chances are, using index mutual funds isn't going to make as much of a difference on your bottom line as they will if you have over 100k.

Here's the math (I kept the MERs a bit higher overall, to account for the facts that MERs are all over the place depending on the company, and funds are plentiful).

For arguments sake, I will say that on average, a basic index mutual fund portfolio consisting of 4 index funds will have an MER around 1%

The average ETF index portfolio with 4 index funds should have an MER around 0.4%

If you have 50k invested, the index mutual funds will cost $500 per year in fees, and the ETF portfolio will cost $200 per year + trading fees (approximately $9.99 multiplied by the number of trades (4 minimum) per year).

If you have 100k invested, the index mutual funds will cost $1000
 per year, while a similar ETF portfolio will only cost $400 per year + trading fees.

As you can see, those percentage points make a BIG difference the more money you have invested.

Mutual Funds vs Index Mutual Funds

The average MER of a D series mutual fund (D is for Do it Yourself) in Canada is 1.1%. But if you are using an advisor, chances are you are paying MUCH more.

http://cawidgets.morningstar.ca/ArticleTemplate/ArticleGL.aspx?culture=en-CA&id=685965

Side note: The best place to find information on mutual funds and ETFs is morningstar.ca
I use this site regularly to sift through data on fund recommendations I get, but I rarely buy mutual funds anymore. Instead, I am slowly moving over to ETFs to save on fees.

Are all ETFs and Index mutual Funds Equal?

NO! I had to say it. not all ETFs are worthy of your hard earned money. It's incredibly important to research the ETFs and index funds you want to purchase, and compare their track record. For example, RBC's Canadian index mutual fund and TD's canadian index fund perform almost identically. However, the MER of RBC's offering is slightly less (0.77%) than TD's (0.88%).

Soctiabank's Canadian index fund has an MER of 1%, and it's performing worse than the RBC offering (currently).

So ... there you have it! Choose wisely and stay informed!

Portfolio Breakdowns and Risk Tolerance

Everyone is at a different stage in their lives, and therefore everyone has a different risk tolerance. I want to suggest though than your age, and not your temperament is what should define your risk tolerance when it comes to saving for retirement. The closer you get to retirement, the more conservative you need to be to preserve your capital. It is only after retirement that your temperament becomes a deciding factor in your asset allocation, along with how much capital you have vs your need for that capital.

Young Adult (15-25) - RISK ON Aggressive years
Canadian Equities - 30%
US Equities - 30%
International Equities - 30%
Emerging markets or cyclical equities - 10%

At the end of this stage, one may choose to continue an aggressive stance. This is perhaps one of the only safe times where one can maintain an aggressive stance and still be an overall conservatively minded investor.

Adult (25-40) - Assertive to Aggressive Building Years
Canadian equities - 25-30%
US equities - 25-30%
International Equities - 25-30%
Bonds - 0-10%

Near the end of this stage, money is rotated from stocks to build a bond portfolio in line with a 25% assertive allocation.

Middle Aged (40-55) - Assertive Building Years
Bonds - 25%
Canadian - 25%
US - 25%
International - 25%

Note: cash is deployed immediately into an asset class as needed. In the later part of this stage, money is rotated from stocks to bonds until the desired allocations for a Balanced portfolio are achieved

Nearing Retirement (55-65) - Balanced Fine tuning years
Bonds - 40%
Canadian - 20%
US - 20%
International - 20%

During the later part of this phase, money is rotated from equities to bonds until the desired allocation between 55 and 70% bonds is reached in preparation for the preserving years.

Retired (65+) - Cautious to Very Cautious Preserving Years
Bonds - 55%-70%
Canadian - 10-15%
US - 10-15%
International - 10-15%

Note: the preserving years is when risk tolerance becomes more about your temperament than about your age. But, it's also about the capital you have. If you have just enough for your needs, capital preservation must come before risk, so you will want to have a much higher allocation to safer, dividend paying securities like bonds (and even preferred shares). If you have money to spare, feel free to allocate more to equities, but keep in mind that equities become much more risky the fewer years you plan on holding them. Perhaps considering a multi-generational approach at this point is wise if you are going to hold equities into your elderly years. Consult a financial professional for specific guidance here.


Happy investing!