Archive for the ‘Asset Allocation’ Category

Currency Exposure

By: Pete | Date posted: 12.06.2011 (11:28 am)

For most investors, foreign currency exposure is nothing more than an after thought. But in a world where most investors are increasingly diversifying their investments across borders, Why? Because adding countries can get you a higher return for the same amount of risk. There are many different ways but in general it is done by investors buying ETF’s that foreign indexes. One core example would be investors that purchase VWO, a Vanguard ETF that tracks the MSCI Emerging markets index. In such cases,

In some (but not all) cases, investors will have the choice between buying an ETF that is hedged for FX or not. Let’s take the example of a Canadian investor that would like to get exposure to US markets via the S&P500.

There are two main options:

#1-Buying a FX hedged ETF such as XSP (from Ishares)
#2-Buying an ETF with no exposure: Either buying such an ETF in Canada or buying one like IVV on US markets.

The difference between the two returns would mostly be fx returns. For example, if you hold the S&P500 and it gains 10% this year while the USD also gains 10% (in regards to the $CAD) you would get the following:

Option #1 +10%
Option #2 +20%

Of course, in the case where the $USD would have done the opposite, the difference in returns would be the opposite. So there is obviously not one option that will always do better. It’s more about looking for the best option for your portfolio.

What Is The Best Option?

Personally, I clearly prefer owning the non-hedged version in almost all cases. Why?

#1-Hedging Costs and Efficiency: Hedging an ETF sounds simple but it’s much more complex in reality because every movement of the index would in theory require a change in the hedge. That makes the strategy often very expensive (trading costs) but also rarely efficient. There have been many studies where they looked at how well hedged ETF’s have tracked their hedged index and the results have been very disappointing.

#2-Additional Diversification: I think it’s critical to remember why you are buying these ETF’s. It is all about adding diversification and in that regard, having exposure to foreign currencies certainly accomplishes that. You are looking for assets that have different profiles from what you already have and hedged ETF’s are not the best match.

I could certainly agree that getting foreign exposure is not always perfect and in some cases, it will end up costing you. But I would argue that over the long term, you will still be better off holding unhedged exposures.

Choose Your Asset Allocation

By: Pete | Date posted: 12.06.2011 (11:15 am)

Each investor has a target asset allocation and that will change over time. Personal changes, net worth fluctuations, an approaching retirement and many other factors will end up playing an important role in how you want your portfolio to look. The more you need the money that you have invested, the less you can afford to lose which means a safer asset allocation.

I consider that US investors would without any doubt have the following asset classes:

-Domestic Stocks
-Foreign Stocks
-Bonds

International investors would have a minimum of 4:

-Domestic Stocks
-US stocks
-International excl. US
-Bonds

Any portfolio that has $10-15K or less would probably focus entirely on these asset classes. When adding additional ones, it would simply mean a more precise split:

-International Stocks would become:

-EAFE
-Emerging Markets

And bonds would become:

-Corporate Bonds
-Government Bonds
-International Bonds

Here are some examples:

Investor #1 (retired) being the most conservative and Investor #10 being very aggressive (very young)

Simple US Investor Portfolio

Domestic StocksForeign StocksBonds
Investor 110090
Investor 215085
Investor 320080
Investor 425570
Investor 5301060
Investor 6351550
Investor 7402040
Investor 8452530
Investor 9503020
Investor 10553510

Simple Foreign Investor Portfolio

Domestic StocksUS StocksForeign StocksBonds
Investor 155090
Investor 27.57.5085
Investor 31010080
Investor 412.512.5570
Investor 515151060
Investor 617.517.51550
Investor 720202040
Investor 822.522.52530
Investor 925253020
Investor 1030303010

More Complex US Investor Portfolio

Domestic StocksEAFEEmerging MarketsCorporate BondsGovernment BondsInternational Bonds
Investor 1100040500
Investor 2150040450
Investor 3200040400
Investor 4252.52.535350
Investor 5257.57.530300
Investor 630101025250
Investor 73512.512.520200
Investor 835202015100
Investor 93522.522.51055
Investor 10352525555

More Complex Foreign Investor Portfolio

Domestic StocksUS StocksEAFEEmerging marketsCorporate BondsGovernment BondsInternational Bonds
Investor 1550040500
Investor 27.57.50040450
Investor 310100040400
Investor 412.512.52.52.535350
Investor 512.512.57.57.530300
Investor 61515101025250
Investor 717.517.512.512.520200
Investor 817.517.5202015100
Investor 917.517.522.522.51055
Investor 1017.517.52525555

As time goes by you could add income stocks, alternative asset classes, and even more. We will provide a number of portfolio examples that you could use to start off with.

Asset Allocation: Portfolio Type: Retirement vs. Agressive

By: Pete | Date posted: 12.06.2011 (11:11 am)

As I have written on other blogs that we own (such as IntelligentSpeculator), I am a strong believer in the bucket system when it comes to personal finances. What is it? Simply that when putting money aside, the first priority that you should have is funding your retirement. Everyone has different needs but as long as you are not on pace to save enough for your target retirement, I think you should stick to funding that account. What do I mean by “on pace”? If you are currently investing $500 per month into your retirement account and by anticipating returns over time you expect that to be sufficient, you would then be able to start working on a 2nd bucket. That bucket could exist to fund a specific project (trip, house, etc), a dream, or even to give away. There could be several buckets depending on how much you are able to save compared to what is required.

You Should Stick To Your Retirement Portfolio Until It Is Well Funded

What is the difference between a retirement portfolio and others such as a portfolio for a new house? In general, a retirement account will be more conservative because individuals do not want to risk as much. Not being able to build that amazing secondary house in California would be sad, but it would probably not bring as much stress as wondering if you’ll have enough to fund your retirement needs right?

What does more conservative mean?

-Less volatility (more fixed income in general)
-More Passive Investing (you do not take the luxury of predicting the future)
-Very infrequent trading (minimizing fees)
-Very long term approach

We will obviously be covering both types but the one we are spending the most energy on is the retirement portfolio, which for most investors is the core of what they’re working towards. It is also the type of portfolio that requires less work but still has incredible added value for the investor, especially given the very long term nature. Why? Paying an additional 1-2% of fees every year can hurt the performance of any portfolio but because of the compounding effect, the most dramatic impact it has is on longer term portfolios.

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ETF Asset Classes

By: Pete | Date posted: 11.23.2011 (11:23 am)

Up until today, we have taken different looks at why you should build your ETF portfolio and the first steps. Eventually, as you get closer to your first few trades, it becomes important to take a deeper look into the different types of ETF’s that can be found on the market. As in most financial markets, the easiest way to classify them is by asset class. Depending on how much money you have to invest in this portfolio, you will gain exposure to a variety of these asset classes. As your assets grow, it is likely that you will add a few ETF’s to the list of your holdings but don’t expect me to recommend anywhere close to 20-25 ETF’s. You can get the exposure and diversification required with a much simpler approach. Here are the main asset classes that you can look into when building your own ETF portfolio.

Equity ETF’s: Stock exposure
Bonds ETF’s: Bond exposure
Commodity ETF’s: All types of commodities such as agriculture, energy, metals, etc.
Forex ETF’s: Currencies
Alternative Asset ETF’s (real estate, private equity, hedge fund replicators, etc)

Those are the main asset classes but among those you will find several sub-classes, styles or categories. First off, you will usually want to get geographical exposure to other regions. In general, for stocks (and ideally for bonds also), investors want to get exposure to:

-Their own country
-US markets (for non-US investors)
-Emerging markets (China, Brazil, etc)
-Europe, etc

For bonds, it’s also important to get some exposure to both government and corporate bonds as they react very differently depending on the circumstances. For most investors that do not fall in the “wealthy category, exposure to bonds and stocks is more than enough to get decent returns.

As you accumulate wealth, you might want to add additional exposures such as commodities, REIT’s, actively managed ETF’s, sub-categories such as dividend ETF’s, derivative based ETF’s that either return inverse or leveraged returns.  However, in most cases, these would be part of speculative ETF portfolios rather than longer term retirement portfolios. I received many questions about examples. I will be providing detailed portfolio examples but here is one example of asset class that should be part of an ETF portfolio

5 Asset Classes:

Domestic Stocks
International Stocks
Emerging Market Stocks
Government Bonds
Corporate Bonds

If you added 4 additional asset classes, it could look like the following:

Domestic Stocks
International Stocks
Emerging Market Stocks
Government Bonds
Corporate Bonds
Foreign Bonds
REIT
Inflation Protected Assets (bonds, gold, etc)
Income oriented stocks

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Determine Your Asset Allocation

By: Pete | Date posted: 11.23.2011 (11:03 am)

When trying to determine what type of portfolio you will end up having, it is important to determine a complete profile

Why Having An Accurate Profile Matters?

In the investment world, there are no perfect portfolios, it simply does not exist. An important factor to consider is that each individual would in theory have a different “ideal” portfolio. Your asset allocation is by far the most important factor that will determine both returns but also risk and volatility. It depends on a lot of different factors that include you, your job, your financial situation, your financial needs, etc.

Why It Matters

Rarely will an investor need to own 100% of stocks or 100% of bonds. The answer usually lies somewhere between the two. You can also add foreign stocks and bonds, risky ones, add ETF’s that focus on income or on capiatal appreciation, add alternative asset classes (commodities, REIT’s, etc). There are almost unlimited possibilities.

What Are Those Factors?

Age: The younger you are, the more risky your portfolio
Your Finances: The richer you are, the more risky your portfolio
Your Financial Needs: The more needs you have, the more risky your portfolio
Your risk tolerance (can you easily live with the idea of losing 20-30 or even 50% of your portfolio’s value over a few weeks) if it means a higher “expected” return?
Objectives: How much of a return do you need to accomplish your financial goals?

Depending on how you will answer those questions, we will be able to better establish what type of asset allocation is the best fit your needs. In a world where we focus on index/passive investing, asset allocation is by far the most important part to decide. There is no right or wrong answer here, the more risk you add, the bigger swings you will have and the better returns over time.

We are working on a quiz to help you determine what type of asset allocation is the best fit for you, be sure to sign up for our newsletter to find out more about it.