With interest rates at historic low levels, and equity markets especially volatile, how are individuals to build a portfolio that will allow for restful nights and a healthy nest egg for retirement?
By assessing their appetite for risk, deciding on their investment goals and diversifying, says Jeffrey Ray, Assistant Vice President, Mutual Funds and Structured Products, Manulife Investments.
The choices facing today's investors are difficult. On one hand, low interest rates mean that anyone counting on GICs [Guaranteed Investment Certificates] to fund their retirement may be out of luck. "If you were to try to grow your nest egg for retirement through guaranteed investments, I'm not sure the math would work out because the rates are so low," says Mr. Ray.
On the other hand, today's equity markets are experiencing frequent ups and downs. "This is more extreme volatility than I think anybody has ever seen over any period of time, and it doesn't look like it's going to dissipate any time soon," he says.
The right approach is to diversify. "Holding different types of assets is number one," he says. "That could be equities, bonds, money market instruments and combinations thereof." That spreads the risk, rather than keeping "all your eggs in one basket."
Diversifying also means looking outside Canada's borders. "You can't just look domestically; it's important to be invested in different places," says Mr. Ray.
"If you look at fixed income or bonds, there are interest rates and yields that are much higher than they are in Canada or the United States. If you look to some of the emerging market countries, and countries like Australia, their government bond yields are much higher than our own – in the four per cent range. If it is yield that you need, you should invest a portion of your portfolio in those countries."
Equities in emerging markets are more volatile than in Canada or the United States, and currency issues add an extra layer of complexity. Still, "from a growth perspective, you're likely going to want to be invested somewhat in emerging markets, where there is a good chance to see some growth."
Diversifying also means not simply expecting one's house to serve as a retirement nest egg, says Mr. Ray. "People seem to be quite satisfied putting money into their home because they feel it's more stable and will be there in the long run. But the real estate market goes through fluctuations. It goes back to my point about not having all your eggs in one basket: having everything in real estate and not buying any equities or fixed income instruments does not make a lot of sense. Real estate prices tend to move in cycles the same way the equity markets do.
"They see times of deterioration, so if you think your house is worth $500,000, it doesn't mean it will be forever. It could go through periods where it's down 10 or 20 per cent. If you need money to put your children through university, and the real estate market's down 20 per cent, you're probably not going to feel too good about having all your money in your house. You would feel the same way if you had all your money in the TSX and it was down 20 or 30 per cent."
Each investor must consider his or her tolerance for risk, he says. "How much can you stomach up and down? How much can you take your portfolio rising or declining? And then create a portfolio to match that appetite or tolerance."
Investors need to decide what their goals are – preferably in discussions with an advisor, says Mr. Ray – and make sure their investment strategy fits those goals. "It could be you want to grow your money as best you can over time, or you want to grow a portion of your money, and you want some of it for income on an ongoing basis. It could be to supplement your income or it could be your sole income.
"If you know you'll be making a big purchase in a number of years, a house or automobile, or putting your children through school, your portfolio can be set up to do that. If you've got to buy something in the shorter term, you'll probably want to have a pool of money that's less risky or more stable, so it's there when you need it."
Progress should be measured "more long term than short term," he says. (He defines the short term as three years or less, medium term as three to five years and long term as five years or more.) "A lot of people, when they get monthly or quarterly statements, tend to become quite emotional and may act on those emotions."
How to prevent panicky reactions? "One way is not to look at all." Realistically, though, a semi-annual or annual review is wise "to make sure you're investing in the things you need to be invested in to get you to where you want to be."
Those with a smart, diversified portfolio usually do well in the long term, he says. "If you're invested in the right areas, things tend to right themselves. Alternatively, if this volatility really scares you and you can't sleep at night, there are safer vehicles."
Studies suggest that people who have a financial advisor tend to stick to their plan more closely than those who don't have one. "If you had to have surgery, you wouldn't try to do that yourself, you'd go to a doctor. If you needed legal advice, you'd go to a lawyer. Your financial portfolio should be dealt with exactly the same way," says Mr. Ray.