2020 has been a year like no other and doubtless many of you are looking forward to how the rest of the year turns out. The economic fallout from the COVID-19 pandemic has seen many people displaced from their jobs and threatened the very existence of certain businesses. Also, American presidential elections typically add additional uncertainty to the markets.
In such times, it can be easy to fall prey to human nature in the management of your portfolio. Basically, when times are bad, the temptation for mutual fund portfolios is to sell everything and run to cash. Considering the points below should help you avoid that temptation.
Know Your Mutual Fund Portfolio Requirements
Will you need to withdraw money from your mutual fund portfolio next year? How about the year after? If you know you will either have to draw money from your portfolio over a short period of time, or think you might need to draw money out, then that amount should not be exposed to stocks.
From an investment perspective, the appropriate minimum holding period for stocks is best looked at as being 5 years or more. This acknowledges the degree to which stocks can change in value over the short term – such as what we have seen this year.
When you deal with shorter term needs by ensuring they can be funded through low risk assets, you know you won’t be forced to draw from your stocks at a point it lost significant value.
Consider this: you are about to sit down with your advisor for a portfolio review. Your advisor is about to tell you that your portfolio has fallen by “x%” over the past 12 months. How low could “x” be where you would still stay invested?
The higher the stock weight, the greater the potential volatility in your portfolio. When you have discussed and agreed with your advisor the range of tolerable portfolio returns, it will provide for a stronger “buy in” and decrease the potential for panic. This agreement is reflected in targets set for stock and fixed income exposure in the portfolio.
Properly Organize the Assets in Your Asset Allocation
Suppose you have agreed with your advisor that the target asset allocation for your portfolio will be 60% stocks, and 40% fixed income investments such as GICs and bond funds. You could obtain that result with one investment: a balanced mutual fund that would maintain such an allocation.
The only problem in that situation is that the bonds and stocks are “stuck together” in such a fund. That won’t be an issue if you plan to let the fund accumulate over a longer period of time. However, in a short period of time (such as September – October 2008), a balanced fund might be down as much as 15%.
Having some dedicated low risk investments in the portfolio provides “time protection” around your longer-term assets. This may sound like the first consideration: the difference is the first point focused on your requirements; this one focuses on your investments.
If you are relying on your portfolio to provide a significant portion of your income in retirement, would having some of that income guaranteed for life make sense?
In that regard, it could be prudent – depending on your age – to look at using some of the investment assets to purchase a life annuity. A life annuity is a contract with a life insurance company where, in exchange for a lump sum premium, the insurer guarantees to pay you a contracted payment for life. With some companies, that payment could even be indexed. A review of the budgeting component of your financial plan with your financial advisor will help to identify whether annuities should be a consideration.
Some people may look at their investment portfolio as effectively being part of their health insurance, be it for day to day, critical care, or long-term care requirements. Unfortunately, where insurability is unlikely, there may be no alternative but to look at assistance from the portfolio.
However, where insurability is possible, transferring this risk to an insurer through such vehicles as health, disability, critical care, and long-term care insurance can not only help your personal health – but also the health of your portfolio by allowing it to stand for the long term.
The pandemic has certainly had its effect on employment. However, for those fortunate to have maintained employment through these months – owing to the reduced choices for discretionary spending – they may find that they have accumulated surplus cash flow.
Should that be the case, the question I would ask is: have you taken full advantage of your TFSA limit? Putting money into your TFSA will still leave that money accessible, but with a little more effort required than tapping your bank card on the debit machine!
The bonus: if you find that additional withdrawal effort a little too much, then that money will accumulate for future needs.
Hopefully, these thoughts will help you reassess the risk and opportunity in your mutual fund portfolio. If you would like to explore these points further, contact your Scrivens advisor!