Practical Personal Investing: Diversification and Assets Allocation

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1 Practical Personal Investing: Diversification and Assets Allocation Diversification and assets allocation are essential elements of Investment Risk management. investment returns are really the by-product of effective risk management. We seek to be paid for the risk we take and are proactive in our risk management approach. (Ontario Teachers Pension Plan website) Diversification helps in reducing risk by investing in a variety of assets. In plain English: Don't put all your eggs in one basket. There are different views on how much diversification is required. The advantage of a diversified portfolio is reduced risk. The disadvantage is the detrimental effect of the underperforming asset class on the portfolio performance. Some investors use rules of thumb, such as assets allocation based on age. For example, one of the rules specifies that a 70-year-old investor should have 70 percent investment in bonds and/or GICs. Practical Personal Investing, Diversification, presented by Greg Shtock 1

2 Do these rules work for everyone? Should you not have an asset allocation strategy that best fits your situation and market conditions? A diversified portfolio seeks a balance between Risk and Return. Find the required balance between the different asset classes that meets your needs. Re-balance your portfolio when a significant change occurs in one or more asset classes. The second consideration is the reduction of your exposure to the markets during severe downturns, such as in 1929, 2000, 2008 and. What about shifting your asset allocation from equities to cash in a severe market downturn? Consider Buy and Hold vs. Active Investment Strategies, which is the subject of our next session. Practical Personal Investing, Diversification, presented by Greg Shtock 2

3 Illustration of Asset Allocation from American Association of Individual Investors Practical Personal Investing, Diversification, presented by Greg Shtock 3

4 Canadian MoneySaver Model ETF Portfolio* ETF Symbol Category % of Portfolio ishares 1-5 Year Laddered Bond CBO Fixed Income 10.0% ishares DEX Universe Bond XBB Fixed Income 5.0% ishares S&P/TSX Canadian Preferred CPD Fixed Income 5.0% ishares S&P/TSX 60 Index XIU CDN. Equity 20.0% ishares S&P/TSX Cdn. Dividend Aristrocrats CDZ CDN. Dividend 15.0% ishares S&P TSX Capped Energy XEG CDN. Equity 10.0% ishares S&P/TSX Global Gold XGD CDN. Equity 5.0% Vanguard Total Int l Stock VXUS Global Non US 5.0% SPDR Euro STOXX 50 FEZ Global Equity 5.0% SPDR S&P 500 SPY US Equity 5.0% Vanguard Div. Appreciation Index VIG US Dividend 5.0% ishares Russell 2000 Growth IWO US Growth 10.0% *MoneySaver Magazine November/December 2013 Practical Personal Investing, Diversification, presented by Greg Shtock 4

5 The chart below shows the percentage of stocks, bonds, and cash owned by individual investors according to the survey carried out by American Association of Individual Investors. Practical Personal Investing, Diversification, presented by Greg Shtock 5

6 Be Aware of the Issues arising from the Correlation and Overlapping of Asset Classes. Correlation is a statistical measure of how two securities move in relation to each other. It is expressed as the correlation coefficient, which ranges between -1 and +1. Positive correlation means that when one security moves up or down, the other security will move in the same direction. Negative correlation means that when one security moves in one direction, the other security will move in the opposite direction. For effective diversification, you want to hold securities that have low or negative correlation to each other. Investors who put their money in stocks can easily tell what percentage of the portfolio each stock represents. Those investors who own funds and ETFs often have a tougher time. That s because funds can hold many stocks, and investors might pay little attention to what the funds underlying holdings are as long as the fund categories seem to suggest a well-diversified portfolio. Practical Personal Investing, Diversification, presented by Greg Shtock 6

7 It is challenging to find investments with negative correlation. Short Selling would have negative correlation. Short selling is motivated by the belief that a security's price will decline, enabling it to be bought back at a lower price to make a profit. Short selling could be also included in a diversification plan to hedge the downside risk of a long position in a related security. Put Option becomes more valuable as the price of the underlying stock depreciates relative to the strike price. Therefore, it would have negative correlation to the underlying stock. Inverse exchange-traded fund (ETF) that is constructed by using various derivatives for the purpose of profiting from a decline in the value of an underlying benchmark. Investing in these ETFs is similar to holding various short positions, or using a combination of advanced investment strategies such as put options to profit from falling prices. These also known as a "Short ETF," or "Bear ETF. Warning: Inverse ETFs should NOT be used as a long term investment due to their structure and re-balancing requirements. Practical Personal Investing, Diversification, presented by Greg Shtock 7

8 Examples of Inverse ETFs. Inverse performance of the Dow Jones Industrial Average ProShares Short Dow 30. Ticker DOG. Expense Ratio 0.95%. It seeks daily investment results, before fees and expenses, that correspond to the inverse (-1x) of the daily performance of the Dow Jones Industrial Average SM. This Short ProShares ETF seeks a return that is -1x the return of an index or other benchmark (target) for a single day, as measured from one NAV calculation to the next. Due to the compounding of daily returns, ProShares' returns over periods other than one day will likely differ in amount and possibly direction from the target return for the same period. - See more at: DOG DIA Practical Personal Investing, Diversification, presented by Greg Shtock 8

9 Examples of Inverse ETFs. Symbol Name SH ProShares Short S&P500 SDS ProShares UltraShort S&P 500 RWM ProShares Short Russell2000 TZA Direxion Small Cap Bear 3X Shares 2013 Russell 2000 SPXU ProShares UltraPro Short S&P 500 QID ProShares UltraShort QQQ FAZ Direxion Financial Bear 3X Shares TWM ProShares UltraShort Russell 2000 PSQ ProShares Short QQQ SQQQ ProShares UltraPro Short QQQ Fund DOG ProShares Short Dow30 EFZ ProShares Short MSCI EAFE SPXS Direxion Daily S&P 500 Bear 3X Shares EUM ProShares Short MSCI Emerging Markets DXD ProShares UltraShort Dow 30 HDGE Ranger Equity Bear ETF DUST Direxion Daily Gold Miners Bear 3X Shares SDOW ProShares UltraPro Short Dow 30 Fund EDZ Direxion Daily Emerging Markets Bear 3x Shares SRTY ProShares UltraPro Short Russell2000 Fund FXP ProShares UltraShort FTSE China 25 BIS ProShares UltraShort Nasdaq Biotechnology SKF ProShares UltraShort Financials DUG ProShares UltraShort Oil & Gas ERY Direxion Daily Energy Bear 3x Shares Practical Personal Investing, Diversification, presented by Greg Shtock 9

10 Additional Source of Information U.S. Securities and Exchange Commission: Beginners Guide to Asset Allocation, Diversification, and Rebalancing To download or read this presentation, go to our website Practical Personal Investing, Diversification, presented by Greg Shtock 10