How to cope

Okay, kids, time for a portfolio update. Yes, 2019 has been terrific for investors. So far this year (and it just turned March) the Dow has added 11.5%. The S&P 500 is ahead 11.8%. And Bay Street has roared – up more than 12%. If markets just go sideways for the next nine months it will still be juicy.

Why the big reversal from December? The trade environment improved, and it looks like some kind of deal will be reached between the US and China. Trump stopped attacking the Fed (although he was at it again over the weekend), constantly undermining American central bank monetary policy. Corporate profits have remained robust, but no longer torrid. And investors started seeing real value in Canadian companies which had been mercilessly sold off, while the P/E ratios for US equities improved.

So here we are. The Dow is within 3% of its all-time high. Canadian bond yields have fallen 22% from a few months ago. The economy may have slowed and everyone you know is pickled in debt, but balanced and diversified portfolios have been just ducky. While the steerage section was moaning about maple last year you might have recalled the suggestion here to boot up domestic exposure a little. Now you know why. Buy low.

But the rest of 2019 might prove to be more volatile. In Canada we have a federal election and a wounded Lib government. Anything could happen after JWR. In the States Trump faces the Cohen fallout, Democratic legal challenges, a fight over his ‘emergency’ wall and, of course, the Mueller report.

Trump considers the economy (and the stock market) to be a proxy for his administration, which boosts the odds for a China deal, or another tax reduction. If the president can do anything about, the GDP will expand, unemployment sink and the Dow moonshoot for 30,000. Get set for quite a ride.

How do you invest for a year like this? Not by retreating into cash, dumping money into a low-energy GIC or (gasp) buying gold. The logic behind a 60-40 growth/fixed income portfolio remains unassailable, but a few tweaks are in order.

The big do-over: markets surge 11+ so far in 2019

First, no harm in having a little more cash on hand since this is a defensive asset and volatility lies ahead. Returns have also improved on cash instruments, so you can at least pace inflation without locking up. How much cash? Try 5%.

The remaining 35% of the fixed-income portion of the portfolio is slightly overweighted to bonds, with 13% in government debt and 7% in corporates. The position in high-yield bonds which made sense over the past few years now carries more risk. Dump it. The remainder of the FI part of the portfolio is made up of preferred shares – which have been trimmed to 15%. Prices have improved since Christmas and yields sit around 4.5%, plus you can benefit from the dividend tax credit.

On the growth side, the maple component was boosted some months ago to 21%, while US exposure was trimmed to 18% and international sits at 21%. The logic was simple. Canada was undervalued. American was inflated. Global growth is powering ahead. The home country exposure is 16% large cap and 5% in REITs. US exposure is all large cap ETFs, while international is 15% Europe and Far East plus 6% emerging markets. Of the above, a little over 20% is in US-dollar denominated funds.

Choose your exchange-traded funds carefully. Embedded fees are important, of course, but liquidity is probably more of a concern, plus the stability of the issuer. You might be tempted to buy a one-size-fits-all balanced ETF, but in doing so you’re surrendering control to an algo. You lose the ability to rebalance in a way that meets your own risk tolerance and performance goals.

Also put assets in the right places. Bonds pay interest, which is taxed more, so stick them inside an RRSP. Emerging markets are likely to be more volatile and dish up superior long-term growth, so they go inside the TFSA. The dividend tax credit on prefs can only be enjoyed in a non-registered account.

The idea of this portfolio is to protect you when markets decline, grab the growth when they advance, and keep you exposed to major asset classes. If you set it up properly, rejigging it once or twice a year (selling off the winners and buying the losers to maintain weightings) then you can basically forget about it.

The worst mistake? Easy. It’s the one most DIY investors can’t get over: buying and selling based on headlines or some pathetic blog. Despite the big crash of 2018, a 60/40 portfolio – if left completely untouched – gained 16% over the last thirty-six months. During the 2008-10 massacre, it returned an average of 5% per year. All you need do is remember the advice being thrown at you last December from commenters on this site (sell! run! sell!) to see why emotion is the enemy.

Set it. Forget it.