Kiss

By Guest Blogger Ryan Lewenza

No I’m not talking about the spandex wearing, blood spitting rock band from the 70s (but how great are the songs “I was Made for Lovin’ You” and “Detroit Rock City”!), rather today I’m talking about the KISS principle, that is “keep it simple, stupid”. A tip of the hat first to one of our clients who reminded me of this great concept that he lives by. I’m also a strong proponent of this, especially as it relates to investing. Our industry has a bad habit of over-complicating things when for most people keeping it simple is the best way to go and often results in the best outcomes. So today I “keep it simple, stupid” by highlighting a few key investment principles and strategies that will help readers improve their investment outcomes and better achieve their long-term financial goals.

1. The Beauty of Balance

Unless you’ve been living under a rock you know that we are not huge risk takers and at our core we believe in balanced portfolios, using a mix of equites and bonds in constructing client portfolios. The key reason we believe in balanced portfolios is that one asset class is always (generally speaking) working while the other is not. For example, in a strong economy stocks generally do well due to rising corporate profits and bullish investor sentiment, while bonds underperform as interest rates and bond yields rise. So in a strong economy stocks are going up while bonds are flat to down.

Conversely, in a weak economy or during a recession central banks are cutting interest rates, which are generally good for bonds (government and high quality corporate bonds in particular) while stocks are generally weak. So bonds are going up while stocks are selling off.

Basically there is an embedded push/pull dynamic within balanced portfolios. This can be seen in the chart below, which compares the relative performance of Canadian stocks and bonds. The green line indicates periods when bonds are outperforming, while the red line indicates stocks are outperforming. This chart essentially captures this push/pull dynamic and why we believe so strongly in building balanced portfolios.

Relative Performance of Canadian Stocks and Bonds

Source: Morningstar, Turner Investments

2. Diversification

Next up is the importance of diversification in portfolios. This is the old adage “don’t have all your eggs in one basket”. We view diversification in two key ways. First, is at the individual security level. We prefer to invest in ETFs, which holds a basket of securities rather than investing in individual stocks or bonds. Numerous studies have shown that to have a well-diversified portfolio – that is a portfolio that removes “non-systematic risk” or company specific risk and leaves the investor with just “systematic” or market risk – you need to hold over 30 different securities. Essentially we’re just talking about minimizing the risk of holding a Nortel, Sino-Forest or Bre-x, which can torpedo a portfolio.

The second element of diversification is to hold a number of different asset classes, ranging from stocks, bonds, cash and then down to specific areas within the equity and bond markets. For equities this would include things like investing in both small and large-cap stocks, and across different sectors and geographies. For bonds this includes holding a mix of government, corporate and high-yield bonds. The reason we want to diversify across different areas is that we never know for certain, which asset class is going to outperform in a particular year. Take a look at the busy table below, which tracks the annual performance of different assets over time and you can see just how random performance can be. So hold a mix of different assets classes to better diversify your portfolio.

Annual Returns for 20 Major Asset Classes

Source: Fidelity

3. Low Fees

Our third KISS principal is to focus on low fees, either looking at the fees on different mutual funds, ETFs etc. or the fees charged by a full-service advisor for the services provided. High fees can have a huge impact on performance and long-term investment outcomes.

For example, let’s compare two portfolios both earning 7% before fees, with one investor paying a 1% fee versus and the second investor who pays a 2% fee. Assuming the two investors both save and invest $20,000/year for 25 years, the investor paying a 1% fee would see their portfolio grow to $2.36 million versus the second investor who would see their portfolio grow to $1.89 million. The 1% higher fee from the advisor or mutual fund company results in a lower ending portfolio value of $465,691 for the second investor.

Clearly, fees are a huge deal and it’s why we prefer to invest in low-cost ETFs and why we charge a 1% fee to clients versus the overall industry at 1.5% and higher.

Ending Portfolio Values for Investors Charged 1% and 2% Fees, Respectively

Source: Turner Investments

4. Saving Early

This is an oldie but a goodie. Do to the power of compounding returns the benefits of staring early to save and invest are immense. If an individual starts saving $20,000/year at age 30 and earns a 6% return over the long-run they would have $2.36 million by age 65. Compare that to a person who starts saving the same amount at age 40 and they would have just $1.16 million at retirement. So saving the same amount but starting 10 years earlier results in a higher portfolio value of $1.2 million at retirement.

Readers don’t waste another day! Start saving now if you want to have financial security, peace of mind, and a great retirement.

Portfolio Values if Start Saving at 30 and 40, Respectively

Source: Turner Investments

5. Taxes and Portfolio Construction

Finally, we live in high tax country and it’s seems to be only getting worse so smart tax planning is a critical aspect in structuring portfolios and one’s overall financial affairs. This includes things like maxing out RSP contributions to reduce your income and taxes paid, topping up your TFSAs to shelter future growth, income splitting pension income, borrowing to invest, which allows you to write off the interest, and focusing on Canadian dividend-paying stocks due to the dividend tax credit.

From a portfolio perspective it’s critical to structure the portfolio in a tax-efficient manner so that you minimize taxes paid and maximize your after-tax return. We don’t want to make clients more money just to send it back to Uncle Sam, or in our case Uncle Trudeau. This involves putting more of your bonds in your RSP as interest income is taxed at your higher marginal tax rate, putting higher growth equities in your TFSA to shelter future capital gains, and placing dividend-paying stocks in your non-registered account, which allows investors to take advantage of the dividend tax credit.

It’s one thing to build a well-diversified and balanced portfolio, but then you also want to structure it as tax efficiently as possible.

So there are five easy and simple strategies to grow your wealth, achieve financial security and have a bitchin’ retirement. Get to it!

Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.