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Organize Your Nest Egg for the Long Haul

Organize Your Nest Egg for the Long Haul

Organize Your Nest Egg for the Long Haul
By Adrian Mastracci

Investors often ask what they should be investing in for the year ahead and beyond. Our answer is that the key is to first ascertain the financial objectives on your priority list. For us, investing has always been and continues to be a journey for the long haul. The initial probe is for you to ballpark where you see the portfolio progress, say in five to ten years.

These queries get your analysis off and running. Perhaps you need a well-designed investment plan to get you there. Preparing or updating your retirement projection can shed more light. Estimate the potential effects of a market decline on your progress. Rechecking whether your investment risk is in line or higher than your comfort is also a welcome exercise.

Organizing your nest egg is first about setting simple, methodical policies and strategies. Then you can delve into investment selections. Applying a little common sense helps ease the scope of your job.

Let’s summarize our core portfolio beliefs:

• Prospects. Revisit what is expected of your portfolio. Figure out which is more important, growing or preserving the nest egg or a balance of the two. It makes a difference on its design.
• Mix. Decide on an acceptable asset mix and invest within it. Rebalancing is a good practice. Yes, sell some leading assets and purchase lagging ones as per the mix. Just stick to quality.
• Diversify. Allocate the portfolio into suitable asset classes. Equities are exciting, but don’t exclude those boring bonds and cash instruments. Real estate is also a good fit for many.
• Global. Own a piece of the entire rock. Sprinkle the nest egg all around the world. The biggest allocation is likely to Canada. Then think about other desirable geographies.
• Profile. The investor profile should not change frequently. Neither in good, nor in bad markets. Some may find it more comforting to invest gradually, rather than all at once.
• Sizzle. Skip the chase for those sizzling hot sectors. They often chill down rather quickly. Besides, too many investors miss the exits when the time is ripe to make changes.

Don’t obsess about which sectors may turn out to be portfolio leaders or laggards. Rather, pay close attention to your total portfolio composition. Assume that there will always be some portfolio laggards. This is a reality many have to accept.

Include as many sectors and geographies as possible. It’s not foolproof, but it delivers more often than not. You can’t control market directions, but you can control every portfolio strategy summarized above.

Organize your nest egg with an approach you control. Just proceed with caution at all times. Use this method for 2013 and beyond. The key concepts are expanded below.

Asset location unveiled
Each of us has a preferred method of organization when putting away clothes in the closet. Similarly, every investor can adopt a preferred organization for their financial closet. It is part of tax planning and is called “asset location.” That is, which investment account is better suited to hold assets that you own.

Relate your location decisions to the types of investment income you will generate. Your selections will produce interest, dividend, capital gain and capital loss income. Ideally, you will prefer three different pools of investments, as follows:

• Non-Registered. Are cash or margin accounts owned personally, in a company or in a family trust? Income from Canadian dividends, capital gains or losses realized in these accounts receives preferential tax treatment over interest income. Your “equity” investments are better held in these accounts for maximum tax efficiency. However, the account owner reports the taxable income every year.
• Registered. Typically include the RRSP, RRIF, LIF, DPSP and a variety of locked-in plans. All funds withdrawn from these accounts are treated as fully taxable, like interest and salary. Interest bearing investments are more suited for such accounts. There is no preferential tax treatment of Canadian dividends, gains or losses and the dividend tax credit cannot be used.
• TFSA. All income earned in this account is tax-fee upon withdrawal. Hence, a mix of investment income types is acceptable for the TFSA. Similarly, dividend tax credits are lost and capital losses can’t offset gains outside this account. Unlike RRSP deposits that stop at age 71, TFSA deposits can be made for your lifetime. Sometimes, it also makes sense to hold investments with high capital gains potential in the TFSA.

Owning specific assets in all three pools provides you maximum flexibility in retirement. However, not everyone may have sufficient savings to allocate among all three. Your decisions to withdraw funds from all three pools can change every year, subject to RRIF minimum draws. Having all three pools also provides more flexibility as to when to start receiving CPP and OAS incomes.

Asset location is an important component that fits like a glove with your asset mix. It’s best to weave both strategies into your game plan at the same time. Ensure that your investment professional covers all the locations bases for your best interests. Your chosen combination of location and mix should deliver on your goals and aspirations.

Ways to diversify
Three observations on diversification stand out. Too many investment portfolios suffer from inadequate diversification. Individual holdings within many mutual funds owned are often the same, or quite similar. Too many investors are not aware they lack diversification.

Diversification strategies are essential, time-tested tools for every portfolio. They improve your chances of achieving better consistency of long-term returns. Basic diversification involves spreading your risks across different selections. All within the allocation targets set within your investment plan.

Broad diversification is one necessary safeguard. You don’t want problems arising in any asset class to ruin your well-designed portfolio. Diversification increases the odds of you being right more often than wrong. If some selections are suffering, others can help cushion the rest of the portfolio.

Here are five simple ways to achieve your portfolio diversification:
• Asset classes. Choosing different asset classes for the plan is a prudent step. Equities, bonds, cash, commodities and real estate are most common.
• Economic regions. Portfolios may include selections from Canada and other regions like the U.S., Europe, Far East and emerging countries.
• Time to maturity. A portion of the portfolio could have a range of investment maturities. From as short as 30 days to as long as 30 years.
• Foreign currencies. Investment selections can be purchased in currencies other than Canadian funds, such as U.S. funds, the Euro or hedged to our Canadian dollar.
• Investment quality. High investment quality trumps reaching out for yield. Trading quality for higher yields increases the potential for bigger losses.

Portfolios ought to contain a variety of investments that don’t all move in unison, although seasoned investors know that is not always possible. Diversification should be front and centre in structuring your portfolio. Always invest your nest egg to reduce portfolio risks and aim for more consistent results. That makes for happier investing.

Your investments need fit and purpose
Investors typically save for decades to reach their goals. Then they spend part or all the nest egg over a few more decades. Saving investors may seek portfolio growth. Spending investors typically prefer stable income streams.

Many portfolios are assembled on a makeshift basis. Others are populated from different product sources over the years. Ask yourself whether all your investments have fit and purpose with your goals. If you can’t answer this, action is required whether you save or spend.

Our approach is to first stop buying random investments for your portfolio. Then, take a close look at the “why” you own what you have. It’s important to achieve two things. All investments must fit your game plan. Every investment requires clear purpose in pursuit of your goals. Otherwise, your collection becomes a tangled muddle of stuff.

This short list of simple steps untangles your muddle:

• Portfolio goals defined. Estimate all the family retirement income goals you desire.
• Probe retirement capital. A “what if” scenario ballparks whether your family capital can outlast longevity, say at least to age 90.
• Pursue asset mix. If you don’t follow a portfolio “asset mix,” find a portfolio manager to design yours.
• Ponder retirement spoilers. Assess potential damages if your portfolio incurs a large loss, high inflation or serious health outlays.
• Plan to invest. Develop your well-conceived plan for the long run, then methodically fill your investment requirements.

Taking these steps assists in shaping a better investment plan. If required, a second opinion can reduce your apprehensions. Always be certain your investments have purpose and are fit to own. Don’t accept anything less.

Baby steps to a portfolio makeover
At some point, every portfolio may require a partial or total makeover, especially, those that keep buying random investments. However, a complete portfolio overhaul can be too much to contemplate. Some investors are also reluctant to initiate such a thorough process.

Starting with gradual tweaks often makes good sense. Ultimately, a total remodelling may be required. Let’s consider some simple baby steps. Start by ensuring that your risk tolerances are comfortable and appropriate.

Follow by selling some losing positions and learning to take some profits. Explore some other alternatives to be sure. Finally, design your gradual investing strategy.

Baby steps help open the gates and create momentum for bigger changes. They also reduce ongoing portfolio mess-ups. Think of them as act one of your portfolio makeover—a methodical road map to your ultimate destination.

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