Tuesday, July 22, 2008

Fixed Income Investments: Should You Have Some?

Now, we know that saving money is wise, and that our savings should be diversified. We've discussed the four steps to wise investing; now let us delve deeper into the realm of fixed income to determine whether or not it might be a valuable component to your portfolio.

Let us first discuss what fixed income products are: essentially, they are products that will provide you with an income stream. They may include things like bonds, GICs, mortgage backed securities, pooled mortgage mutual funds, income trusts, and even real estate funds and trusts.

These types of products will provide you with an income stream based upon interest rates, or in the case of income trusts and real estate funds, income, rents or royalties.

The reason to own them is simple - they tend to be less volatile than equity, which can provide your portfolio with some stability. Further, the continuous flow of income into your portfolio can be a welcome addition in times of serious volatility. It can be comforting to know that cash is continuing to come in, even though the values of some of your other products are declining.

So, the question becomes, how much is correct for you? This can only be determined by undertaking an objective assessment of your tolerance for risk. The more comfortable you are with risk and volatility, the less fixed income you should hold versus equity. Therefore, the less comfortable you are with risk and volatility, the more fixed income you should hold.

Fixed income products themselves can be rated according to risk: GICs are significantly less risky than bonds, bonds (usually) less risky than income trusts. Ultimately, the total risk of the product will be based upon what guarantees are associated with it, and what degree of diversification can be found in the underlying holdings.

Fixed income products are usually very sensitive to interest rate changes. For example, when dealing with bonds, the "coupon" rate or rate of interest paid back to the bondholder is set at the time the bond is issued, and will be in some way related to the current interest rate environment. Because bonds can usually be traded on the open market, their market value is determined by the length of time they have to maturity coupled with their current "coupon" rate. Due to these factors, if a bond is issued and then interest rates fall, the value of the bond will go up, as new bonds that are issued are likely to be issued at a lower coupon rate, thereby making the first issued bond more attractive to investors, as the income from the bond will be higher.

Similarly, if a bond is issued and then interest rates go up, the value of the bond will decrease as new bonds issued will likely have a higher coupon rate attached to them.

GICs, on the other hand, can not be traded on the open market, and are generally considered to be fairly safe. What you buy is what you get.

Ultimately, having a fixed income position can be a useful way to reduce your portfolio volatility, and can provide you with opportunities for rebalancing, as fixed income and equity cycles do not tend to correlate very closely.

As always, consider discussing things with your advisor.

Monday, June 23, 2008

Budgeting - The Foundation of Financial Success

The very foundation of every good financial plan is a cash flow plan, or budget. Budgets are actually fairly simple to create, but require that the budgeter is honest with themselves. Aye, there's the rub. As it turns out, most people would much rather not investigate the truths in their spending habits, as it is in those truths that their personal demons lie...

Some don't want to admit they spend that much money on "entertainment", others spend too much on shoes or other clothing items, some aren't interested in facing the fact that the interest costs on their short term debt are higher than what they allot themselves for food.

Yes, these are unfortunate issues. In fact, the lack of will to look plainly at their spending habits is the number one reason most people spend their entire lives playing catch up, rather than enjoying the fruits of their labours.

See now why it's useful to have a coach? Often I have spent time going over the budget specifics with clients of mine in order to assist them in getting smart with their cash flow. I once saved a family $1700 per month in unnecessary cash flow expenditures just by rearranging their debt. That's big money. Imagine what benefits you might find just by spending the time to investigate where all the money goes.....

How many of those monthly transactions that occur automatically out of your bank account are necessary? How many of those transactions can you even say for certain that you know what they are? Don't you think that it might be important to know where your money goes?

Now, why again can't you save an additional $50 or $100 per month?

So, the question becomes, what's the process? Well, the first thing to do is to begin documenting every transaction that you make. One of the often discovered side benefits of this particular activity is that, when you're actually forced to write down your purchases ALL THE TIME, it can sometimes change your decisions and curb some of those unnecessary impulse purchases.

Then, you need to start posting those purchases to individual expense categories, such as rent/mortgage, utilities, groceries, fast food and snacks, liquor, cigarettes, gasoline, bus passes, vehicular maintenance, car lease or purchase payment, subscriptions, insurance, savings, etc. You get the drift.

At the end of a couple of months, you'll see some clear patterns emerging in terms of each expenditure category. Here is where you need to actually spend some time thinking about what's really important. Ask yourself the following questions: Is this item important enough to my future goals to require this percentage of my income? Is this item more important than that item?

You need to start to prioritize. Again, this is where it can be useful to have a coach to whom you make yourself accountable. The simple fact is, most people will not go all the way through this process, as they're simply too weak to be honest with themselves.

How about you?

Once you've been through the thought process and considered your spending habits and patterns, once you've spent the time prioritizing the categories, you can begin to allocate your future funds to the individual categories. This, my friend, is your cash flow plan.

The next step is to stick to the budget. Again, useful to have a coach here to keep you honest. Nonetheless, however, there's simply no chance that you're going to be successful unless you monitor your expenditures, and stick to the amounts you've budgeted. This goes back to building good habits.

If you are able to create an honest budget predicated on genuine numbers and thoughtful consideration of your life goals, and then have the discipline to stick to that budget, you are on your way to executing your very own financial plan, and will very likely find considerably more financial success than most others out there. You can do it if you really want it.

But it does help to have a coach.

I'd be really interested to see comments below from readers who have spent the time to do a proper budget, and how that has been valuable to them. Thanks for your time and feedback!

Tuesday, June 17, 2008

What is a Mutual Fund?

One of the primary reasons I got into this business in the first place was that I had identified that there were a lot of people out there who were investing money using mutual funds, though they didn't really understand what a mutual fund is or how it works. This troubled me deeply, as I felt very uncomfortable with the idea of so many people trusting so much money to a system they understood very little about. As I learned more about financial markets and how they worked, I came to understand that a great deal of financial anguish on the part of individual investors was the result of a poor understanding of the behaviour of their investments. As such, I decided that my life's work would be to educate, advise, and assist regular folks in making wise investment decisions.

So, what is a mutual fund?

The simple answer is that a mutual fund is a pool of investors' money, managed by a professional money manager. The manager will usually have a team of people working for them, including analysts, traders, and other professionals. The manager's job is to grow that pool of money by making wise investment choices.

An mutual fund will usually have a specific mandate, which means that they will choose their investments based upon the "mission" of the fund. First and foremost, the fund will either be an "equity" fund or a "fixed income" fund. An equity fund will buy stocks of publicly traded companies. A fixed income fund will usually purchase bonds and other types of debt securities. Generally speaking, equity funds are considered to be "riskier" or more volatile than fixed income funds.

Equity mutual funds will usually have a geographic mandate, which means that they'll only invest in a certain geographical region such as Canada, Europe, US, Asia, etc. Sometimes they will have a sector mandate, meaning that they'll concentrate on a certain economic sector such as materials, retail, infrastructure, financial companies, etc. They may also choose to invest in companies based upon their size.

Usually, an equity mutual fund will also have a certain investment philosophy as well. They will seek out companies based upon a value approach, or a growth approach. The value approach seeks to identify companies that are trading at a price less than a professionally calculated "intrinsic" value, usually based upon their financial performance and the value of their assets. The growth approach seeks to identify companies which have the potential to grow at a rate superior to their peers, based upon a particular competitive edge in their market.

What does all this mean to you? Well, the fact that mutual funds have these investment mandates means that you're able to build a diversified portfolio of investments. You're able to own different funds that represent different sectors of the economy, and that represent different geographies. This is important, because these different sectors and regions experience different economic conditions and circumstances. By spreading your money around a bit, you reduce the risk that the value of your portfolio will experience wild swings up and down. Of course, its the wild down swings that we're trying to avoid.

Something else to note: it costs you money to own a mutual fund. The cost of owning the fund will be reflected in the Management Expense Ratio (MER), which is expressed as an annual percentage of the fund's total assets. This amount may be anywhere between 1 and 5% per year, or more sometimes. These days, average MERs tend to run in the neighbourhood of 2 - 3%. The thing to remember about the MER is that the fund's performance is reported to you NET of the MER, which means that if the fund reports that it returned 8% last year and had an MER of 2%, it actually returned 10% but kept back 2% for expenses, thereby passing along a net gain of 8% to the investors.

Mutual funds are an affordable and reliable way for the passive, every day investor to participate in equity and fixed income investing. Because direct investing in stocks and bonds is expensive and requires a great deal of very specific knowledge, mutual funds can provide opportunities to grow your pool of money, helping you to plan for prosperous future.

Wednesday, June 11, 2008

Mortgage Insurance - Why Using Individually Owned Insurance is the Right Answer.

On February 6th, 2008 the CBC show Marketplace provided a most valuable bit of public awareness to an issue that, up until then, was not widely understood. The issue is that of mortgage insurance. Namely, pitfalls of bank owned creditor insurance versus the value of having individually owned life insurance. The complete episode can be found here on the CBC website. I'd suggest you watch it when you have a moment. It's worth seeing if you currently have or plan to get a mortgage.

Let me begin with some brief explanations.

When you get a mortgage, it's generally considered to be advisable that you have some life insurance to cover the value of the mortgage in the event of death. For example, if you have a family you may wish for them to be able to stay in the family home in the event of your death.

Usually, when you get a mortgage, the mortgage officer or broker will offer you the opportunity to insure the mortgage. The product that they are offering is bank owned creditor insurance. The insurance is paid for by you, and owned by the bank. In the event of your death, the mortgage is subsequently paid off. Well, that's the general idea, anyway.

There are a number of problems with the bank owned creditor insurance. Of them, the most worrisome is that they are not underwritten until time of claim. What this means is that the contract essentially states that, provided that you are insurable without ANY additional risk considerations, they will honour the insurance contract AFTER they have had a chance to do a thorough investigation AT THE TIME OF CLAIM. However, because there are very, very few cases that meet those criteria, many claims get denied. This is because many common illnesses and sicknesses for which you have been treated warrant further investigation, which is an additional risk consideration.

The point is not that you were a riskier case, the point is that everything needed to be disclosed. Where this thing tends to go off the rails is that, when answering the brief questionnaire presented by the mortgage agent, people tend to think in terms of "serious issues" rather than answering the question fully and completely, and are not coached adequately on how to answer the questions by the mortgage agent. The mortgage agent, by the way, is not a licensed insurance professional, and therefore does not have the necessary training with regard to insurance law, practices, procedures, or documentation. Have a look at the first question in the questionnaire. How would you answer that question? What if you didn't actually read it, but rather had it read out loud to you, word for word, at conversational speed? Would you answer it "no"?

Let me ask you another question. Have you been to the doctor at all, for any reason in the last two years? If so, you should have answered yes to that first question.

The sad thing is that many, many people answer "no". As such, they are denied claims because they are considered to have answered fraudulently. At claim time, the underwriters have access to ALL of your medical records in order to determine whether or not you meet the claim criteria. And the real issue here is that the mortgage agent or broker bears no liability for having done a shoddy job of the application. They are not held accountable.

Contrast this with a licensed life broker who IS held accountable for doing shoddy work. The licensed life broker or agent can be fined, or lose their license for not acting in their client's best interest at ALL TIMES.

The long and the short of it is that you would have a better measure of protection if you were to have a product that was underwritten at the time of application. In this circumstance, the insurance company does an investigation into your insurability prior to offering you a contract of insurance. However, once offered the contract, provided that you have not lied on the application, the insurance company MUST NECESSARILY pay out the claim at time of death.

Herein lies the difference: with mortgage (creditor) insurance, they decide whether or not to pay you at the time of claim. With individually owned insurance underwritten at application time, the insurance company determines how much to charge you in return for a promise to pay at time of claim.

Of the two, the individually owned insurance provides better knowledge that the financial risk has been managed.

Have a look at all of the information regarding this issue on the Marketplace site. There is a table that further details the difference between the two types of coverage, and a slough of comments from the public regarding the issue. It's a valuable read.

Speak to your financial advisor. This is important stuff.

Saturday, June 7, 2008

Get Off the Bandwagon! Mind the Oil!

This week I met with a mutual fund wholesaler from a very well known and reputable firm. Alas, he was imploring us, as advisors, to have faith in a couple of their very well known and historically popular funds, though recent performance has been nearly the worst it has ever been.

One of the arguments this wholesaler offered was that chasing the winners is rarely a good strategy. With that, I was forced to agree. As this article in the Financial Post so eloquently states:

It appears many advisors are giving clients what they want rather than the tough love they require. Advisors are more informed than typical investors because of how they spend their days, but "that makes them susceptible to being caught up in the latest fad," Mr. Richards says. Even so, he still believes "the vast majority" of investors benefit from dealing with experienced advisors who provide "a second opinion to curb the excesses. A good advisor operates as an emotional anchor."
Well, with that said, let us turn our attention to the subject of oil. Oil is a subject much talked about in a wide variety of circles. In fact, the price of oil has gotten to the point where nearly everyone is somewhat familiar with the current price of a barrel of oil. To me, this is indicative of a serious issue.

This recent article in Fortune details a well considered argument for a future correction in oil prices. I tend to agree with the position.

What's the point? The point is that everyone has been very excited about the profitability of the energy sector for a long time. The price of oil is higher than it has ever been. High enough that consumers are beginning to change their behaviours and other forms of energy supply are starting to come on line, thus reducing demand.

Beware the advisor that has you overweight in energy, or for that matter, overweight in Canada, which is primarily energy and financial stocks. The wise choice is still, as it was always, not to gamble on sectors or trends, and rather to focus on the long term with a well diversified and regularly rebalanced portfolio.

Thursday, May 29, 2008

Evidence of Inadequacy

Report on Business is reporting today the release of a new study by the C.D. Howe Institute calling for the creation of yet another government administered pension plan. The premise of the report's recommendation is that not enough Canadians have access to an employer sponsored pension plan and, of those who do not, many are not utilizing the savings vehicles in place to provide for post retirement income, such as RRSPs and the like. The position the report holds is that the managed money world (mutual funds, etc.) is fraught with high fees, which erode investors' returns, thus hampering their ability to accumulate sufficient retirement assets.

So, the moral of the story is that not enough people are saving money to fund their retirements. The C.D. Howe Institute obviously sees this as being detrimental to the future health of Canada's economic environment, and therefore is calling for government intervention.

Though I most certainly agree that not enough people are saving enough money for themselves, robbing from their future to finance their todays, I have a difficult time with accepting that the government should step in to save people from their own lack of foresight.

Do I believe that there are some outrageous fees out there? Yes. I think that there are a number of mutual fund companies that are charging fees that do not adequately reflect the value they're providing to individual investors. However, I do not believe that having the government step in and take over the business of managing retirement money for Canadians is an appropriate response to the issue. Perhaps enhancing the regulations on money managers with respect to how they levy fees might be a more measured and appropriate response.

How do you feel? Should the government be stepping in to save us all from ourselves, or does the responsibility for a happy retirement lie on the shoulders of the individual? I'd be interested to hear your comments.

Tuesday, May 20, 2008

Habits

Hi folks,

There are various different "levels" at which an advisor can assist the client. These can range all the way from the very basic "coaching" to help you develop habits, to the very involved process of estate planning.

In my experience thus far, most people who haven't before worked with an advisor are in the riskiest place of all, the "I don't have an emergency fund" place. Usually, when I encounter this circumstance, the first thing we'll do is get started on some type of a regular savings plan. Many advisors will, at this time, suggest that the client begin an RRSP and suggest using some specific mutual funds. This is where I differ.

The problem with the "I don't have an emergency fund" place is that the risk of needing to dip into that RRSP fund is huge. All it takes is a broken vehicle, a leaky roof, or a dead furnace to erase all that hard work. People will either dive deep into short term debt solutions such as credit cards or lines of credit, or redeem RRSP funds, often incurring sales fees and usually causing some serious tax inefficiency, not to mention the forever lost RRSP contribution room.

So, the risks are pretty high, as most people will at some point in their life encounter the broken vehicle or dead furnace problem.

As a risk management guy, I'm always looking at ways to reduce risk. The best solution I have seen for the beginning saver is to start by building good habits.

Good habits to build:

  • save some of every single paycheque
  • budget your cashflow and monitor your expenditures
  • limit the amount of impulse purchases to a fixed dollar amount per week or month
  • never ever touch saved money without due consideration as to the consequences of that action

That last point is essential, and here's why. I've worked with a number of younger families (30-45 years of age) who have made a HABIT of redeeming their RRSP funds or other long term savings to offset shortfalls in cashflow, to pay off credit cards, or to pay for trips or other big ticket items. The problem with this behaviour is that, psychologically, the individual has now crossed the "Do Not Touch This Money" line. That may sound like it's no big deal, but people tend to repeat the behaviour. This is what takes most people off track from reaching their financial goals, and what usually leaves them mired in the short term debt cycle.

So, learning good money habits is essential. In order to do this, the advisor must act as a coach, encouraging the client to save in low risk, low volatility, liquid vehicles such as high yield savings accounts or money market funds so as to build up an emergency reserve as a cushion. Then, only after the client has been able to develop saving as a habit, should we look at putting some of it away for longer term goals.

Have you ever redeemed money from your RRSP? When was the last time your credit card had a zero balance? Perhaps finding a good coach would be helpful.

Friday, May 16, 2008

Segregated Funds

Hello again,

The following message isn't for everyone.

An important aspect of planning your investments and your financial future is risk management. Of course, this is where a qualified professional can come in handy... Nonetheless, let's have a conversation about the stuff nobody wants to have a conversation about.

What are some of the risks you'll face as you work toward executing your financial strategies? Here are a few to consider:

- you get sick, can't work, and therefore have no income
- you die
- you divorce, your spouse takes half of everything, alimony and/or child support take a large chunk of your income
- you get fired, laid off, downsized.
- a fire or other natural disaster destroys your home and everything in it.
- your business fails
- you get sued

I'm sure there are more, but I'm not trying to freak you out or otherwise depress you. What I'm trying to do is to demonstrate that, irrespective of all of the hard work we do to earn an income and save some money, there are going to be times when events conspire to ruin good people.

So, what can be done? Briefly, get some insurance. In most of the situations mentioned above (except the marital ones, those issues are outside of my purview of expertise), different types of insurance can help offset the risk.

Did you know that there was a way to protect your investments in the event that your business fails or you get sued? There is. Use segregated funds.

Segregated funds work very similarly to mutual funds, except that they are an insurance product. Essentially, you, the insurance contract owner, owns the insurance contract. The insurance contract has contractual claim to the investment assets.

The brilliant part of this arrangement for the contract holder is that, because its an insurance contract, its governed by insurance legislation. Because of that, it cannot be seized by creditors*.

So, if you get sued or become insolvent, your segregated funds should be safe, whereas had your portfolio been constructed exclusively of mutual funds, stocks, bonds and real estate, all of your assets would be at risk.

Another little known benefit of segregated funds is that, because they are an insurance product, they are paid out upon death directly to the beneficiary and therefore circumvent probate. For most, this is likely a non-issue. However, probated wills are public documents, viewable by anyone. Did you know that? Some people would prefer some discretion in certain circumstances (sensitive family issues, mistresses, general privacy concerns, etc.) and would benefit from having some of there assets in an insurance vehicle such as segregated funds.

Now, with all that said, I'm not here to tell you that segregated funds are the end all be all of investing, because they're not. I've spent a lot of time searching for good ones, and there aren't many. Also, they tend to be more expensive to own, as there are certain guarantees inherent in them that standard mutual funds don't have, such as guarantee of principal. So, they're not for everyone all the time, but they can fill a niche for some folks such as business owners and professionals which other products simply cannot.

* - According to the Canadian Life and Health Insurance Association:

• Potential creditor protection
When the contract’s named beneficiary is a spouse, child, grandchild or parent of the insured person (or, in Quebec, the contract owner), when the beneficiary is designated irrevocably or, in some provinces, where the contract is registered (for example, as an RRSP), creditors cannot seize a segregated fund contract if the contract owner declares bankruptcy or fails to pay his or her debts, as long as he or she has not entered into the contract for the primary purpose of shielding assets from creditors. In some instances, courts of law have deemed the purchase of segregated fund contracts while the creditor was insolvent as an attempt to shield assets, and disallowed the creditor protection.
**(from the CLHIA Guide to Segregated Fund Contracts)

Wednesday, May 14, 2008

Life Insurance... do you need it?

I've been licensed to sell life insurance for over two years now and I'm here to tell you, nobody wants to buy life insurance. My theory is that people simply do not want to admit their own mortality. They would rather just not think about it. So, when I come along and suggest that we discuss the possible consequences of dying, I hear things like, "Oh, I don't believe in insurance," or, "no, I'm not interested."

The unfortunate fact is it's my responsibility to my clients to point out where their financial risks are, and then educate them as to how they may reduce or eliminate those risks. And, that's really all insurance is for - to help people manage or eliminate certain financial risks.

So, back to the question - do you need life insurance? In order to answer that question, first something needs to be made clear... life insurance is not for you - life insurance is for the people you leave behind. Therefore the question becomes, if you die, will the people that you leave behind suffer financially in some way?

There are a few ways to look at this issue. First and foremost one must assess what actual costs their death will incur. Usually then, we're talking about final expenses such as funeral costs, fees paid to your executor to manage your estate, a burial plot, and things of that nature. But, we're also talking about estate taxes which can turn out to be fairly significant if, for example, you own a cottage or some other valuable assets.

Secondly, we must consider something else of considerable significance: lost wages. Does your family count on your income in order to maintain their standard of living? If so, all that money that you won't earn needs to be taken into account.

So, now that we've determined that there may be a need, we need to start classifying the risks. We need to split them up into the "if you die" category, and the "when you die" category. For example, though your family may count on your income now, you do plan to retire at some point. So, that is not going to be a permanent need. Rather, that risk could be offset with a temporary product. In other words, if you die before you retire, that could create a financial issue for your family.

However, items such as final expenses and estate taxes will be an issue no matter when you pass away. So, those are better managed with a permanent insurance product. We could say that when you die, there will be costs that must be paid in some way, and insurance might provide that cash for you.

Ultimately, determining your insurance needs is a rather involved process that requires a considerable amount of thought and consideration. Of course, always be sure to deal with a qualified professional who is prepared to take the time to get to know your specific circumstances.

It seems to me as though there is something inherent in the insurance buying process that forces us to acknowledge our mortality and admit to ourselves that death is inevitable. Understandably, this is never easy. But, I'm here to tell you that there is a certain degree of relaxation and reassurance that happens once you've been through the process of dealing with this stuff. And, if there are people that count on you to provide for them, then getting adequate insurance is simply the responsible thing to do.

The Four Steps to Wise Investing

Investing money isn't as complicated as it seems, but it does require some consideration, planning, and strategy. There are four steps that are the foundation of any good investment strategy.

Risk Tolerance

Understanding your tolerance for volatility in the value of your investments is critical. Ask yourself, can I handle a 10% decline in the value of my investments? How about 20%? 40%?

Something that I’ve learned is that tolerance for risk tends to go up when people understand why things go up and down. So, I’d suggest that you don’t pay too close of attention to the day to day movements in price. Instead, spend your time learning more about why things go up and down.

Time Horizon

Knowing how long you plan to invest for is essential as well. Once you have identified your time horizon, you can determine the appropriate type of investment vehicle. For example, equity cycles take at least 7 – 10 years, and therefore should be avoided as a short term investment. Investing in equities for a short term horizon runs the risk of needing the money when the value is depressed, which of course is contrary to the goal. Conversely, fixed income investments such as GICs, bonds, and Real Estate Investment Trusts tend to pay out a steady stream of income, though don’t tend to produce wild swings in their value like stocks will. Because of that, they are more suitable for shorter time horizons.

A very good way to approach the time horizon issue is to spend some time thinking and prioritizing your financial goals. For example, if you’re wanting to replace your car in 5 years, go on a vacation in 2 years, and retire in 20 years, you should consider having different “pools” of investment money for each of these goals.

Asset Allocation

Asset allocation refers to the way different classes of assets relate to each other in your investment portfolio. It is your asset

allocation that will determine what type of return you are able to achieve over the long term. There are essentially 2 primary asset classes that the novice investor should consider using: equity (stocks) and fixed income (or bonds, etc). I refer to these classes as ownership (equity) and loanership (fixed income)

Equity (stocks) – when investing in equity, you become a part owner of a company. As such, you have an opportunity to participate in the profits and growth of that company over time.

Fixed Income (bonds, GICs, etc.) – when you invest in fixed income products, you are essentially investing in debt. Mortgage funds and real estate investment trusts are other examples of fixed income products. These are methods of pooling money together for the purpose of lending it out. The return on these products is usually in the form of an income stream.

As mentioned previously, the relative ratio of these two asset classes in your portfolio will determine the overall volatility and return of the portfolio. So, investors with a short time horizon or a low tolerance for risk should have more fixed income products, and investors with long time horizons and a higher tolerance for risk should have more equity products.

Rebalancing

Rebalancing refers to maintaining a particular balance of individual investments in your portfolio. Because different investments will move in different ways at different times, the particular weighting that you might like each to have in your portfolio might change over time as some go up and some go down.


So, let’s imagine that you’ve decided that your portfolio should have 25% weightings each in US Stock, European Stock, Asian Stock, and Global Bonds:


Now, let’s imagine that one year later, their relative performance looks like this:



As you can see, in order for us to take this back to the original balance at 25% each, we will have to sell the Asia and US stock to buy more of the Euro stock and Global bond. This forces us to maintain our discipline in sticking to our original investment policy of 25% weightings, as well as forces us to sell high and buy low. Equity and Fixed Income tend to perform in cycles. By maintaining your discipline in rebalancing, you take advantage of that cyclical pattern.

In conclusion, if we are to follow these 4 steps rigorously, it takes the guesswork and uncertainty out of our investment strategy, and gives us a fixed benchmark to work from.