Cut your risk with our 3-part portfolio management strategy

One of our Successful Investor Wealth Management clients recently turned 70, and he wonders what effect this should have on his portfolio management. He now has 85% of his portfolio in stocks, 15% in short-term T-bills and zero in long-term bonds and other long-term fixed-return investments.

This Successful Investor Wealth Management client has a pension that provides most of the cash flow he needs. So his 15% cash holding, plus dividends, can supply all the cash he is likely to need from his portfolio for the next year or two. Only then would he need to worry about selling any of his holdings. Before then, we will probably sell some of his holdings, due to a change in fundamentals or a takeover.

Our three-part portfolio management strategy helps cut risk — and holds the potential for strong returns

Some investors feel it’s “safer” to include substantial holdings of cash and bonds in a portfolio, rather than focus on stocks. It’s true that this usually dampens a portfolio’s volatility, since the value of the cash won’t change, and the values of the bonds and stocks may often move in opposite directions.

However, we think it’s more cost-effective to seek safety by following our three-part portfolio management philosophy.

First, invest mainly in well-established companies. When the market goes into a lengthy downturn, these stocks generally keep paying their dividends, and they are among the first to recover when conditions improve.

Second, avoid or downplay stocks in the broker/public-relations limelight. That limelight tends to raise investor expectations to excessive levels. When companies fail to live up to expectations, these stocks can plunge. Remember, when expectations are excessive, occasional failure to live up to them is virtually guaranteed, in the long term if not in the short.

Third, spread your money out across the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities). This helps you avoid excess exposure to any one segment of the market that is headed for trouble. This will also dampen your portfolio’s volatility in the long term, without the shrivelling in its potential that you’d get if you invest significantly in bonds yielding little more than 4%.


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Because of this investor’s age and conservatism, we have, of course, focused his portfolio management on relatively low-risk stocks. That makes the value of his holdings more stable. Adding some bonds to his portfolio might make it somewhat more stable — but less profitable.

Portfolio management: Rising interest rates would push down the value of long-term bonds

Regardless of age, we advise all investors to stay out of long-term bonds. That’s because long-term interest rates on bonds are still bumping along near 4%, which doesn’t even cover taxes and inflation for many investors.

On June 1, the Bank of Canada raised its key interest rate by 25 basis points, to 0.50%. That’s still very low by historical standards, but we think interest rates will likely move higher in the next few years. That would push bond prices down.

Heavy deficit spending by governments, coupled with the rapid expansion of the money supply that’s now underway, could cause an upturn in inflation. That would push interest rates up, and push down the value of existing bonds. Bondholders can, of course, get back the face value of their bonds by holding on to them until they mature. But by then, the bonds’ face value will have lost substantial purchasing power because of inflation.

Stocks are more adaptable to higher inflation than bonds

Stocks can also suffer in a period of rising inflation, of course. But they can still gain if the companies adapt to inflation, as well-managed companies are likely to do. In any event, the value of corporate assets can rise along with inflation. Bonds, in contrast, inevitably lose due to inflation. Their value is denominated in cash — interest payments and repayment of principal at maturity — and inflation shrinks the purchasing power of cash.

To top it off, this investor plans to leave the bulk of his portfolio to his children. You might even say he is investing on behalf of his children, who are now in their 30s. Under the circumstances, he should invest with their retirement in mind, since his is already well secured.

If you’d like me to personally apply my time-tested approach to your investments, you should consider becoming a client of my Successful Investor Wealth Management service. Click here to learn more.

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