Investment planning

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Welcome to the Financial Wisdom Forum. There are many knowledgeable and helpful people who are part of this online community. Most of these posters are willing to share their time and expertise with new posters who are looking for help, but they can't or won't give advice in a vacuum. We need to know some important things about you, including all the investments you already have. Otherwise, we may be advising you to buy into a fund that overlaps your present holding(s), doesn't fit your asset allocation plan, or, worse, is either too risky or too conservative for your investing temperament. To make sure you get the help you need, we would like to provide a few suggestions.

Educate Yourself

If you have never taken the time to educate yourself on investing basics, you should do that now. There are several easy-to-read books that do not require math knowledge, finance interest, or hours to read. Check out Recommended reading for a listing of books on various investment topics. [1]

Investment Plan

After educating yourself, the first step on your investing journey should be to settle on an investment plan that includes your desired asset allocation. Your investment plan should look out into the future and include things like a new car or home purchase in a few years, education expenses for children, and retirement, just to name a few. All of these goals require money in different time frames, and the money should be invested accordingly. Studies have shown that your asset allocation will determine more than 90% of the variation in your portfolio return, so you should focus on your asset allocation first rather than on fund selection.

Since risk and return are directly related, your asset allocation should balance your NEED to take risk with your ABILITY to withstand the ups and downs of the market. NEED can be determined in many different ways. If you are young, you have the benefit of many years of compounding, so in one respect your NEED to take risk is low. On the other hand, your portfolio size is probably small, leaving you with a long way to go to reach your retirement goals. As a result, you could argue that your NEED to take risk is high.[2]

For people closer to retirement, it may be possible to more closely determine NEED. First, estimate approximately how much income you will need annually after retirement. For this example, we’ll assume you need $100,000 per year. Next, look at any pensions or government benefits that will provide a source of income. If a pension provides $30,000 per year and CPP + OAS provide an additional $20,000 per year, then your portfolio would need to provide an extra $50,000 each year. To prevent running out of money, you should probably start by withdrawing 4% a year or less with an annual inflation adjustment. To generate $50,000 per year at 4% requires a minimum portfolio size of $1,250,000. How close are you to your goal?

Turning to ABILITY, this relates to your ability to withstand the ups and downs of the market without getting nervous and making changes to your asset allocation. Selling in the face of a decline is about the worst thing you can do. Here is a table offered by author Larry Swedroe,[2][3] based on the 1970s bear market:

Amount of decline for various stock/bond allocations
Max Equity Exposure Max loss
20% 5%
30% 10%
40% 15%
50% 20%
60% 25%
70% 30%
80% 35%
90% 40%
100% 50%

There are other ways to determine an asset allocation, including several rules of thumb:

  • Your age in bonds. So, if you are 40 years old, then use a 60/40 (equity/bond) allocation.
  • 110 minus your age = equities (110-40 yrs old=70/30 asset allocation)
  • 120 minus your age = equities (120-40 yrs old = 80/20 asset allocation)

Asset Allocation

Once you have identified the split between stocks and bonds, you need to focus on whether you prefer to use funds that cover large parts of the market (Total Market funds) or whether you prefer to slice and dice your portfolio into sub-asset classes.

One part of the market that everyone needs to consider is international investing. The Canadian stock market is far less diversified than the US market, and is highly dependent on just three sectors:[4][5] financials; energy (oil and gas); and materials (gold and mining). Therefore, an investor who purchases only Canadian securities may have insufficient sector diversification.

Portfolio Construction

After settling on your primary asset allocation you can turn to selecting funds that flesh out your desired asset allocation and placing them in the most tax efficient manner. If you do not have taxable accounts, then tax efficiency isn’t a huge concern but it is still a factor that should be considered. It is usually best to consider all of your investments together. If you are married you should usually blend accounts held by both spouses into one unified portfolio.

The best place to start building a portfolio is by making a list of all your current investment accounts and the investments in each account.

Finally, you must consider the tax consequences of investing, especially in taxable accounts. Generally, the most tax efficient way to use your different accounts is (our thanks to Taylor Larimore and David Grabiner from our sister Bogleheads forum for this list):

1. Invest as much as possible in your tax-deferred and tax-free accounts.
2. Put the most tax-inefficient funds in your tax-deferred and tax-free accounts.
3. Use only tax-efficient funds in taxable accounts.
4. If all else is equal, put funds with higher expected returns in tax-free (TFSA) accounts in preference to tax-deferred (RRSP / RRIF / LIRA / RESP) accounts.

Here is a list of securities in approximate order of their tax-efficiency. (Least tax efficient at the top.):

Hi-Yield Bonds
Taxable Bonds
Real Return Bonds
REIT Stocks
Stock trading accounts
Balanced Funds
Small-Value stocks
Small-Cap stocks
Large Value stocks
International stocks
Large Growth Stocks
Most stock index funds
Tax-Managed Funds

Investing Priority

The general rule of thumb for investing priority is:
1. RRSP up to the company match
2. RESP up to getting the CESG maximum
3. Max out TFSA
4. Rest of RRSP
5. Rest of RESP
6. Taxable Investing

Now that you have established your investment plan you can follow the Asking portfolio questions link to learn how to post your portfolio and receive many helpful suggestions.

See also

Notes

  1. Several authors post on our sister Bogleheads forum frequently and usually answer questions related to their books. Taylor Larimore, Mel Lindauer, and Michael LeBeouf wrote the book The Bogleheads’ Guide to Investing. The series continued with The Bogleheads Guide to Retirement Planning. In addition, Financial Advisor Rick Ferri has an online book available called Serious Money and Larry Swedroe has several easy to read books available, including The Only Guide to a Winning Investment Strategy You'll Ever Need: The Way Smart Money Preserves Wealth Today. Another along these lines is The Coffeehouse Investor. All of these books can help you build a base of knowledge in just a few hours. A list of other books is available on the Bogleheads Reading List.
  2. 2.0 2.1 Bogleheads® forum post - Investment Planning by member Laura, viewed December 9, 2015
  3. Bogleheads® forum post - Asset Allocation/Swedroe chart by Larry Swedroe, viewed December 9, 2015
  4. MSCI Indices, Global Industry Classification Standard (GICS®) Structure - GICS - MSCI, retrieved November 28, 2012.
  5. iShares Canada, XIC Overview: Sector Breakdown, viewed May 22, 2012. Sector breakdowns as of that date were: Financials, 31.59%; Energy, 25.76%; and Materials, 18.52%.