Couch Potato Basics, Part 2: Pure Asset Allocation

This post is the second in a five-part series outlining the primary benefits of the Couch Potato strategy.

Most investors understand the importance of diversifying. By spreading your money across different asset classes—cash, bonds, stocks, real estate, commodities—you can lower your portfolio’s overall risk and boost your returns over the long term. In fact, your asset allocation is probably your single most important investment decision.

Unfortunately for investors buying actively managed mutual funds, getting that target asset mix is often extremely difficult.

Say you decide to split the equity portion of your portfolio equally among Canadian, US and international developed countries. For your domestic and US stocks, you choose the Trimark Canadian Series A and Trimark US Companies, respectively. You round things out with the Dynamic EAFE Value Class fund, because it trounced its benchmark in 2009. (That benchmark, the MSCI EAFE index, includes 16 developed countries in Europe, plus Australia, New Zealand, Japan, Hong Kong and Singapore.)

You might reasonably expect this would put about 33% of your money in each of the three regions. But you’d be wrong.

The Trimark Canadian fund has less than 70% of its holdings in Canadian stocks: 24% is in the US and 6% is overseas. The Trimark US Companies fund has just 85% in US stocks and more than 11% overseas. As for the Dynamic fund, it holds almost 14% in cash, and a whopping 26% in emerging-market countries that are not even part of the index in the fund’s name. How can Dynamic call this an EAFE fund at all?

As these examples make clear, actively managed mutual funds are financial meatloaf: you never know exactly what’s in them. An investor buying these three funds with the intention of holding about 33% in Canada, the US and developed overseas markets would actually wind up with 26% in Canada, 36% in the US, 26% in the EAFE countries, plus 5% in cash and 9% in emerging markets. That portfolio would have a decidedly different risk profile than the one the investor had planned for.

ETFs and index funds, by contrast, offer pure exposure to whatever asset class you choose to invest in. You can get precisely equal weightings in Canada, the US and overseas developed markets by buying three ETFs from iShares. Index mutual funds would also do the trick neatly and precisely. All meat, no filler.

Part 1 : Low costs

Part 3:Transparency

Part 4: Flexibility

Part 5: Tax efficiency

Most investors understand the importance of diversifying. By spreading your money across different asset classes—cash, bonds, stocks, real estate, commodities—you can lower your portfolio’s overall risk and boost your returns over the long term. In fact, your asset allocation is probably your single most important investment decision.

Unfortunately for investors buying actively managed mutual funds, getting that target asset mix is often extremely difficult.

Say you decide to split the equity portion of your portfolio equally among Canadian, US and international developed countries. For your domestic and US stocks, you choose the Trimark Canadian Series A and Trimark US Companies, respectively. You round things out with the Dynamic EAFE Value Class fund, because it trounced its benchmark in 2009. (That benchmark, the MSCI EAFE index, includes 16 developed countries in Europe, plus Australia, New Zealand, Japan, Hong Kong and Singapore.)

4 Responses to Couch Potato Basics, Part 2: Pure Asset Allocation

  1. Dale Rathgeber January 14, 2010 at 1:42 pm #

    Not all mutual funds are “meatloaf” with the investor having difficulty ascertaining the country of origin. For example Excel’s India and China funds are self-explanatory. Moreover, free and easy-to-use sites such as Globefund let an investor know where the fund is invested, and the top holdings, by percentage, in a couple of clicks. You have failed to sufficiently emphasize the drawback with index ETFs. They will leave an investor with little likelihood of out-performing anything other than a very mediocre return; most of these funds have too much diversification.

  2. mike macdonald January 23, 2010 at 5:39 pm #

    Even ETFs are getting suspect in their intent to help investors. Small sector based ETFs in combination with broad based ETFs can result tilt holding significantly. Focusing on large broad based markets prevents accidental overweight/underweight issues in a portfolio and helps minimize concentration risk.

  3. Sam January 25, 2010 at 9:11 am #

    Thanks for writing the blog – most useful to us “new Canadians” not used to investing here!

  4. Canadian Couch Potato January 25, 2010 at 9:30 am #

    The Excel India and China funds have appallingly high MERs (over 3%). Which helps explain why the India fund has trailed its benchmark over three-, five- and ten-year periods, according to Globefund.

    If you want to invest in China or India, iShares is launching new Canadian-listed ETFs, which (gasp!) hold only Chinese or Indian equities and charge well under 1%.

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