Time for an asset allocation tune up?
Is your investment portfolio ready for 2007? To make the most of what the coming year has to offer, you may need an asset allocation tune up.
The asset mix of your portfolio is critical to performance and risk management. Studies show that how you divide your money among various types of assets, not the individual securities you own, accounts for the bulk of long-term investment profits.
With financial markets experiencing considerable volatility in 2006, and with new tax regulations affecting some types of investments, a review of your asset allocation is more important than ever. Shifting market conditions or changes in your financial situation may call for adjustments to your long-term strategy. Enhanced tax breaks for dividend income could also mean it's time to rebalance assets.
Whatever your situation, your first objective should be to ensure that your portfolio is well diversified and includes all the major asset classes - cash-equivalent investments, fixed income and equities (individual stocks or mutual funds). A balanced portfolio improves your chances of earning consistent investment returns that meet your financial goals.
Review your portfolio to see whether it meets the diversification test. Does it have too much of one asset type? Are you overly focused on a single investment, or a handful of individual investments? If so, it may be time to make changes.
Diversification is important because not all investment classes behave the same way. A portfolio with significant representation in all major classes lets you take advantage of upturns in prices, at the same time offering protection from too much of a negative shock when one asset group or security encounters turbulence.
Proper asset allocation can also improve the after-tax returns of your investments. Outside a RRSP you can take advantage of tax breaks for investments that generate capital gains and dividends. Changes in the May 2006 federal budget raised the federal tax credit for dividend income so it effectively equals 27.55% of dividends paid, up from 16.67%. Some provinces have also increased their dividend tax credit.
There is no ideal asset mix for everyone. It depends on your goals, age, risk tolerance and other factors. But there are some basics that apply to all portfolios. Start with a foundation of solid core investments, working your way up to securities that offer the potential for greater returns.
Think of an investment pyramid. The base consists of cash and savings. The next tier consists of income investments, such as GICs and bonds. Growth and income investments such as mutual funds and quality stocks form the next level. Then it's growth investments, such as growth mutual funds and growth stocks. The top tier of the pyramid consists of aggressive growth stocks and mutual funds.
Your asset mix should be constructed as a long-term strategy. Don't change it in reaction to short-term events. But it will be affected by major market trends, financial goals, and how long you have to reach your objectives. |
