Balance And Diversification – Part 1

Hi everyone and thanks for coming back to a new blog post on FOMOTINA. I really appreciate it greatly! I didn’t think that after such a short time blogging that several hundred readers would already be reading what I write. My initial goal was that if I could eventually help at least one person out in understanding my approach to investing, my efforts have been worth it. It’s very humbling.

On that note, let’s get started.

In my prior blog, My Investment Portfolio, I talked about the first three lessons I learned about investing. Today, we’re going to start to discuss Lesson #4: You shouldn’t keep all your eggs in one basket. In other words, if you want to become an investor, you must consider balance and diversification. One asset strategies like: 

  • putting all your money into a house;
  • gambling on one high flying stock or even several;
  • only investing in company stock with your employer;
  • putting all your money into GICs with a bank;
  • putting all your money in crypto (I do not advocate anyone putting even a small portion of their money into crypto).

They are all very, very, very bad ideas. Mainly, if they go down in value or lose all their value, you have no way to recover. By all means, exceptional cases can happen where large profits can occur using a one asset strategy. The issue is, they’re the exception. Not the rule. And we’re all here to focus on an investing strategy that’s replicable, consistent, and done in a profitable way minimizing emotions, stress and uncertainty. And one asset strategies don’t fit within that.

We’ll focus high level today on how fixed income and equities complement each other. For some context, I’ve added a screenshot below of my portfolio.

The ETFs shown in yellow form part of the fixed income component of my B&D portfolio. This is the safe(r) stuff in the B&D. The ETFs/stocks shown in blue form part of the equity component which is the growth(ier) stuff in the B&D.

So, why do I hold both categories in my portfolio? Two reasons really. The first is to balance out risk (which can also be represented by volatility) and return. The second reason is for rebalancing purposes (I will be devoting a blog post specifically on the topic of rebalancing in Part 2).

When talking about risk and return, I like to also think about greed. Unlike Gordon Gekko from the movie Wall Street, greed is not good. Not for investors on an individual basis, that is. Well, it’s not really good for anyone actually regardless of how well he sells the idea.

Leaving Gordon Gekko in the rear view mirror, let me further substantiate my position. Let’s consider Peloton or Shopify. They were high flyers. Lots of people hopped on the uppa uppa uppa train and bought in. Should we ask ourselves how many people bought in at or near the peak price for these stocks when the frothiness was heavy? I’m thinking lots. Rhetorically, do you think most sold at peak? I don’t think so either.

Are many still holding either of those because they can’t stomach the idea of turning a paper loss into a real loss or sold them in the dumps? Probably. Why? Greed. And a degree of fear. I don’t think anyone can deny that. I congratulate the stock market pumpers, marketers and mainstream media for appealing to the FOMO and TINA within the general population. It’s the reason I named my blog FOMOTINA. It’s also the reason why I believe writing about an alternative to that type of gambling is relevant. I also congratulate the few who bought low and sold high because there are a few who did. It’s statistically likely that those few are not you and it’s definitely not me however I do recognize their extreme luck and good fortune to be just at the right place at the right time. Salute!

Seeing the above results of greed at its finest, how do you counter that? Diversification through a multi asset strategy. The complete opposite of the single asset strategy mentioned earlier. A complement of fixed income focused ETFs and equity focused ETFs in most cases does the trick. The occasional individual stock mixed in within that in proportion to the rest of the portfolio sometimes can make sense too (after all, I currently hold some ENB as well as BMO in mine). While some parts of the portfolio may go down in value, others will go up creating a balance and stability. An analogy I relate this all to is that of nature.

The more diverse a biosphere is (plant and animal life), the healthier, less stressed, and more balanced it all is. Everything keeps everything else in check. That includes disease. Now look at mono-culture farming. Mono-culture farming requires constant outside checks and balances to keep things going properly and even with that, soil depletion and erosion along with plant and animal diseases occur regularly.

The analogy also works for your investments. On that note, let’s look at two pieces of my portfolio. VSB and XSP. I’ll focus on each ETF/stock in the portfolio in detail in future blog posts but for now will keep it to these two to keep it simple. Please note that I have no affiliation with either companies that manage these ETFs, they just form part of the holdings within my B&D portfolio.

VSB is an ETF I hold in my portfolio within the fixed income category. It currently contains 477 bonds at the time I write this. Not bad for holding a diversified basket of assets within one ETF. Per Vanguard’s Factsheet, this ETF has the following objective:

The fund seeks to track, to the extent reasonably possible and before fees and expenses, the performance of a broad Canadian bond index with a short-term dollar-weighted average maturity. Currently, this Vanguard ETF seeks to track the Bloomberg Global Aggregate Canadian Government/Credit 1–5 year Float Adjusted Bond Index (or any successor thereto). It invests primarily in public, investment-grade fixed income securities issued in Canada.

In other words, it invests in pretty safe stuff, relatively speaking. Those bonds have a short duration period which helps further (we’re currently living in a time of rising interest rates and high inflation so shorter durations on bonds help because once the ones held in the ETF mature, they get replaced by others with higher interest rates – the longer the time for bonds to mature, the less attractive they are for investors – longer duration bonds become more attractive than shorter ones when interest rates go down). With that relative safety though, the returns are lower but I don’t hold this ETF for the interest payment it provides. When I get to the rebalancing piece in Part 2, it will become clearer.

As you can see in the chart above for VSB, there is a chance of losing some of the capital but the risk/volatility is pretty low. Now, let’s look at XSP.

XSP is an ETF I hold in my portfolio within the equity category. It currently contains 504 stocks at the time I write this. Here too, pretty good for holding a diversified basket of assets within one ETF. Per IShares Factsheet, this ETF has the following objective:

Seeks long-term capital growth by replicating the performance of the S&P 500 Hedged to Canadian Dollars Index, net of expenses.

This ETF invests in 500 large companies in the U.S. The S&P 500 has pretty tough criteria for a company to be a part of it and those companies that fail to maintain minimum qualifying standards are replaced with others that can. Regardless, there is a higher level of risk/volatility to holding it. The dividend payment on this is not large however the main reason for me to hold this is its capital growth potential.

Along with growth potential, it can also swing in the opposite direction as well (cue the risk and the volatility that causes FOMO and TINA). Does that mean I shouldn’t hold this ETF? Absolutely not! As mentioned earlier, with higher “calculated” risk/volatility comes the potential for higher returns.

Now, if we looked at both VSB and XSP together on the chart below, do you start to notice a pattern?

If not, don’t worry. I’ll go into detail regarding that as part of the next blog post which will focus specifically on rebalancing. This is a subject I absolutely love and I hope you’ll be there to read it once it’s posted.

What are your thoughts on Lesson #4? Do you apply this philosophy in investing as well as in life? Or, do you agree with Gordon Gekko? He does wear a nice suit and speaks well after all. 

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