Reader C.G. asked the following question (slightly edited) on asset allocation:
I have recently taken over management of my investment portfolio and will convert it over time to an ETF-based portfolio. Can you direct me to sources that will provide me with a proper understanding of asset allocation, stocks-vs.-bonds etc.? Most books are very informative but they do not give Canadian information. The only one that I know of is the Canadian edition of the book by Dan Solin. Are there other Canadian sources and if so, would you subscribe to their recommendations?
There are many excellent books – Unconventional Success, The Little Book of Common Sense Investing, Four Pillars of Investing, Random Walk Down Wall Street etc. come to mind – that provide guidance for developing your own asset allocation. Paul Farrell, a columnist on MarketWatch.com tracks a number of sample passive portfolios that you could use as a model. However, it is true that these portfolios are targeted toward American Investors.
Your asset allocation should ideally have at least four classes: cash, bonds, real estate and equities. Canadians can follow US recommendations on how to split the portfolio among the four major asset classes. The allocation to cash and bonds is driven mainly by your risk tolerance. Real estate is a bit of a special case and the % suggested by experts is all over the map ranging from 0% to 20%.
Canadian investors are in a different boat compared to Americans on how to split their equity portion between domestic and foreign. The US stock market is well diversified compared to ours which is concentrated in Financials and Resources. If we allocate the exact proportion to Canadian markets as our weighting in world markets, we would allocate only 3%.
Many studies have shown that investors worldwide have a home country bias and tend to overweight their respective domestic markets. We have one very good reason to overweight (compared to a 3% equity allocation) our equities: dividends from Canadian corporations are taxed favourably. Dan Solin, for instance, suggests putting 10% of the equity portion in Canadian equities. Personally, I have a target of 20% of total allocation in domestic stocks. I don’t have a very good reason for that exact percentage.
Dividing the foreign equity portion is very simple: I just split US, other developed markets (EAFE) and emerging markets according to their respective world market capitalization. Here are some resources for Canadian investors: