When you’re particularly uneasy about the economy and markets, stuffing cash under the mattress isn’t the answer. Gold bricks aren’t either. Both these options imply that you know what’s going to happen, which you don’tGetty Images/iStockphoto
The market has been hitting new highs. Resource stocks are up and down like a yo-yo. And with Donald Trump and Brexit, gold is back in the conversation.
In these confusing times, what is an investor to do? Are there any places to hide?
Before we go searching, we need to recognize there are always uncertainties. It's a constant part of investing. With Brexit looming and Mr. Trump agitating, it may be more uncertain than usual, but we never know where stock prices are going in the short to medium term.
I should disclose off the top that I'm taking a cautious tack in my fund, the Steadyhand Founders Fund. The political landscape in the United States and Europe is a factor. I see high valuations, even higher debt levels and a heavy reliance on near-zero interest rates leading to lower than usual returns over the next five years.
Where to find shelter will depend on the purpose of the money.
If you're retired and drawing a paycheque from your portfolio, hiding places are hard to find. We're all living longer, so we need to generate an income for 20 to 40 years while guarding against inflation. With fixed income securities yielding so little, this means investing in a diversified portfolio that can earn 3 per cent to 4 per cent a year.
There's no getting around the fact that a portfolio of bonds, and Canadian and foreign stocks will have down periods. So, shelter must come from holding a separate spending reserve. This cash buffer can be used to make up any shortfall after interest, dividend and pension income, and most importantly, provide a cushion while your portfolio rides out the bumps.
Given the good markets we've had, it's a good time to replenish the reserve (or set one up) by putting aside an amount equivalent to two years of required spending. It won't earn much, but when the inevitable market correction comes, you'll be glad you took some cover.
If you're at the other end of the spectrum and don't need the money for at least 10 years, the search is much easier and dare I say more fruitful.
As a long-term investor, your portfolio needs to fit with your goals, time frame and temperament. At our firm, we call it a strategic asset mix, or SAM. Your SAM is the combination of asset types, geographies and industries that is most likely to achieve your return objective. It's an educated guess. There are no guarantees and requires some tradeoffs. After all, to achieve true diversification, you won't love everything in the portfolio.
When you're particularly uneasy about the economy and markets, stuffing cash under the mattress isn't the answer. Gold bricks aren't either. Both these options imply that you know what's going to happen, which you don't.
There are hedge funds and bank-sold structured products that set out to reduce market risk, but they require a higher level of expertise and are expensive.
No, when you're at wits end, it's time to go to your home base – the long-term asset mix that you've previously agonized over. Markets bounce around, but they rise over time and you need to be there. So your SAM should always be your secure place.
If it's your nature to have a portfolio that reflects your views of the world (and you have some skill and experience), your asset mix shifts should still be done in the context of your SAM. That means tilting your portfolio, not making wholesale changes. No investor is smart enough to time the market and catch all the trends. For evidence of that, we need look back no further than last year. Everyone got everything wrong in 2016.
So, you may hold more cash, or shift in or out of U.S. stocks, the banks and high-yield bonds, but you always want to make your bets in the context of a broadly diversified portfolio. As an example, our Founders Fund has a SAM of 60 per cent stocks and 40 per cent fixed income. I'm currently hiding with slightly fewer stocks (57 per cent), considerably less bonds (25 per cent) and an unusually large cash reserve (18 per cent). The fund is prepared for choppier markets, but hasn't abandoned its friend SAM.
Tom Bradley is president of Steadyhand Investment Funds Inc.