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SHOULD HE REBALANCE TO A “DEFENSIVE” PORTFOLIO?
9/24/2017 6:13:34 AM
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Fund Library Q&A
Your questions about financial planning, investments, and portfolio management answered by an industry expert



By Robyn K. Thompson  | Friday, November 11, 2016


Q – With the election of Donald Trump as U.S. president, I feel that political uncertainty is going to increase stock market volatility, so I’m considering realigning my portfolio, which now consists of a mix weighted to more aggressive growth-oriented mutual funds and ETFs with a few fixed-income funds added to mitigate risk. What are your thoughts about rebalancing to a more defensive portfolio, and what should I include? – Wayne S., Gloucester, Ontario

A – When I’m asked about “defensive” or “aggressive” funds, it usually has to do with relative levels of risk that an investor is willing to accept (with “volatility” being a key metric here).

Some fund categories can be construed as perhaps less risky and more “defensive” than others. For instance, money market funds are considered ultra-conservative and virtually risk-free, because they invest in highly liquid short-term government Treasury bills. Their unit values generally don’t fluctuate. The flip side is that money market funds pay out virtually nothing and may even produce a negative yield once you factor in tax and inflation.

Fixed-income funds are slightly more risky than the ultra-defensive money market funds, and typically provide a better return. That’s because bond prices and yields can change depending on both the prevailing level of interest rates and on interest rate expectations.

Equities can produce the largest gains and losses, and wide swings in volatility, and are thus are not generally considered “defensive” as an asset class (although within equity portfolios, the term “defensive” is frequently used to describe stocks that may be relatively less volatile, owing to their status as shares of large, blue-chip, dividend paying companies).

Playing it smart

Given the election results and all the subsequent media hype of recent days, you may be tempted to rebalance to “defensive” fixed-income funds and hold more cash in the form of money market funds. But that would be committing the cardinal portfolio sin of managing by emotion. No one can say what a Trump presidency will bring, any more than anyone could have said what an Obama presidency would bring when he was first elected.

In addition, by buying, selling, rebalancing, and reallocating, you’re not only generating costs in the form of brokerage commissions, but you may very well be inadvertently accumulating a hefty tax bill on the various buys and sells of your investments through the year. It all takes a sizeable chunk out of your investment returns and puts it in someone else’s pocket. There’s probably no other activity in the world where individuals will so eagerly perform a robbery on themselves.

It is far more prudent to approach your portfolio decisions from a perspective that looks at overall asset allocation, tax-efficiency, and cost. By this, I mean you should decide honestly about your level of risk tolerance. Then construct a diversified portfolio comprising safety, income, and growth assets in various proportions that reflect your risk comfort level. And stick with it. The key is to step back from the daily noise of the trading screen for long enough to take a look at your whole portfolio. And then ask yourself:

* Is it tax efficient? Am I attracting maximum tax with every transaction or am I minimizing the tax hit? Am I maximizing my use of Tax-Free Savings Accounts (TFSAs) and Registered Retirement Savings Plans?

* Is it low cost? Am I using investment strategies that reduce my overall trading, transaction, and management costs, such as allocating at least some portion of my asset mix to low-cost exchange-traded funds? In the case of mutual funds, have I looked at corporate class shares?

* Am I mitigating risk? Am I diversifying my portfolio with enough non-correlated asset classes to suit my tolerance for risk? Am I using hedging or income-generating strategies with options? Or am I essentially “throwing darts” every day, and hoping for the best?

These are not particularly easy questions to answer, and you might just have to consult a financial advisor to help you get and keep your investments on the right – tax efficient – track. And that’s the best “defensive” strategy of all. – Robyn

Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management , a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at rthompson@castlemarkwealth.com for a confidential planning consultation.

Notes and Disclaimer

© 2016 by the Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.

The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.

 
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