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PETER DOLEZAL: Geographic diversification for stronger financial portfolios
Does geographic diversification provide value in an Investment portfolio? Rarely has the benefit been as clearly proven as in the 2013 performance of the world’s major stock markets.
The TSX Composite Index closed the year with a very respectable increase of 9.55 per cent. With the inclusion of dividends, the total return of this Canadian Index reached about 12.7 per cent — an excellent result by historical standards — but, when measured against the performance of other world markets, not necessarily a great result.
Many of us continue to limit our investments to Canadian equity and fixed income products — perhaps because this strategy tends to best suit our comfort level. Despite the fact that Canada makes up only about three per cent of the world’s capital markets, we are hesitant to diversify our investments geographically.
As a result, we miss out on the huge opportunities embedded in the other 97 per cent of the world’s financial products.
As a case study, 2013 demonstrates quite dramatically, the value of geographic diversification. Despite the Canadian market’s solid performance of this past year, our markets actually not only lagged most International ones but also trailed in a dramatic fashion.
Major examples include the U.S. S&P 500 Index, which gained 32.4 per cent, and the broad World Index, which rose 33.9 per cent. Many International sub-indexes, such as Global Health Care, Global Water and Global Infrastructure all delivered returns ranging from 25 to 36 per cent.
Yes, our risk is reduced and long-term returns enhanced when we diversify our sector and product holdings within Canada.
We can however, achieve even better results and moderate shorter-term portfolio volatility by including a significant component of International holdings.
Investments in Non-Registered portfolios should probably continue with a greater bias toward Canadian holdings. Dividends received from Canadian companies enjoy a tremendous tax advantage over those received from International holdings.
However, even in those portfolios, we should hold a modest amount of International content. Our RRSP, RRIF and TFSA accounts however, can include as much non-Canadian content as the investor desires; tax issues are not a factor for these accounts.
Some investors may limit themselves to Canadian holdings simply because they are not aware of how easy it is to include geographic diversification in a portfolio. Others achieve diversification through high-cost mutual funds — usually, not the best approach.
An investor can as easily achieve geographic diversification through very low-cost Index funds or Exchange Traded Funds (ETFs). The latter, bought and sold like a stock on the TSX Exchange, will, if purchased through a Discount-Trading platform, attract a per-transaction commission cost of less than $10.
By all means, celebrate your Canadian portfolio’s solid 2013 results. But do consider the benefit of including a significant component of your equity investments from beyond Canada’s borders.
A retired corporate executive, enjoying post-retirement as an independent Financial Consultant (www.dolezalconsultants.ca), Peter Dolezal is the author of three books, including his most recent, The SMART CANADIAN WEALTH-BUILDER. Contact Panorama Rec Centre to register for Peter’s Elder College Spring session — Financial and Investment Planning for Retirees and Near-Retirees (Wednesdays, March 19 to April 16).