The media and the financial services’ marketing teams have done a good job preaching the virtues of "diversification" or, not putting all your eggs into one basket. By holding investments across different asset classes, different countries and different investment styles you can reduce the volatility in your portfolio (volatility is just another word for "risk").
But far too often I will see people’s portfolios with large concentrations in the Canadian stock market. Now, this is a tricky subject to broach because as you know the Canadian stock market has been one of the best performing stock markets for the last 5 years globally.
However, if you do believe in diversification then you would have a tendency to spread your money around a little bit more. One fact that gets tossed around often is that the Canadian stock market represents approximately 3% of the world’s total equity. So for people who ONLY invest in Canada, but then tell me they have diversified across all 10 subsectors of the TSX I have to wonder if they have missed the point… While they are investing across the different major industry categories, they are still limiting their investment universe to 3% of the total spectrum!
Investing in the Canadian index is not that great when you consider that the top 3 subsectors (Financials, Materials and Energy) represent 75% of the TSX! Our stock market is not a very well diversified one to say the least. Healthcare stocks make up around 1% of the TSX so if you want any meaningful exposure to healthcare you would have to go south or overseas to Europe.
It has been proven time and time again, that if you expose yourself a little more to foreign equities (even though they may be more volatile), they tend to have different up/down cycles than Canadian equities. Adding these riskier asset classes to your portfolio in moderation can actually serve to DECREASE your overall portfolio volatility while increasing returns.
Given that the Canadian stock market has had double digit positive returns for the last 4 calendar years and perhaps heading to a 5th, you know that when we have a strong over-performance above the long term average, eventually something has got to give! Currently, many institutional asset allocation services do not hold more than 30% of their portfolios in Canadian equities. Food for thought…
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