Posted by Proper asset allocation wasn’t a concept I adopted until I made mistakes in my first few years of investing.
I’ll have an upcoming post on everything you need to know on asset allocation. In short:
Asset allocation is identifying the right mix of stocks, bonds and other assets that balances (1) achieving your investment targets and (2) letting you sleep well at night.
Before I adopted a thoughtful asset allocation strategy, I definitely did not achieve my investment targets and it kept me up at night.
My First Asset Allocation Plan
In 2012-2013, I started investing in my TFSA account with about $15,000. (Prior to that, I had foolishly kept it in a TFSA High Interest Savings Account. I don’t count that as investing.)
Just like the old adage “don’t put all your eggs in one basket”, I knew that I should diversify! My asset allocation plan was to split my $15,000 into 5 sets of $3,000.
From reading personal finance articles and magazines, I also knew about the 80/20 equity/bond split. I was early in my working career, so it seemed like a sensible allocation.
My plan was to buy $3,000 of a Bond ETF or ~20% of my portfolio. I would also identify 4 stocks to invest in at $3,000 each or ~80% of my portfolio. My portfolio concentration would only be ~20% in any given company. I would benefit if one of my picks “made it big”, but my portfolio wouldn’t be wiped out if one stock tanked.
Over the next few months, I started deploying my capital and finding the right stocks to buy. By mid-2014, my portfolio looked something like this (at cost basis):
| Name | Ticker | Cost Basis | % of Portfolio |
|---|---|---|---|
| Canadian Oil Sands | COS | $2,429 | 17% |
| Eastern Platinum | ELR | $2,418 | 17% |
| BMO Equal Weighted REIT Index ETF | ZRE | $3,824 | 26% |
| iShares BRIC Index ETF | CBQ | $2,629 | 18% |
| iShares CDN Corporate Bond ETF | ZCB | $3,171 | 22% |
| Total | $14,471 | 100% |
Investment Rationale: Buy in “hot” sectors & companies
While my portfolio choices may look random, I did have some rationale behind each pick. It just wasn’t a particularly intelligent or data-driven rationale.
Living in Canada, commodities & resources is one of the hot topics for investing at that time. In talking with friends, their investing tips was to buy the dip in resource companies. Naturally, I should overweight in resources to benefit from the inevitable upswing! Everyone needs natural resources!
With that as a fundamental belief, my investment rationale was:
- Canadian Oil Sands: everybody needs oil and COS was an established name. We can’t make more oil, so it will only get more expensive over time
- Eastern Platinum: as a precious metal, platinum was the more obscure and more rare cousin of gold and silver. If it’s rare, price will only go up!
- REIT ETF: real estate only goes up!
- BRIC (Brazil, Russia, India, China) ETF: Developing countries is where the growth will be at. Think of the population and economic growth that will happen in these regions!
Since I was young, bold and (a little) stupid, my picks were geared towards high growth and high reward.
The Result?
After holding the assets for 2-3 years, I had to liquidate my portfolio and use the funds towards a downpayment. When I started the TFSA, I knew the money is likely to be used within 5 years to buy a property. I wasn’t certain that I would end up buying a property, but I knew it was a possibility.
| Name | $ Gain / (Loss) | % Gain / (Loss) |
|---|---|---|
| Canadian Oil Sands | -$11 | -0.5% |
| Eastern Platinum | -$2,208 | -91% |
| BMO Equal Weighted REIT Index ETF | +$148 | +4% |
| iShares BRIC Index ETF | -$225 | -9% |
| iShares CDN Corporate Bond ETF | +$24 | +0.7% |
| Total | -$2,272 | -16% |
Since I had a hard closing date, I had to sell all my positions that I otherwise would have kept for a longer term. Ultimately, I lost ~$2,300 or -16%.
As I look back this portfolio composition and the results, I do cringe at my (slightly) irrational decisions. But what exactly was flawed with it?
Avoid my asset allocation & investment mistakes
1. Significant concentration in natural resources sector
By splitting the investment in 1/5ths, the initial idea was to diversify and manage risk. However, by investing ~40% of my portfolio into natural resources, I was extremely skewed towards the success or failure of that sector. In short, this was a high risk portfolio.
2. No US and International developed market exposure
While I had some international exposure through the BRIC ETFs, it was a very high risk choice as BRIC (or developing) markets are inherently volatile. The Canadian exposure offered some diversification, however investments into US and/or other developed markets would have better balanced the very high risk portfolio.
3. Buying stocks based on rumours and gut-feeling
Instead of conducting research and analysis on the company’s performance, I was basing choices on anecdotes and rumours.
“My friend made money buying & selling Eastern Platinum. Therefore, I should also invest to make money.”
Ms. LJ’s inexperienced and flawed rationale
4. Investing money required in the medium term vs. long term investing
Since I did not have a firm timeline for purchasing a property, it did make sense to invest the money in the interim. However, if I was contemplating using those funds within 5 years, it doesn’t make sense to create such a high-risk portfolio. I should have established an asset allocation that was low or medium risk at most to account for the potential need for a downpayment.
Asset allocation strategy is only as good as the underlying rationale
While the initial intent of setting an asset allocation strategy is helpful, the underlying investment strategy has to be rational.
One could set an asset allocation strategy of 100% penny stocks, but it doesn’t mean make it a sensible, rational strategy.
I’m happy I made these mistakes earlier on in my personal finance journey. While a -16% drop definitely hurts both my ego and my wallet, a ~$2K loss doesn’t break the financial independence journey. Better to learn that on a small portfolio than on a larger one!