April 1997

Essential to
Diversify by Strategy

© Talbot Stevens

The only real protection against economic, political, currency, inflationary, and tax related risks is to diversify.

Because no one knows where stocks or interest rates will be a year from now, one of the most important steps in reducing risk is to diversify by asset class. We should always maintain a mix of stocks or equity funds, bonds, and cash (GICs or treasury bills).

Canadians also need to diversify geographically. Canadian markets represent less than 3% of the world's equity opportunities. Investing internationally reduces risk, and has produced higher returns as well.

With mutual funds, we should diversify by manager and management style. While a single mutual fund diversifies in dozens of different stocks, no one knows who will be the best fund manager over the next 20 years, so we should spread our money among several (2-6) funds.

While these forms of diversification are well known, there is another type of diversification that receives almost no attention.

Most Canadians have the majority of their retirement investments in a single investment strategy — RRSPs.

What would happen if the government came along and increased the taxation on that strategy by, say 20%? For most middle income Canadians, that is exactly what happened when the new seniors benefit was introduced in the 1996 federal budget.

It doesn't matter how good any investment strategy is — whether it is RRSPs, leverage, unleveraged capital gains, or whatever — is it safe to have almost all of your retirement funds in any single strategy?

To protect what you could have at retirement, especially on an after-tax basis, it is critical to also diversify by strategy.

The previous two Strategy Sheets have shown that for many, non-registered equity funds are better than RRSPs. Therefore, it makes sense to also have some money outside of RRSPs, leveraged or unleveraged.

In my seminars, I used to educate how conservative leverage could produce a larger retirement fund than RRSPs. Now, the more important reason to consider a balanced combination of RRSPs and conservative leverage is to diversify by strategy.

Using leverage to implement an “RRSP meltdown” or “freeze” can help those with everything in RRSPs rebalance their strategies. These concepts will become even more valuable in the future as people try to restructure their investments to avoid the seniors benefit clawback.

A related issue is the fact that most Canadians have the bulk of their net worth in their house. Is it a good retirement strategy to have most of your net worth in a real estate investment that is expected to grow at zero-ish percent per year?

Consider using conservative leverage to get a small portion of that house equity working harder for you.

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