Walk this way for an effective portfolio

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This article was published 09/09/2023 (1114 days ago), so information in it may no longer be current.

Edward Goodfellow is on a money mission.

The Victoria-based financial advisor and finance instructor at Royal Roads University aims to help anyone willing to listen build a better portfolio — either with their adviser or on their own as a do-it-yourself (DIY) investor.

He’s so dedicated to this cause, Goodfellow recently self-published a book with FriesenPress, based in Altona, called 7 Steps to a Better Portfolio.

He recently spoke with the Free Press about the new book and what it can offer average investors.

“The whole idea is, ‘How do you improve the odds for a retail investor in this very complicated world of investing?’” says Goodfellow, a certified financial planner (CFP), chartered professional accountant (CPA) and financial analyst charter-holder.

“Essentially, we use data to show how things work and where market returns come from to build better portfolios” that is much like how pensions manage money.

If you’re wondering what those seven steps are, look no further. Goodfellow provided a brief rundown.

Step 1: Allocate capital around the world

Think of your portfolio consisting of just $1 with each of its 100 cents allocated to different assets and geographies, or eight different buckets. The first is global bonds, which is often the largest bucket, especially if you’re retired. (This segment of the portfolio can also consist of some GICs, too.)

Other buckets include U.S., Canadian, international and emerging markets equities, or stocks. As well, it’s advisable to have one bucket for real estate, and another called “other,” which allows people to add a little pizazz to their portfolio, which could be a technology stock focused exchange-traded fund (ETF), Goodfellow adds.

Step 2: Diversification

If allocation provides breadth for the portfolio, diversification offers depth, Goodfellow says. “You diversify because the nature of tomorrow is very hard to predict,” he says, noting any given equity market has 11 different sectors, like industrials, materials, financials and health care.

Now, here comes the part that might ruffle investment industry feathers.

You don’t get diversification by picking stocks. While you can get diversification from actively managed mutual funds, Goodfellow notes those typically have higher fees than ETFs. What’s more, no managers beat their benchmark index all of the time. In fact, most are unlikely to do it most of the time, he says.

Ergo, buying and owning an ETF tracking the performance of the S&P TSX Composite Index, for example, for a management cost of less than 0.1 per cent per year, offers the best odds of long-term capital growth to meet long-term goals like retirement.

Step 3: Focus on where the returns come from

As mentioned, it’s difficult to outperform indices like the S&P 500 over the long-term. So, the best strategy is to own the S&P 500 for the long term. Since 1983, this index has had an annualized return of more than 11 per cent. In dollar terms, $1 invested in 1983 would be worth about $78, assuming dividends were reinvested. An added upside is that the strategy involves no financial decisions except buying the index. That said, a few slants in equity portfolios may add outperformance. Those are adding slightly more small cap stocks than large cap stocks; favouring value (think bargain-priced) stocks slightly more than growth long-term, and favouring the most profitable companies. “If you tilt your portfolio to favour these, data shows you should get slightly higher returns than an index fund that doesn’t long-term.” Goodfellow adds that beyond these slants, trying to pick the best stocks consistently is often too challenging. “It’s like finding a needle in a haystack.” Instead, own the haystack with an index fund. And if you seek additional performance by including in factors like profitability, Goodfellow suggests looking at providers like Dimensional Funds that have used this strategy effectively since the 1980s.

Step 4: Academia

Goodfellow argues that academic rigour, like the scientific method, have made the world much better on many fronts, including finance.

“Based on statistical research, we know how markets work and where returns come from,” he says, noting those aforementioned factors leading to outperformance are backed by years of research.

Another side of financial science, he adds, is behavioural economics, examining how we make rational and, more importantly, irrational decisions — which brings us to Step 5.

Step 5: Strategy risk

The biggest risk to your portfolio is often you. “People start out with the strategy I’ve outlined — based on statistical evidence — and then they will change their mind.”

But long-term strategies only work if you stick to them for the long-term.

People have trouble sticking to a plan and get sidetracked by greed, fear and the next shiny, new investment.

Step 6: Investment choice risk

All of what has been outlined in the previous steps is about increasing the odds of a good outcome long-term. But as previously mentioned, people can be mesmerized by new, exciting investments. “So, they look to really low probability outcomes, like crypto or meme stocks, and they don’t think through things.” Sure, sometimes, you will win big, but most of the time, the house wins.

Step 7: Cost and taxes

Obviously, you want to keep both to a minimum. With ETFs, you will keep fees as low as possible. Today, for instance, you can get an S&P 500 index fund for 0.02 per cent. With respect to taxes, whether you hold investments in your RRSP, tax-free savings account or non-registered accounts can make a big difference in returns after-tax. On this front, investment advisers/financial planners can really help, he adds.

More than anything, however, portfolio construction is about using low-cost, tax-efficient strategies to make the markets work in your favour as much as possible, Goodfellow says.

“And by following these seven steps, you are giving yourself better odds of a successful outcome.”