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The Asset Class Matrix

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After each calendar year, we can look back and observe which investment asset class performed the best.  Was it International Equities?  Was it High Yield bonds?  Or was it US Small Caps?  Good to know, but there is a danger of concluding that the year’s winner is the best place to invest your savings.

Take a look at this matrix of annual rankings of key asset classes over the last decade (click the chart to open a pdf in a new page):

Matrix-invest_class

You will see that the asset class rankings shift all over the place from year to year.  In some cases, the worst performer one year becomes the best performer in the very next year.  No one can predict with consistent accuracy, the future rankings of these asset classes.

So, while the returns of these individual asset classes swing widely, a portfolio built with a balance of all these asset classes will smooth out the variation.  And no need to predict the winner if you have all the bases covered.

Can Investments be Overdiversified?

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A well-known investment adage is, “don’t put all your eggs in one basket.”  The literal translation is, if the one and only basket falls, then all your eggs will be broken.  But if you kept your eggs in several baskets, then the fall of one basket will not destroy your entire stock of eggs.

Applied to financial investing, the rule is, don’t put your entire savings into one company’s stock.  If that one company fails, then all of your savings will be gone.  The solution is to diversify – spread your investment dollars over several unrelated businesses and industries.

Unfortunately, many Canadians apply the “one basket” rule to financial institutions.  That is, they “diversify” by spreading their investment savings over two or three different financial institutions.  Not only is this NOT an application of the rule, but by doing so, the savings might actually end up in the same basket!

Each financial institution may not be aware of what the other financial institutions are recommending for the client’s portfolio.  As a result, the client may end up with the same stocks in all of their investment accounts.

Sometimes, overdiversification can lead to no diversification.

A Savings Habit – Plan your meals

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In almost every case, a meal prepared at home cost less than the same meal in a restaurant, take-out, or delivery.  So, if you’re looking for a way to reduce your monthly food bill, choose homemade meals over eating out.

That’s easier said than done.  You come home from work and you’re tired and hungry.  Is this a moment when you’re going to start chopping carrots, peeling potatoes, and seasoning your meat?  And that’s assuming you even have all those ingredients in your refrigerator.  It’s hard to start a habit of home cooked meals, when the conditions aren’t in line with the goals.

To get the savings habit of homemade meals going, plan your meals ahead of time, perhaps on a weekly basis.  Choose a time – probably on the weekend – where you figure out what you will have for dinner on each of the days ahead.  Then, set yourself up for success by making sure you have what you need readily available.  That may call for grocery shopping and maybe some weekend “bulk” cooking, like preparing a lasagna or roasting a chicken.

“Failing to plan is planning to fail.”  (Alan Lakein, author on personal time management, including, “How to Get Control of Your Time and Your Life”)

A Savings Habit post.

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Transitioning from Employment to Retirement

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Employment provides a flow of paycheques.  Cash flow management may be minimal while you’re employed because when you spend one paycheque, you know that another one is on the way.  Not only that, the right amount of income tax is often already withheld from your pay, so that come Tax Day, there is no more income tax owing.

Retirement requires a lot more cash flow management.  For example, it is most likely that income tax withheld from a pension cheque (if any) will fall short of the total income tax owing come Tax Day.  That calls for planning.

Needing to find extra cash on Tax Day is minor compared to the devastation that can happen if your retirement pension comes solely from savings (like an RRSP, or a company lump-sum retirement amount) and there’s been no planning.  I know of a couple who received a large payout when the husband retired.  They were not used to any kind of money management and saw the payout as a windfall for big-ticket spending.  They spent it all within a few short years.  The wife, who eventually became widowed, lived a long time, with government pension as her only income.

If you are not used to hands-on cash flow management (tracking money in and money out), don’t wait until retirement and risk the hard lessons.  Get to know your personal cash flow while you’re still employed and determine what the difference will be when those employment paycheques stop, and the pension pay begins.

Prager U: How to Raise Kids who are Smart about Money

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In this Prager U video, narrator and personal finance expert, Rachel Cruze offers three principles for raising kids to be smart about money.  Very sound advice overall, although I would not dismiss the use of allowance as a money management teaching tool, as she does.  Cruze is correct that when children earn their own money, they will experience “accomplishment” with their purchases, rather than “entitlement” as when money is given to them to spend.  She views allowance as a form of giving money for “breathing” (i.e., for nothing).

When parents actively teach their children money management with the use of allowance, then it’s not for nothing.  Cruze suggests that children should “work” for their “pay” by doing age-appropriate chores around the house.

Allowance or payment for chores?  Which is the better money management teaching tool?  Parents will know the answer, because they know their children.