With each new year, it’s a good idea to check your asset mix

How you distribute money among stocks, bonds, cash is the key to portfolio risk

If you have any money invested in stocks, exchangetraded funds or mutual funds, chances are that you woke up on New Year’s morning feeling a little richer than the year before.

The year just ended was a remarkably strong one for stock markets, especially in New York. Our own TSX lagged well behind Wall Street but still managed to post a modest gain of 6 per cent for 2017. However, that’s all history. What do you do now? The starting point is to check your asset mix. How much do you currently have invested in stocks, bonds and cash? Repeated studies have shown that how you distribute your money among those three classes is more important than the actual securities you hold. It also is the key to the amount of risk in your portfolio.

After what happened in 2017, chances are your asset mix is out of whack from what you originally intended. Let’s assume a balanced portfolio with $100,000 that was invested 60 per cent in stocks, 30 per cent in bonds and 10 per cent in cash at the start of 2017. Let’s look at what happened. We’ll assume the stocks were divided equally between Canada and the U.S. The S&P 500 was up almost 20 per cent last year so we’ll assume an overall gain for the equity side of 13 per cent, or $7,800. The FTSE TMX Canadian Universe Bond Index was ahead 2.52 per cent for the year, for a profit of $756 on that portion of the portfolio. We’ll be generous and give the cash balance a 1-percent gain for the year, or $100.

So here is where we stand entering 2018. The equity side of the portfolio has a value of $67,800. The bonds are worth $30,756, while the cash balance is $10,100. The total value is $108,656.

The new asset mix is 62.4 per cent stocks, 28.3 per cent bonds, and 9.3 per cent cash. In other words, without you having bought or sold anything your portfolio became more risky in 2017, even though you made money.

Those percentage changes may not seem like a lot.

But if they are ignored over a period of time they can leave you with an asset mix that is far removed from what you originally intended.

When stock markets are strong, people tend to overlook these warning signs. Why mess with what’s working? But stocks don’t go up forever. Sooner or later there will be a bear market — it’s never failed yet. Your equities could lose half their value or more, as happened in 2000 and 2008.

If you’re young, you have years to recover from such a hit. But older people who are coming up to retirement or are already there would be highly vulnerable in this situation.

For example, in 2008 a portfolio that was 60-per-cent stocks and 40-per-cent bonds would have lost 15 per cent. But if the mix was 80-per-cent stocks and 20-per-cent bonds, the loss would have jumped to more than 22 per cent.

The bottom line is that the older you are, the more asset mix matters. You need to protect your money against the downturn that will inevitably occur.

So as one of your new year’s resolutions, decide to take a hard look at your portfolio.

Don’t spend the time admiring how well your assets have performed in recent years.

Instead, ask yourself if you would be comfortable with your asset mix and the securities you own if 2018 turned out to be a repeat of 2008.

I’m not predicting that will happen. But it could. The Goldilocks economy won’t last forever. Make sure you’re ready for whatever gales are out there. Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters.