Investment

How to Simplify Your Investment Portfolio

Published

4 months ago

July 10, 2024

Exchange-traded fund providers have flooded the market with all sorts of novel assets and strategies: single-stock ETFs, leveraged and inverse ETFs, and even spot bitcoin ETFs can be accessed through your brokerage account with the click of a mouse.

You don’t need any of it. Basic stocks and bonds are still the workhorses of real long-term investments, and access to them through tax-efficient ETFs has never been easier or cheaper.

Combining them in the right proportions can be another sticking point. Complex mathematical models that solve for an “optimal” portfolio look like one remedy. But they can create a false sense of security because the future is so difficult to predict with any degree of accuracy.

These complex tools still provide some insight. They demonstrate some simple and timeless principles that every investor should understand. Portfolio construction ultimately rests on a few basic ideas that have withstood the test of time. Investors need to incur enough risk to achieve a rate of return that will allow them to meet their goals. And they have two asset classes to help dial in the right amount of risk and return: high-risk stocks and low-risk bonds.

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Portfolio construction is ultimately about combining different assets to achieve a desired rate of return, level of risk, or both. In its ideal form, it tries to minimize the amount of risk necessary to achieve a desired rate of return or maximize the amount of return for a given level of risk.

Diversification plays a big role in achieving that objective. Diversifying a portfolio means holding multiple assets that perform in unrelated ways so that one won’t wipe out the entire portfolio when it goes through a rough patch. The trick lies in figuring out how much of each asset is necessary to realize the greatest benefit.

Harry Markowitz, the late Nobel Prize-winning economist, is credited with formalizing the mathematics behind portfolio construction. His model, still used by many financial professionals, calculates the precise weighting of stocks and bonds necessary to achieve an ideal portfolio—one that maximizes the rate of return for a given level of risk.

The math behind Markowitz’s framework is complicated—too complicated for most to comprehend. But it’s built on some simple concepts that can help any investor make better long-term investment decisions.

Exhibit 1 illustrates the output of Markowitz’s model, a chart commonly referred to as an “efficient frontier.” The plot shows various mixes of US stocks and bonds that produced the highest level of return (the vertical axis) for a given amount of risk (the horizontal axis). The point at the left end of the chart represents a low-risk portfolio of 100% investment-grade US bonds (proxied by the Bloomberg US Aggregate Bond Index), while the high-risk portfolio at the right end held only US stocks (proxied by the S&P 500). The points in between represent various mixes of those two assets.

Source: Morningstar Direct, author’s calculations. Data from January 1976 to October 2023.

There’s an easy conclusion to draw without reading too much into the numbers. Higher rates of return require taking on more risk. That means owning more stocks and fewer bonds. And there’s some nuance at the extreme ends of the chart. The least risky portfolio wasn’t the one fully allocated to bonds. It had a small investment in stocks, so the most risk-averse investor can further cut back on risk by owning some riskier equities. At the other end of the chart, the most aggressive investor can make a meaningful reduction in risk with only a modest hit to their long-term total return.

Precision isn’t the strength of Markowitz’s model. Does that make it completely useless? Hardly. It still provides valuable insights for constructing a long-term investment portfolio.

First, stocks and bonds behave differently from one another. Their correlation coefficient (a measure of their relationship to one another) was about 0.24 over the full period in Exhibit 1 (January 1976-October 2023). For context, a coefficient of 1 would imply that they moved in lockstep, while 0 would mean their movements had no measurable relationship. Assets with low correlations are desired, as they’re what lead to a diversified portfolio.

Those conclusions aren’t likely to change much if more asset classes were included, such as international stocks. Exhibit 3 shows the correlations across four major asset classes between January 2001 and May 2024. Stocks, whether domestic or international, were closely tied to each other, with correlations ranging between 0.7 and 0.9. Bonds, on the other hand, tended to behave in a very different way. Their correlations with all three regional stock markets were much closer to 0.

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Investment

Tesla shares soar more than 14% as Trump win is seen boosting Elon Musk’s electric vehicle company

Published

3 days ago

November 6, 2024

Anne Joseph

NEW YORK (AP) — Shares of Tesla soared Wednesday as investors bet that the electric vehicle maker and its CEO Elon Musk will benefit from Donald Trump’s return to the White House.

Tesla stands to make significant gains under a Trump administration with the threat of diminished subsidies for alternative energy and electric vehicles doing the most harm to smaller competitors. Trump’s plans for extensive tariffs on Chinese imports make it less likely that Chinese EVs will be sold in bulk in the U.S. anytime soon.

“Tesla has the scale and scope that is unmatched,” said Wedbush analyst Dan Ives, in a note to investors. “This dynamic could give Musk and Tesla a clear competitive advantage in a non-EV subsidy environment, coupled by likely higher China tariffs that would continue to push away cheaper Chinese EV players.”

Tesla shares jumped 14.8% Wednesday while shares of rival electric vehicle makers tumbled. Nio, based in Shanghai, fell 5.3%. Shares of electric truck maker Rivian dropped 8.3% and Lucid Group fell 5.3%.

Tesla dominates sales of electric vehicles in the U.S, with 48.9% in market share through the middle of 2024, according to the U.S. Energy Information Administration.

Subsidies for clean energy are part of the Inflation Reduction Act, signed into law by President Joe Biden in 2022. It included tax credits for manufacturing, along with tax credits for consumers of electric vehicles.

Musk was one of Trump’s biggest donors, spending at least $119 million mobilizing Trump’s supporters to back the Republican nominee. He also pledged to give away $1 million a day to voters signing a petition for his political action committee.

In some ways, it has been a rocky year for Tesla, with sales and profit declining through the first half of the year. Profit did rise 17.3% in the third quarter.

The U.S. opened an investigation into the company’s “Full Self-Driving” system after reports of crashes in low-visibility conditions, including one that killed a pedestrian. The investigation covers roughly 2.4 million Teslas from the 2016 through 2024 model years.

And investors sent company shares tumbling last month after Tesla unveiled its long-awaited robotaxi at a Hollywood studio Thursday night, seeing not much progress at Tesla on autonomous vehicles while other companies have been making notable progress.

Tesla began selling the software, which is called “Full Self-Driving,” nine years ago. But there are doubts about its reliability.

The stock is now showing a 16.1% gain for the year after rising the past two days.

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Investment

S&P/TSX composite up more than 100 points, U.S. stock markets mixed

Published

4 weeks ago

October 16, 2024

Anne Joseph

TORONTO – Canada’s main stock index was up more than 100 points in late-morning trading, helped by strength in base metal and utility stocks, while U.S. stock markets were mixed.

The S&P/TSX composite index was up 103.40 points at 24,542.48.

In New York, the Dow Jones industrial average was up 192.31 points at 42,932.73. The S&P 500 index was up 7.14 points at 5,822.40, while the Nasdaq composite was down 9.03 points at 18,306.56.

The Canadian dollar traded for 72.61 cents US compared with 72.44 cents US on Tuesday.

The November crude oil contract was down 71 cents at US$69.87 per barrel and the November natural gas contract was down eight cents at US$2.42 per mmBTU.

The December gold contract was up US$7.20 at US$2,686.10 an ounce and the December copper contract was up a penny at US$4.35 a pound.

This report by The Canadian Press was first published Oct. 16, 2024.

Companies in this story: (TSX:GSPTSE, TSX:CADUSD)

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Economy

S&P/TSX up more than 200 points, U.S. markets also higher

Published

4 weeks ago

October 11, 2024

Anne Joseph

TORONTO – Canada’s main stock index was up more than 200 points in late-morning trading, while U.S. stock markets were also headed higher.

The S&P/TSX composite index was up 205.86 points at 24,508.12.

In New York, the Dow Jones industrial average was up 336.62 points at 42,790.74. The S&P 500 index was up 34.19 points at 5,814.24, while the Nasdaq composite was up 60.27 points at 18.342.32.

The Canadian dollar traded for 72.61 cents US compared with 72.71 cents US on Thursday.

The November crude oil contract was down 15 cents at US$75.70 per barrel and the November natural gas contract was down two cents at US$2.65 per mmBTU.

The December gold contract was down US$29.60 at US$2,668.90 an ounce and the December copper contract was up four cents at US$4.47 a pound.

This report by The Canadian Press was first published Oct. 11, 2024.

Companies in this story: (TSX:GSPTSE, TSX:CADUSD)

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