Diversification: Not a one-size-fits-all

March 22, 2018

Contributed by: Edward May, CFP® | Senior Financial Consultant, MD Management Limited

Contributed by: Edward May, CFP® | Senior Financial Consultant, MD Management Limited

Whether you’re just starting to invest or have been doing so for some time, you probably know the golden rule of investing: don’t put all your eggs in one basket. In other words, diversify your portfolio.

Diversifying means buying securities from multiple asset classes (e.g., equities, fixed income, cash) and different industry sectors and geographical areas. When you diversify, it helps to reduce risk, but it doesn’t completely eliminate it. Diversifying gives you a smoother ride, which can help you stay focused on your investment objectives when markets are volatile, rather than panic and sell.

What’s great about diversifying your portfolio these days is that anyone has the ability to diversify regardless of how much money you have. Back in the mid-1980s, when I first started in the financial industry, it was much, much harder to diversify. But these days, whether you have $500 or $5 million to invest, you can own a well-diversified portfolio.

For a medical student or resident who’s just beginning to invest, a managed portfolio solution can be ideal. This is a single mutual fund investment that holds a diversified mix of underlying funds that are carefully selected, combined, monitored and rebalanced to fulfill a range of risk and return characteristics to help you meet your financial goals. Where it gets interesting are the possibilities for diversification as physicians build their wealth.

How to diversify if you have significant assets

The basic building block of diversification is asset class: equities, fixed income and cash. For the average investor, it means owning publicly traded stocks and bonds (whether directly or through mutual funds and exchange-traded funds).

As you accumulate more assets, you can start expanding the asset classes you invest in and consider real estate (e.g., rental properties, farmland and timberland) and alternative investments such as hedge funds, derivatives, foreign currency and private equity.

These different asset classes provide additional diversification benefits because they have a lower correlation to traditional asset classes, giving you the chance to generate potentially greater long-term returns. How much you allocate to alternative investments would, of course, depend on your individual situation.

One area that’s becoming more accessible to wealthier investors is private equity investments.

What is private equity?

Private equity strategies invest in shares or holdings in a company that isn’t listed on a stock exchange. Think Facebook before its initial public offering.

Private equity investments can be complex, whether the company is a start-up seeking venture capital, a mature company looking to expand or a company that needs capital to restructure. It takes a special kind of expertise to analyze, evaluate and invest in private companies. Like the public stock market, private equity can generate growth – but because the investment is privately held, investors are looking to improve performance through operational changes or new ideas. It means investors have a lot more say in the future of the company.

For the most part, private equity investments have typically been accessible only to sophisticated institutional investors such as pension funds, since the minimum investment amount is usually $1 million or more. However, these strategies are becoming available to qualified Canadians. In Canada, being an “accredited” investor means having either an income of $200,000+ before taxes ($300,000 if combined with a spouse) or net financial assets of $1 million before taxes or net assets of $5 million (which could include real estate). Besides being accredited, private equity investments are also best suited to long-term investors who are looking for higher returns over time through a patient, long-term approach.

One of the most compelling reasons to invest in private equity comes back to the increased diversification benefits for a portfolio. Although private equity has similar characteristics to public equities, there are additional factors that drive private equity (think long-term investment horizon). These different factors provide lower correlations relative to traditional stocks and bonds, which in turn provide further diversification and a more robust risk-return profile for a portfolio.

When you think of eggs in a basket, private equity is simply another basket you can use.

For more information about private equity investing for physicians, see md.cma.ca/platinum. MD Platinum™ is a new offering with a low initial minimum investment and is exclusively available to MD clients until April 30.

Edward May, CFP® is a Senior Financial Consultant with MD Management Limited. Contact him at edward.may@cma.ca.

MD Platinum™ is a trademark of the Canadian Medical Association, used under licence.

The information contained in this document is not intended to offer foreign or domestic taxation, legal, accounting or similar professional advice, nor is it intended to replace the advice of independent tax, accounting or legal professionals. Incorporation guidance is limited to asset allocation and integrating corporate entities into financial plans and wealth strategies. Any tax-related information is applicable to Canadian residents only and is in accordance with current Canadian tax law including judicial and administrative interpretation. The information and strategies presented here may not be suitable for U.S. persons (citizens, residents or green card holders) or non-residents of Canada, or for situations involving such individuals. Employees of the MD Group of Companies are not authorized to make any determination of a client’s U.S. status or tax filing obligations, whether foreign or domestic. The MD ExO® service provides financial products and guidance to clients, delivered through the MD Group of Companies (MD Financial Management Inc., MD Management Limited, MD Private Trust Company, MD Life Insurance Company and MD Insurance Agency Limited). For a detailed list of these companies, visit md.cma.ca. MD Financial Management provides financial products and services, the MD Family of Funds and investment counselling services through the MD Group of Companies. MD Financial Management Inc. is owned by the Canadian Medical Association.

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