Financial and Business Succession Planning, J. Paul Wilson, CFP, Halifax, Nova Scotia, Canada

1. Broad assets classes and their percentages
2. Specific securities within those classes
3. Correlation
4. Strategic asset allocation, Modern Portfolio Theory and Efficient Frontier

Asset allocation is the process of determining the proportions of different assets to be included in an investment portfolio. It’s a multi step process. The process begins with a decision on the broad asset classes to include in a fund and the exact percentage to allocate to each class. Depending on the type this may be more complicated than it seems. An equity fund, for example, will most likely contain securities only from the equity asset class. A balanced fund however, could contain both fixed income and equities.

Once the broad asset classes and their percentages have been identified, the next step is to select specific securities within those classes. This is where it gets complicated. The fund manager now must do hours of research to decide which securities to include in their fund. Needless to say, fund managers rely quite heavily on teams of analysts to help them make buying and selling decisions for the fund. If you have invested money today in any form of mutual fund you will likely have gone through an asset allocation process. Done only once and left alone an asset allocation process becomes less and less of value. Since the asset allocation process leads you to certain investments there will be growth or losses over time in those investments. You have to ensure that a re-balancing or review takes place on a regular basis within your portfolio. Only by coming back within you risk profile will you maintain the integrity of your plan.

The next step is to decide how this all comes together to meet your needs and match your Risk tolerance. This is where correlation and the Efficient Frontier come into play. Strategic asset allocation is one of the principles of Noble Prize winning Modern Portfolio Theory. Modern Portfolio Theory in turn, is how the concept of the Efficient Frontier was developed.

Correlation shows the relationship that one investment has with another. That relationship can be quantified by a correlation value. The correlation values are between +1 and -1. The closer the correlation of assets is to +1, the more closely returns move together (i.e. the fund goes up, the other fund goes up). On the other hand, the closer the correlation of two assets is to -1, the more divergent the returns are (i.e. one fund goes up, the other fund goes down). You should use a process with software (we use Investment Voyager) that takes into consideration the correlation of all the funds involved. If you didn’t take correlation into account, your portfolio wouldn’t be properly diversified and you will be exposed to more risk.

Strategic asset allocation software are scientifically developed to identify combinations of investments that offer the best return at the least risk. For example to determine these combinations, the returns of all types of investments were examined for the past 40 years. Then sophisticated investment optimization software was used to calculate the most effective investment combinations for each level of risk. These combinations form the Efficient Frontier, which is the basis for each investment profile. Each dot in this graph represents a specific fund. The line represents the Efficient Frontier – the specific combination of funds that produce optimized returns at each level of risk.

Here is a sample using these combinations to produce five investment profiles.

"Too many cooks can spoil the broth”

If you have funds invested through several different sources and you have not looked at your overall diversification including correlation then your portfolio is likely not properly diversified.

 
The next steps

1. Solidify your investment objectives and your investment philosophy.

Achieve long-term growth with the lowest possible level of risk along the way? Conserve for your legacy? Increasing income? Conserve capital?

2.  What is your current situation?

Complete a questionnaire to determine your risk profile

A quantitative analysis of your existing portfolio will determine if it matches your risk profile provide a diversification analysis

3.  Recommendations

Specific to each situation

4. Action Plan 

Rebalance and transfer assets as needed (may be taxes and or fees)

Review and rebalance as needed. (As one portion of the portfolio grows faster than another)



J. Paul Wilson, CFP, CLU, CH.F.C., TEP
380 Bedford Highway, Halifax, Nova Scotia, B2N 2L4
Office (902) 405-8665 Direct (902) 982-2377 Mobile (902)488-4982
Toll-free Fax (866)-436-1207 Email paul@jpw.ca

Desjardins Financial Security Investments Inc.
Branch Office
110-230 Brownlow Avenue
Dartmouth, Nova Scotia. B3B 0G5
Branch (902) 468-0814
Direct (902) 982)-2377
Fax: (902-468-7292

NOTE:

The information contained in this article is intended to provide general guidelines only. The application and impact of the law can vary widely from case to case based on the specific or unique facts involved. Accordingly, the information in this article is not intended to serve as legal, accounting or tax advice. Users are encouraged to consult with their professional advisers for advice concerning specific matters before making a decision.

Make your investment decisions wisely. Important information found in the funds' simplified prospectus. Please read this carefully before investing. Commissions, trailing commissions management fees and expenses all may be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently. Past performance of the funds may not be repeated.

A description of the key features of the segregated fund policy issued by the insurance company is contained in the information folder. Any amount that is allocated to a segregated fund is invested at the risk of the policyowner and may increase or decrease in value.

Desjardins Financial Security Investments Inc. (DFSI) is not providing the financial planning service and will not be supervising this activity. You should not rely on DFSI for review of the plan. DFSI is neither charging nor being paid any fees for this service and will not be liable for any errors or omissions. This Financial Planning Service is done solely through jpw.ca Insurance Retirement Investments.