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Salvaging your shattered holdings

Globe and Mail Update

When a sports franchise hits the skids, the euphemism of choice is that the team is in a rebuilding phase.

This brings us to your portfolio. After a year of stock market hell, is a rebuilding phase in order? Read on if you think so because this edition of the Portfolio Strategy is all about ways of reassembling what the markets and bad investment planning have torn apart.

Let's start with how not to rebuild. That would be selling your stocks and equity funds en masse at this late date and moving into Treasury bills or other safe investments, all of which will lock you into returns of 4 per cent all the way down to below 1 per cent, depending on the term.

“You'll never come back if you sell and hold cash,” said Mark Yamada, president of PUR Investing Inc., a money management firm. “That's a certainty. You certainly won't lose any more money, but you won't come back.”

Now, what about maintaining the status quo in your portfolio and waiting for a market rebound to carry your investments higher? Mr. Yamada says hanging on is a viable strategy for rebuilding your portfolio because, with the markets having already plunged, the level of risk you face is much reduced.

Warren MacKenzie, chief executive officer of Second Opinion Investor Services, said staying the course in a portfolio is an acceptable strategy only if you've ascertained whether you have a sound mix of investments. The proper way to evaluate your portfolio is to compare it with an appropriate mix of benchmark stock and bond indexes (the Nov. 22 Portfolio Strategy looked at benchmarking – you can read it by clicking here).

If your portfolio has done better than the benchmarks – your Canadian stocks or equity funds have done better than the S&P/TSX composite index, in simple terms – then leaving your portfolio alone is an option as far as Mr. MacKenzie is concerned. “But if you're down 20 per cent and you should only be down 10 per cent, you don't want to let that ride.”

Rebuilding a portfolio is less a matter of deciding what securities to buy or sell than it is a back-to-basics process that considers your tolerance for risk and the rate of return that you'll need to achieve your investment goals. Lots of investors have found in the past year that they're not as comfortable with the risks posed by the stock markets as they thought they were. And yet, they may need a higher level of return than they can get in bonds or guaranteed investment certificates in order to generate sufficient savings for retirement or other goals.

“Just because you need a higher return doesn't mean the market is going to give it to you,” Mr. MacKenzie said. “In planning for retirement, you may have to revisit your planned spending habits. It may be easier to curtail your spending a bit than to get a higher return.”

Another option is to increase the amount of money you save for retirement. For instance, you could put an additional $5,000 a year in the new tax-free savings account that will be available starting in 2009.

In a bizarre twist, the bear market may have already given you a nudge in the direction of a more balanced portfolio. Imagine you started out the year with a $100,000 portfolio that was 70 per cent invested in stocks and 30 per cent in bonds. If the bonds held steady and the stocks lost 40 per cent, then you'd be left with $42,000 in stocks and the same $30,000 in bonds. If you wanted to move to a 50-50 split between stocks and bonds, you'd simply have to sell $6,000 of your equity holdings and buy bonds. Net result: You have $36,000 in stocks and $36,000 in stocks.

Mr. MacKenzie argued that it's more important to get yourself into the right asset mix than it is to try to position yourself for a stock market rebound that could erase some of your losses of the past year.

“If we knew for sure that all the problems were over, we'd say, hey, load up on equities and enjoy the returns,” he said. “But I'm not confident that's the case. So my position is to take no more risk than necessary.”

Rebalancing may require that you sell hard-hit stocks or equity funds that you've been inclined to hold on to for a rebound. Again, though, your portfolio should be guided first by your mix of assets and secondarily by the actual securities you hold.

“A lot of people look at their losses and say, I can't sell,” Mr. Yamada said. “The reality is that you have to start today and look forward to build a portfolio. You can't just sort of sit there and freeze.”

Mr. Yamada suggested an approach to rebuilding a portfolio that is somewhat unconventional. You take a majority of your portfolio, say 80 per cent, and invest it conservatively in bonds, guaranteed investment certificates or dividend-paying blue-chip stocks and then put the remainder in an exchange-traded fund that provides two times the return of a particular stock index.

These ETFs are sold in Canada by Horizons BetaPro and they come in bull and bear versions for major stock indexes like the S&P/TSX 60 and S&P 500. You'll use the bull version here, which would give you double any index moves in a day. Example: if the S&P/TSX 60 index goes up 5 per cent in a day, the S&P/TSX 60 Bull Plus ETF (HXU-TSX) goes up 10 per cent. This ETF would fall 10 per cent if the index lost 5 per cent.

Some investors have complained that leveraged ETFs do not deliver double-the-market performance over the long term, and this in some cases is true. Still, Mr. Yamada thinks they're a useful way for investors to keep most of their assets in safe but boring and low-yielding securities while still feeling like they'll participate in a market rebound.

“Investing is as much psychological as anything else,” Mr. Yamada said. “If you have 80 per cent of your portfolio on solid ground and you have a portion in something that is going to get a pop on the upside, then at least you're going to see some action.”

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