At the risk of sounding like a broken record, I firmly believe that the most important component to my portfolio is my asset allocation. I think it is even more important than owning dividend growth stocks! As I do regularly these days, I made a recent portfolio move in the name of asset allocation. I bought some more of one of my fixed income assets – iShares CDN Real Return Bond Index Fund (xrb.to) in order to bring my fixed income allocation closer to target.[ad#tdg-embedded]
My fixed income asset allocation percentage is determined using a simple formula taught regularly by John C. Bogle, founder of Vanguard (the big index fund company). He explains that the easiest way to determine what an individual’s fixed income percentage should be is to allocate your age equivalent to fixed income assets. For example, I am 35 years only and as such, my fixed income percentage in my portfolio should be 35%. When I turn 45, then the reasoning is that I should then hold 45% in fixed income. I like and use this because it is simple and very easy to apply.
Being a Canadian, I am focused right now on building up a fixed income portfolio with Canadian fixed income instruments. My thinking is that I am underweight in fixed income as it is, so I should bring my fixed income allocation up to target in my home country and then as I get older and need more and more fixed income, then I can spread it out to other country fixed income opportunities.
I use two funds as part of my allocation. The first is a short-term bond fund. I hold short-term bonds simple because they are less volatile. In a bond, there are two main risks: maturity and credit. Maturity refers to the fact that rising interest rates tend to depress the prices of longer term bonds more than shorter-term bonds. As a result, long-term bonds can have much higher swings in price and in my mind are therefore riskier. The short-term bond fund I use is the iShares CDN Short-Term Bond Index Fund (xsb.to).
The second fund is a real-return bond fund. Real-return bond funds are Government of Canada bonds that pay a rate of return that is adjusted for inflation. Unlike regular bonds (like the short-term bond above), this feature assures that your purchasing power is maintained regardless of the future rate of inflation. I think this component is important because bond fund typically have a lower rate of return that stocks and inflation can eat a lot of purchasing power out of fixed income assets. As a result, adding in some additional protection from inflation hopefully will help maintain my future purchasing power in retirement. The kicker is that I need to pay for this protection the form of a higher MER – 0.35% for the real return fund and 0.25 for the short-term fund. The fund I use is the one mentioned above, iShares CDN Real Return Bond Index Fund (xrb.to).
Fixed income assets are an important component of my portfolio. I have devised what I believe is a strong strategy and will continue to bring it up to target allocation over time.