Three Common Mistakes We See With Investment Portfolios
With the recent launch of i2i Private Investment Counsel at i2i Capital Management (and throughout our careers in general), Peter Hodson and I have had a chance to see several portfolios of all shapes and sizes over the years. Some big, some small, some focused on income and dividends, some focused on passive income—the list goes on. There can be more than one way to “peel a potato” when it comes to investing, but there are a few common mistakes over the years that we have seen many investors make.
Mistake 1: Too Many Dividends!
Don’t get us wrong, dividends are great. Who doesn’t love sitting at the beach and having a company deposit a monthly or quarterly dividend directly into your bank account while you sip on a spicy margarita! What’s more, they are treated more efficiently from a Canadian tax perspective than regular income is. Dividends certainly have a place in a portfolio, but we find that a great deal of Canadian investment portfolios hold far too much in the way of dividend-payers. Yes, they offer an income stream and a bit of stability (sometimes) in a portfolio, however this is often at the expense of an even more tax-efficient form of returns: Capital gains!
While dividend-payers can, and do, still grow in value, a dividend-payer is typically more mature and has a lower level of growth compared to companies that aren’t paying a dividend. By default, a portfolio that has too much in dividend-paying companies also probably owns too many mature, low-growth or no-growth companies. This then crowds out a portfolio from the opportunity of holding those great growth companies that really contribute to an investor’s wealth. Further, a portfolio with too many dividend-paying names is also likely concentrated in a few certain sectors such as Financials, Utilities and Real-Estate Investment-Trusts (REITs). Investment portfolios that are too focused on dividends tend to be too focused on these more mature types of sectors as well, leading to additional concentration risks in a portfolio.
Often, it seems that a growth company is misconstrued as a “risky” company, so it is also important to keep in mind that growth doesn’t necessarily mean small or risky. Meta (META), Microsoft (MSFT), and Nvidia (NVDA) are growth companies that pay negligible dividends, but we wouldn’t necessarily consider them “riskier” than a company growing lower single digits on the top-line that pays a 3%+ yield.
Dividends belong in a portfolio in some shape or form, however in most cases, a portfolio shouldn’t be comprised solely of dividend-payers!
Mistake 2: Not Enough U.S. Exposure!
Canadians are some of the guiltiest of home bias across the globe. While we understand and can relate to the frustrations of what is going on south of the border, this home bias existed long before this tension started and like it or not, the U.S. is one of the largest economies in the world, it is home to some of the best companies in the world, currently and probably throughout all of history. Investment portfolios should reflect this reality regardless of where you live.
According to Vanguard, Canada1 makes up 2.6% of the global market. Meanwhile, Canadians typically have 50% of their portfolio exposed to Canada, a market that is highly exposed to Energy and Materials. Yes, this exposure does pay off at times (such as last year), however, they are nonetheless volatile sectors reliant on moves in commodity prices.
One argument we hear is that owning Canadian companies with international revenues helps mitigate this risk. The Vanguard research dispels this myth and highlights that even with international revenue diversification, companies tend to move in tandem with their home market, regardless of revenue diversity.2
Of course, this doesn’t mean Canadian companies shouldn’t be an important part of your portfolio. There are plenty of great entities in the Great White North, and there are some good reasons for some home bias in a portfolio, such as taxes and foreign exchange exposure. Often, though, exposure to Canada is far too high in investment portfolios, in a stock market (TSX) that is already overconcentrated toward Financials and markets tied to Commodities. Financials and Materials.
Mistake 3: Too Many Holdings!
The numbers can vary depending on where you look, but typically, the benefits of diversification tend to wear off at around 25-to-35 portfolio holdings. This differs depending on the type of diversification. For example, holding 35 Canadian stocks is far less diversified than holding 35 companies across several markets. Regardless, 25-to-35 names is typically the optimal range.
Often, when looking at portfolios, we see holdings in excess of 60 holdings. Now, having additional diversification is not a bad thing, but it also is not helping matters. Further, those additional, small holdings start to crowd out better ideas in the portfolio. Are holdings 51-to-60 “must own” companies compared to the first 50 companies? Probably not. Finally, holding 60+ companies can become lofty to monitor and stay on top of, and in reality, is just becoming a market-like portfolio.
ETFs, while great products, are also adding a bit of a wrench into portfolios with too many holdings. What we are seeing lately is that you might already have a diversified portfolio of stocks, but then a portfolio will have these “fillers” of already diversified ETFs. This can make sense if looking for quick and easy exposure in the markets for a term, but if left unchecked, they can tend to be redundant in an already diversified portfolio, while adding additional (albeit low) fee drag or maybe even add additional complexity that is not overly necessary. With that said, they can have their place for filling in holes or exposures that an investor might not have an interest in doing themselves, but often we see these holdings more as adding redundancy.
While these are some of the common mistakes we see, the fortunate thing is that they are not debilitating to your investment journey. In most of these cases, an investor is still invested and benefiting from the general trajectory of the market. For our next article, we want to highlight some mistakes we see that might be less common, but far more critical to a portfolio.
Ryan Modesto, CFA - CEO, i2i Capital Management
1 https://www.vanguard.ca/content/dam/intl/americas/canada/en/documents/HOBI_052024_V14_secure.pdf
2 Ibid.