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Wobbly markets, evolution of the balanced portfolio, pre-retirement income splitting, tax loss...

Wobbly markets, evolution of the balanced portfolio, pre-retirement income splitting, tax loss harvesting

Quarterly | September 29, 2020 | Brendan Greenwood CIM, QAFP, B.Comm

The US Federal Reserve is creating conditions for asset bubbles that options trading and momentum trading are making bigger!

Policy makers have committed to keeping interest rates near zero for an extended period to cushion the adverse impact COVID-19 has had on the economy. With discount rates even lower than pre-COVID levels people are willing to pay high prices for tech stocks and alternative investments such as precious metals.

Despite the challenges that COVID-19 has created for business, market sentiment shifted in the spring and summer. People took the summer off and looked ahead with expectations of a vaccine in the fall, improving economic data and that life would normalize.

The positive outlook of the spring and summer fueled a huge market rally led by the mega-cap tech giants (Facebook, Amazon, Apple, Alphabet and Microsoft). These five companies recently made up almost 23% of the index, the highest concentration in at least 30 years according to a Goldman Sachs analyst. You remove these 5 companies from the S&P 500 and your strip out most of the S&P 500 market gain for this year (see chart).

Both individual and institutional traders have been using options to speculate on big tech companies and magnify gains. This along with momentum trading, (the tendency for individual investors to buy stocks that have risen the most) has pushed big tech stock valuations well above historical averages. Tesla’s share price has gained over 400% just this year. If we look back at the dot come bubble of the late 90’s when valuations were pushed too high too quickly, companies like Amazon lost 98% of their value.

The world today does not look exactly like the dot com bubble of the late 90s, many technology companies have stronger balanced sheets and growing recurring revenues, however valuations have a natural way of reverting back to their longer-term historical means. Remember that chasing returns never ends well, expect volatility ahead.

Searching for returns with less risk - The evolution of the 60% equity / 40% bonds portfolio in a low interest rate world

There has been a lot of talk about the demise of the traditional balanced 60% equity and 40% bond portfolio. The traditional balanced portfolio has provided strong returns relative to the market while minimizing volatility over several decades. These portfolios benefitted from falling interest rates that contributed to a rise in the value of bonds held in a portfolio. Now that policy makers have indicated interest rates will remain near zero for the foreseeable future a shift in thinking is required.

Investors need to explore alternatives to low yielding government bonds. Here are some options that could be considered:

1) Short-term corporate bonds

A short-term corporate bond position can provide higher yields over government bonds and more liquidity than longer-term corporate bonds. The added liquidity allows for room to take advantage of falling equity prices during periods of volatility.

2) ETFs that use covered call and put strategies

These ETFs provide the opportunity for enhanced yield and can add stability to a portfolio through their options writing. The heavier role of retail investors along with the upcoming election has further exacerbated the already heightened volatility caused by the pandemic. This increased volatility works in favour of these funds because they can receive higher premiums for the options they write.

3) Fund of hedge funds

Owning a fund of hedge funds can provide valuable diversification to a portfolio and a position that is less correlated to equity in your portfolio. Long-short equity hedge funds, which bet on stock prices rising and falling, only lost an average of 5.75% in March when markets plunged, and went on to gain an average of 13.67% in the first 8 months of 2020 (data from investment bank Nomura).

4) Precious Metals

Gold, silver and platinum can provide some diversification away from stocks. With government bond yields near zero, investors are looking towards precious metals to store value and hedge against inflation.

Pay less tax on investment income outside of RRSPs and TFSAs

The Canadian government has lowered the prescribed rate on loans to connected individuals to 1%. If one spouse earns considerably more than the other, consider setting up a prescribed rate loan to give the lower income partner more to invest and take advantage of their lower tax rate. This rate is fixed for the length of the loan. If you have loaned money to a connected party at a higher rate you may want to arrange to repay that loan and establish a new loan at the prescribed rate of 1%.

Reducing tax through sale of investments outside of RRSPs and TFSAs

If you have experienced losses in a portion of your investment portfolio consider matching losses against gains before the end of the year as part of your periodic portfolio rebalancing. You can use capital losses for the current and past three years to offset gains during any of these periods to recover taxes paid or owing. Capital losses can also be carried forward indefinitely to offset future gains. If you do not have capital gains to offset your capital losses it is possible to transfer that loss to a spouse to offset their capital gains. I recommend speaking to your tax advisor when employing this strategy to ensure attribution and superficial loss rules are avoided.

Brendan Greenwood is an Investment Advisor with Worldsource Securities Focused on personal pension strategies and leveraging technology to provide progressive institutional style investment solutions for professionals, incorporated individuals, business owners, retirees and their families.

For other articles authored by Brendan Greenwood on issues impacting business owners and individual investors see

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the fund facts before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.

This material has been prepared for informational purposes only and should not be considered personal investment advice or solicitation to buy or sell any securities. As well, it is not intended to provide, and should not be relied on for, tax, legal or accounting advice. It may include information concerning financial markets as at particular point in time and is subject to change without notice. Every effort has been made to compile it from reliable sources, however, no warranty can be made as to its accuracy or completeness. Investors should seek appropriate professional advice before acting on any of the information here. The views expressed here are those of the authors and writers only and not necessarily those of Worldsource Securities Inc., its employees or affiliates. There may also be projections or other "forward-looking statements." There is significant risk that forward looking statements will not prove to be accurate and actual results, performance or achievements could differ materially from any future results, performance or achievements that may be expressed or implied by such forward-looking statements and you will not unduly rely on such forward-looking statements. Before acting on any of the information provided, please contact your advisor for individual financial advice based on your personal circumstances. Worldsource Securities Inc., is the sponsoring investment dealer and the member of Investment Industry Regulatory Organization of Canada and the Canadian Investor Protection Fund.

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