One of the important tenets of DIY investing is to make sure your asset allocation is on track and ‘on point’. According to Investopedia, asset allocation is an investment strategy that balances risk and reward by looking at your time frame, your risk tolerance, and your investing goals. Sure, I would have loved to have gotten at 20% return on my portfolio in 2017 by investing everything I had into the S&P500, but alas, I decreased the risk by investing in Canadian, International, and fixed income instead of ‘putting all my eggs in one basket’, so to speak.
Asset allocation is all about moderation and keeping things balanced. However, for many Canadian investors, things are not that balanced and heavily weighted towards Canada. This is called home bias (towards Canada). Home bias is when the investor has a preference for investing in domestic securities rather than investing in foreign securities.
Why Home Bias Towards Canada is Not Ideal
In this Vanguard Canada infographic, you can see why Home Bias is not ideal for the Canadian investor. Home bias for the United States isn’t a big deal because the US is not heavily weighted towards three sectors like it is for Canada.
According to Statistics Times, the US makes up about 25% of the world’s GDP and Canada is about 2.05%.
The Canadian market accounts for 4% of the total global market according to Vanguard and yet many Canadian investors have much more than 4% of Canadian equities in their investment portfolios. Much much more. About 56% more.
In the Vanguard infographic, Canadian investors have about 60% of their portfolio invested in Canadian equities.
Canada is overweighted in certain sectors, namely financials (do you own more than one bank in your investment portfolio? I know I do! I have BMO.TO (Bank of Montreal) and also National Bank (NA.TO)… I have a friend who has huge portions of his portfolio in BMO, TD, Royal Bank, CIBC, BNS, and National Bank! Might as well create his own Canadian bank ETF). In addition to financials and banks, the other two sectors that Canada is overweighted in are energy and materials.
When you have your asset allocation unbalanced, this creates increased volatility. I know that if I had most of my portfolio in Canada my returns wouldn’t have been as great, since the TSX was mainly flat last year.
The Reason for Canadian Home BIas
There are a few reasons why Canadian home bias exists.
One of the reasons is because we like poutine so much. If you haven’t tried poutine you are missing out. It is french fries sprinkled with squeaky cheese curds and drenched in gravy.
Just kidding, well, poutine is great but that’s not the reason for Canadian home bias in terms of portfolio allocation.
One reason for home bias in Canada is mainly due to favourable taxation. There is preferential treatment for dividend income for Canadian companies. Canadian companies issuing dividends are taxed at a favourable rate. When you are taxed so much I suppose you look for ways to get taxed less, one of which is to hold a portfolio that has a lot of Canadian dividends! In fact, US dividends are subject to a 15% withholding tax, though this may be recouped. Another reason is that there is less currency risk when you are holding just Canadian equities and Canadian dollar investments. Currency exchange is another reason for Canadian home bias. When the Canadian to US dollar exchange is not ideal, fewer people convert their Canadian dollars to American dollars and less NYSE listed stocks are purchased. The cost of currency conversion can really add up.
my home bias experience
Back in 2015 my asset allocation in my investment portfolio was heavily favoured towards Canadian equities.
Here’s a snippet of my portfolio asset allocation from 2015.
- Canadian equities 42%
- International equities 16%
- US equities 21%
- REITs 2.5%
- Bonds 18.5%
As much as I love Canada (yes I’m one of those people who has a Canada flag on their backpack when they travel abroad)…as you can see, 42% is really way too much “Oh Canada”! I think it was even more heavily weighted to Canada before 2015, there were times I was over 50% Canada.
Of course, there are companies within my Canadian equities portfolio that have a lot of business outside of Canada- for example SNC Lavain (SNC.TO) is a professional services and project management company that has offices all over the world and has 14% of their business in Asia, 23% in the Middle East and Africa, and 11% in Europe. I still classify this as a Canadian equity just to keep things simple.
It took a few years of regular dollar cost averaging and regularly checking my asset allocation to make sure I’m slowly ‘steering the ship’ in the right direction. I’m not one for selling things off to rebalance as I don’t like to trigger capital gains unnecessarily and would prefer to add on to my portfolio. However, it has finally paid off and my asset allocation is more balanced.
In 2018 my asset allocation for my investment portfolio is as follows.
- Canadian equities 28%
- International equities 23%
- US equities 28%
- REIT 2.5%
- Bonds 18.5%
I have still got some work to do as I’d ideally like to maintain an asset allocation of:
- Canadian equities 25-30%
- International equities 25%
- US equities 25-30%
- REIT 5-10%
- Bonds 15%
Since I have implemented these changes my portfolio growth has improved and I have not suffered from the flaccid non-performing portfolio that I had before when it was heavily weighted in Canada. I still get antsy and lustful, pining for the Canadian dividends and buying more Canadian bank stocks for example, but when I see that I have too much Canada I hold my horses and then look at buying something else outside of Canada to add to my portfolio.
I ‘gently’ rebalance about four times a year and just dollar cost average over time. For example, I stopped buying Canadian index ETFs when I saw that I was heavily weighted in Canada. Then I stopped buying bonds when I saw I was too heavily weighted in bonds for my liking. It’s my ‘slow investing’ approach that seems to work for me and my investing personality.
Nowadays there is financial technology to help you rebalance if you don’t want to be doing the math yourself. Passiv is free for Questrade users for the first year and they run the math for you and tell you exactly how many shares to buy of ETF “A” and how many to buy of ETF “B” to maintain your asset allocation.
Readers, what is your asset allocation?
Do you have Canadian home bias?
How often do you rebalance your portfolio?
GYM is a 30 something millennial interested in achieving financial freedom through disciplined saving, dividend and ETF investing, and living a minimalist lifestyle. Before you go, check out my recommendations page of financial tools I use to save and invest money. Don’t forget to subscribe for blog updates, a free dividend yield spreadsheet, and the free Young Money Bootcamp eCourse.