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While the traditional Couch Potato portfolio mix of global equities and Canadian bonds is a simple and effective approach with good historical returns, it’s a bit too simple for my taste. The main problem is that it doesn’t cover investors for all economic conditions and fluctuations, which leaves numerous portfolio holes.
For example, in the 1970s and early ’80s, there was an extended period of high inflation and no growth, or what’s referred to as stagflation. It was a terrible combination in which few assets performed well. Gold, commodities, and real estate would have greatly helped portfolio returns, as shown in the chart below. But those assets are mostly missing from a traditional Couch Potato portfolio.
Asset performance in various economic conditions
All-weather ETF portfolios
We can greatly increase diversification and reduce portfolio risk by adding some of these asset classes into our Couch Potato mix. That way, no matter what the economic conditions—growth or contraction accompanied by either inflation or deflation—you will always have an asset or assets that are delivering positive returns. There is always something working. A good example of the portfolio strategy is demonstrated by the Permanent Portfolio.
In other words, we can build an “all-weather” Couch Potato portfolio.
It is not well known, but even a balanced portfolio can fail for a decade or more. The following chart uses U.S. stocks and U.S. bonds. An investor could improve the situation slightly by adding Canadian and global stocks, but the theme and risk to the balanced portfolio prevails.
Stocks and bonds don’t always cut it.
Here are the main assets we’ll add into our all-weather portfolios, with suggested ETFs:
- U.S. treasuries. Long-term treasuries punch above their weight as risk managers for stock markets, because they increase to a greater degree than a total bond market fund. (Suggested: BMO Long-Term US Treasury Bond Index ETF, ticker ZTL.)
- Short-term bonds. These bonds can work like cash protecting against a rising rate environment, as is often experienced during inflationary periods. (Suggested: iShares Core Canadian Short Term Bond Index ETF, ticker XSB.)
- Long-term bonds. They are known to punch above their weight as stock market risk managers. That is, they offer more convexity (the ability to go up when stocks go down). (Suggested: BMO Long Federal Bond Index ETF, ticker ZFL.)
- Gold and commodities. These “real” assets are perhaps the best inflation fighters. Gold is known as an inflation asset (although it doesn’t have a perfect record) and is also a safe-haven asset for when big shocks occur. A basket of gold plus other commodities offers a greater chance of success during a bout of serious inflation or stagflation. (Suggested: Purpose Diversified Real Asset ETF, ticker PRA.)
- Real estate investment trusts (REITs). Real estate is known for providing additional inflation protection. It is also an asset that often does not move in tandem with stock or bond markets, adding additional diversification for a balanced portfolio. (Suggested: iShares Global Real Estate Index ETF, ticker CGR. Note that PRA also holds REITs as a real asset; however, the total portfolio REIT exposure from PRA is small at just over 1%.)
- Other. You could also consider adding real return bonds that offer a yield plus an inflation adjustment as an additional inflation asset, and/or that new digital gold known as bitcoin. (Here’s an article on bitcoin that will help you to gain an understanding of this new asset.) Neither of these assets, however, are included in the sample all-weather portfolios below. To add bitcoin—many suggest a 5% portfolio weighting—you could trim from your real assets holding (PRA).
- To round out the bond portfolio you could certainly consider corporate bonds and high yield corporate bonds.
A note on the regional allocation of stocks within the all-weather portfolios. We will add developing markets to the mix, and use separate ETFs for each of the Canadian, U.S. and developing markets. This avoids the global index weighting that currently greatly overweights the U.S. stock market, and instead allows us to hold Canadian, U.S. and international stock markets in equal weight.
Advanced Conservative Portfolio
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Equities: 30%
Canada (XIC): 10%
U.S. (XUS): 10%
Developed International (XEF): 5%
Developing International (XEC): 5%
Real Estate: 10%
Global REITs (CGR): 10%
Fixed Income: 40%
Canadian long-term bonds (ZFL): 15%
Canadian short-term bonds (XSB): 10%
U.S. treasuries (ZTL): 15%
Real Assets–Gold and Commodities: 20%
Purpose (PRA): 20%
Advanced Balanced Portfolio
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Equities: 50%
Canada (XIC): 16.7%
U.S. (XUS): 16.7%
Developed International (XEF): 8.3%
Developing International (XEC): 8.3%
Real Estate: 10%
Global REITs (CGR): 10%
Fixed Income: 30%
Canadian long-term bonds (ZFL): 10%
Canadian short-term bonds (XSB): 10%
U.S. Treasuries (ZTL): 10%
Real Assets–Gold and Commodities 10%:
Purpose (PRA): 10%
Advanced Balanced Growth Portfolio
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Equities: 60%
Canada (XIC): 20%
U.S. (XUS): 20%
Developed International (XEF): 10%
Developing International (XEC): 10%
Real Estate 10%:
Global REITs CGR: 10%
Fixed Income 20%:
Canadian long-term bonds (ZFL): 6.6%
Canadian short-term bonds (XSB): 6.6%
U.S. Treasuries (ZTL): 6.8%
Real Assets–Gold and Commodities 10%:
Purpose (PRA): 10%
Advanced Growth Portfolio
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Equities: 60%
Canada (XIC): 20%
U.S. (XUS): 20%
Developed International (XEF): 10%
Developing International (XEC): 10%
Real Estate: 10%
Global REITs CGR: 10%
Fixed Income: 20%
Canadian long-term bonds (ZFL): 6.6%
Canadian short-term bonds (XSB): 6.6%
U.S. Treasuries (ZTL): 6.8%
Real Assets–Gold and Commodities: 10%
Purpose (PRA): 10%
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