We all know the drill. Once we’ve got our monthly budget all sorted out, it’s time to start thinking about what to do with any extra cash we may have. Sure, you can splurge, but there’s no better feeling than watching our hard-earned money grow by investing.
But here’s the million-dollar question: where do we put that extra money to maximize our returns? Well, the answer to that question lies in our individual risk tolerance — that is, how much volatility or unrealized losses can we handle without panicking and making a hasty, regrettable decision like panic-selling.
But it’s not just about risk tolerance. It’s also about diversification. Putting all of your eggs in one basket, like a single stock or stock market sector can be literally break your investment strategy. Here’s how I would personally invest for maximum diversification with just $5,000.
The Russian nesting doll analogy
Portfolio diversification can be measured by various fancy financial math formulas, but for the layperson, I like to use the Russian nesting doll analogy.
The smallest doll can be thought of as investing in a single Canadian stock — say, Enbridge (TSX:ENB). Investors who invest only in Enbridge take on a lot of risk. The company could do poorly, cut its dividend, or even go bankrupt.
Moving up to the next doll would be investing in the entire energy sector, which included Enbridge and other oil and gas companies. The risk here is the energy sector underperforming, which it has done before.
The next doll represents investing in the Canadian stock market, which encompasses many different sectors. The main risk here is Canada underperforming.
The next doll represents investing in the world’s stock market outside Canada. The risk we worry about here are stocks underperforming for extended periods of time.
The largest doll represents maximum diversification by adding bonds. With bonds, we can potentially offset the risk of our equity holdings doing poorly.
The right ETF to use
So, a diversified portfolio is one that holds Canadian, U.S., and international stocks weighted by market cap from all 11 stock market sectors, with a bond allocation (say, 20-40%), depending on your time horizon and risk tolerance. How do we achieve this?
Well, instead of buying thousands of different stocks and bonds, or dozens of different exchange-traded funds (ETFs), there’s a simpler way. Buying an all-in-one ETF like BMO Growth ETF (TSX:ZGRO) can potentially offer investors a one-ticker, one-stop shop for their portfolio needs.
ZGRO is as diversified as it gets. Right now, the ETF holds a total of nine underlying ETFs that cover thousands of stocks and bonds from Canadian, U.S., international developed, and emerging markets. There’s no need to worry about or predict which market or asset class will outperform.
The ETF is currently split in a 80% stock and 20% bond allocation, which is a fairly aggressive growth-oriented mix suitable for young investors. Best of all, it charges a low management expense ratio of just 0.20%. With ZGRO, all investors need to do is periodically buy more and reinvest dividends.
