Diversify Your Portfolio to Protect Against Market Volatility

For long-term goals, look beyond short-term investments

When markets are volatile, investors flock to the perceived security of short term investments. While short-term investments have a role to play as part of a diversified portfolio, using them incorrectly can undermine your long-term financial security.

People often "park" their capital in a safe, low-yielding investment until the markets settle down, and then move it to a more appropriate long-term vehicle. Too often, however, they wait too long. The potential costs are high. Keeping your investments in low-risk/low-return vehicles for too long can prevent you from achieving your long-term goals.

Inflation’s erosion

Conservative “no-risk” investments such as money market funds don’t protect a portfolio from the erosion caused by inflation and income tax. Over the long term, inflation is a far more serious risk than market volatility.

For example, $300,000 in savings now will be worth only about $200,000 in 10 years if inflation averages 3% annually.

Over 20 years, the same rate of inflation cuts the nest egg to $163,138. Although inflation has been low for the past few years, over the past quarter century the average annual rate of inflation has been more than 5%. Inflation takes a bite over the short term as well. Suppose that your conservative investments pay 5% a year. If inflation averages 3%, your real return is just 2% per year. And if that income is subject to a marginal tax rate of 40%, your return drops to 0.

Equities protect

The most effective way to produce stronger returns and protect against inflation erosion is through equity investments such as growth mutual funds. While equities can be volatile over the short term, in the long term they have historically outperformed fixed income and money market investments and outstripped inflation.Outside a registered plan, equities bring beneficial tax treatment. While interest income is fully taxed, capital gains are taxed on only 50% of their value and dividends from Canadian companies qualify for the federal dividend tax credit.

Experience tells

To protect your portfolio against short term market volatility, you need to diversify. For example, along with equity mutual funds your portfolio should include some bond and money market funds. In addition, your investments should be spread out across a number of geographical regions and encompass more than one investment style.

You can rely on the objective, professional guidance of a CIBC adviser in building a portfolio to take you safely through market ups and downs.

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