The iShares Core Equity ETF Portfolio gives you a portfolio of 100 per cent stocks from around the world.Tijana Martin/The Canadian Press
Canadian and U.S. stock markets have been on a tear these past few years. That’s led to fear of a market correction and suggestions to decrease the risk in your portfolio ahead of a market decline.
For some investors, this can mean selling some stock holdings and investing in bonds or cash.
But before you move into safer investments, ask yourself whether that’s the right choice. For investors with long time horizons – roughly seven or more years – adding cash and bonds to a portfolio isn’t necessary. If stocks decline, you can ride it out. Let the market do its thing and just hang on.
There’s a saying among self-directed investors on the internet: “XEQT and chill.” It’s the modern term for “buy and hold.”
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XEQT-T is the ticker symbol for the iShares Core Equity ETF Portfolio, an exchange-traded fund made up of other ETFs. This asset-allocation ETF gives you a portfolio of 100 per cent stocks from around the world. There are other similar products: We could also say ZEQT and chill, or VEQT and chill – these are the BMO and Vanguard equivalents.
This mantra is rooted in the idea that stock markets have always recovered from big downturns, so why worry about the next one? Maintaining an all-equity portfolio will result in higher long-term returns than one with bonds in it, which can make a big difference in the growth of your savings.
The case for moving toward bonds is that they have a stabilizing effect on a portfolio. They are less volatile than stocks, and often move in the opposite direction. When the stock market goes into a tailspin, bonds might rise a bit. And if they do decline, it’s usually by a much smaller degree than stocks. (The exception was 2022.)
That means if you have a portfolio of 75 per cent stocks and 25 per cent bonds, a stock market decline of 20 per cent might result in your portfolio falling just 15 per cent, assuming bonds are flat for the year.
This seems attractive, but what does it actually accomplish? If you are investing for the long term – remember, that’s seven-plus years – the gyrations of the stock market don’t matter.
Crucially, adding bonds will lower your returns over the long run. A portfolio of 75 per cent stocks and 25 per cent bonds is expected to return about 7.3 per cent a year on average based on returns from the past 20 years. Meanwhile, an all-stock portfolio is expected to return more like 8.7 per cent. If you invest for 20 years, that’s a big difference. See for yourself using this online investment return calculator.
The conventional approach to asset allocation says investors need a mix of stocks and bonds, and as people age, the allocation to safer investments such as bonds and GICs should increase. One shortcut for making the asset-allocation decision is to choose the allocation to stocks based on your age: Subtract your age from 110, and that’s how much you should have in stocks, while the rest should be in bonds. This means a 40-year-old would have 70 per cent of their portfolio in stocks and the rest in bonds.
As with many shortcuts, the results are often not ideal. In this case, a 70/30 portfolio is an unnecessary level of safety for a 40-year-old saving for a retirement that is still 20 years or more into the future. Stability in a portfolio isn’t necessary for people who don’t plan on selling their investments any time soon. XEQT and chill is the new credo.
Of course, investing isn’t all about numbers – it’s also emotional. The all-equity strategy can be stressful for some people. The last thing you want is to be losing sleep worrying about the stock market. XEQT and chill isn’t for everyone. And to be clear, it’s also not for money that will be needed in the next seven years.
This might seem a little tone-deaf, given where we are with stock markets, but it’s not. Asset allocation is not about what the market is doing – it’s about you.
As soon as you start making asset-allocation decisions based on what’s happening in the world, you are engaging in market timing, making bets about where markets are going. And studies show time and again that market timing doesn’t work.
If you’re an all-equity investor, don’t worry about the next market decline – just XEQT and chill.
Anita Bruinsma is a Toronto-based certified financial planner at Clarity Personal Finance.