The Portfolio Doctor

By David Cruise and Alison Griffiths
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The Patient: Elizabeth Fong, 42

Situation: Medical technology sales, single parent, 1 child - 13.

Income: $56,000

Debts: Mortgage, $123,000. Car loan $3,300.

Investments: $78,000 in 19 funds in three self directed RRSPS, one with an adviser.

Concern: "I think I qualify as a serial investor. I counted up seven different RRSPs over the past 10 years, though I am down to three now. I need to simplify so I can manage it myself. I would also like to decide on an asset allocation which I read is important."

It is a little early for spring cleaning but that's what Elizabeth Fong needs to reduce her holdings to a manageable level. She owns too many funds to list so we will pick and choose to give her an example of how to create a portfolio that she can maintain.

This process of consolidating accounts and winnowing down holdings is going to take a few months and patience is key. Some readers in the same situation have simply given up, sold everything and started afresh. But in Fong's case, the result will be expensive as she has deferred sales charge fees attached to many of her funds and there will also be trading fees to pay.

Fong notes that she intends to contribute $400 every month to her RRSPs. Her son's education is being taken care of by the father so she can devote all her savings to her RRSPs. "I am currently paying $372 on my car loan. When it is paid off I am considering putting the money into my RRSPs and increasing my mortgage payments."

This is a smart plan because she will be reducing her non-tax-deductible debt, while increasing her tax deductible retirement contributions.

An asset allocation is an excellent tool to help Fong prune her investments. She calls herself an "ultra conservative" investor. However, 14 of her 19 mutual funds are equity (the rest are bond, balanced and income funds). Of her equity investments seven are funds investing in a broad mix of large Canadian companies, three are Canadian natural resource funds, two are U.S. small cap funds, one is a China fund and one is a Far East fund.

Fong's current asset allocation is nearly 75 per cent equity. Ultra conservative - we think not. This is a fairly aggressive allocation, especially considering that 50 per cent of her equities are in sector or niche funds.

A moderate asset allocation might be 60 per cent equity, 30 per cent fixed income and 10 per cent cash. A more conservative allocation would have a lower equity portion; say 50 per cent with 30 to 40 per cent fixed income and 10 to 20 per cent cash. In an ultra conservative mix we'd expect 30 to 40 percent equity, at most.

Fong's portfolio is made riskier by tons of duplication and poor diversification south of the border and globally.

Fong notes that she has a savings account but no savings per se. She only uses the account to hold small amounts for upcoming purchases. She could allocate roughly 10 per cent of her savings to cash, some of which should be held outside her RRSPs. As a single parent with a teenager and a house, she needs to have an emergency account.

Ten per cent of Fong's savings amounts to $7,800 but she doesn't have that in hand and it would make no sense to pull half of it out of her RRSPs for an emergency account. Fong can simply divert some of her retirement savings to a cash account and aim to maintain $3,000 to $4,000 in it. As the money is drawn for house repairs, or braces, for example, she can build the account back up again.

Since Fong has so many funds in three accounts, we suggest, for simplicity sake, she consolidate them with one firm. (Consider the one with the lowest fees and best statements.) That will take a few weeks to accomplish. While Fong is waiting for the accounts to be transferred she can start thinking about an asset allocation and what kind of investor she really is. Fong believes she is "ultra-conservative", but her choice of funds to date doesn't reflect that characterization.

There is no rule of thumb about how much one should have invested in each of the major asset classes: cash, bonds and equities. However, it is far better to err on the side of caution. It's easy to add equities down the road if you feel your allocation is too conservative. But it is much harder to reduce, especially when holding mutual funds with deferred sales charges still attached.

Let's just say Fong chooses a 60-30-10 equity-bonds-cash allocation for her portfolio. That will be her blueprint as she moves ahead and prunes her portfolio.

Next, Fong needs to group the funds by creating one list for those with remaining deferred sales charge (DSC) fees and one for those funds with the DSC schedule finished. Within those two lists the funds should be grouped again; Large Cap Canadian Equity, Canadian Natural Resource, Canadian Bond, U.S. Small Cap and Far East.

It seems like a lot of work so far but only by following this methodical process will Fong streamline her investing accounts and set herself up for the future. Notice, we haven't even arrived at what funds to sell yet.

The next step is to refine her allocation further. Assuming that Fong has chosen 60 per cent equities, $46,800 of her $78,000 will be invested in this asset class. But the decision making doesn't stop here. She must now decide how much in Canada and how much in other countries. That is geographical asset allocation.

Fong also needs to decide how much of her investments she wants in large companies and how much in medium and smaller size companies. This is asset allocation by size.

Generally speaking, have a larger percentage of your money in larger companies and a smaller percentage in niche and sector funds. So the China fund, which is riskier, might comprise only 5 per cent of her equity allocation, or less than $2,500.

Tired yet? Fong's portfolio is an object lesson in why simple is better when it comes to investing.

Next week, we'll provide a possible allocation table for her and show how to choose which funds to keep and which to toss.