Blogs & Comment

The income investor as benchmark

You need an asset allocation strategy, but first you need to understand what kind of investor you are.

Now that we have a suggested asset allocation for the start of 2012, we can discuss for what type of investor that allocation is best suited. After all, the correct asset and securities mix depends a great deal on that individual’s investment objectives, preferences and constraints. One size does not fit all investors.

The answer involves categorizing investors, something I don’t like to do (because there can be so many exceptions), but it’s a useful exercise here. My suggested allocation is aimed at the typical income investor, a category that falls between aggressive growth investors and conservative safety investors.

Great, so who or what is an income investor? To me, an income investor is someone who primarily wants three things. First, they want a secure price base for their securities, not one that bounces up and down like a yoyo, or even too much at all, except perhaps throughout the ups and downs of the economic cycle. Second, the income investor expects a steady income from that stable price base. For bonds this means issues that are not at risk of defaulting on a payment; for stocks a dividend is essential, and not one at risk of a cut, or one that fluctuates through good times and bad.

If those two concerns are satisfied, a third goal then comes into play. This is to have that stable stock price base gradually move higher over time, or to see that stable dividend regularly increased. Ideally, both will happen. If these three goals are achieved, the income investor will be very satisfied, and will make a very good return over time, perhaps much more than he or she budgeted for.

Recall that the tactical asset allocation I’ve recommended for the start of 2012 is a 5/50/45 mix (5% cash, 50% fixed income, 45% equities), and this is what I suggest for the typical income investor.

(Note that what I am recommending here is a tactical shift of the asset mix. It is intended to exploit capital market expectations that, if correct, will temporarily be a better mix than the equivalent standard strategic mix—10% cash, 40% fixed income, 50% equities. A passive investor would not make these tactical shifts; he or she would simply rebalance back to the strategic mix.)

Now, what if your investment profile doesn’t match that of the typical income investor described above? That’s fine; you can still use the suggested allocation as a starting point and go from there. If you are more conservative, you will want to raise the fixed income component at the expense of equities. As an opposite example, someone who is a little more aggressive than the income investor described above (as is the case with me personally) will want their mix skewed a little the other way.

So please do use it. As I often say, having a plan, even an imperfect one, is better than not having a plan at all.

Postscript: Now with my next recommendation I jump into the deep end. Each year I try to pick the one of four Canadian sectors that income investors tend to favour: banks, non-bank financials, telephone utilities and non-telecom utilities. This year I’m going with the banks to outdo the other three, in case anyone braves taking that into account within their Canadian equity allocation.