Time to get on the couch

Diane is a fairly conservative investor and would like to convert her cash to the couch potato portfolio, but she hesitates. “I know market timing isn’t something you’re supposed to do, but with markets at their highs now I hesitate to put my money into couch potato ETFs at this time. I’m wondering if there’s a better way to do this.”

The couple is also trying to catch up on their RRSP contribution room. Paul still has about $120,000 in back contribution room available to him and they are planning to put away $30,000 a year for the next four years to use it up. “The good thing about it is that there will be large chunks to rebalance the RRSPs over the next four years,” says Diane. “I’ve already decided that the tax refunds will go right into our TFSAs to use up some of that outstanding contribution limit as well.”

Sign up for our free investing newsletter »

But even though Diane seems to have a good portfolio plan, fear of losing her money is paralyzing her. “We’ve had some financial setbacks over the past three years and I don’t want to make a mistake at this point,” she says. “So I’m just trying to decide the best way to implement a couch potato strategy while minimizing the risk of investing all our money at the wrong time.”

Diane has two other considerations. Her bank advisor told her it would be best to simply invest in a dividend paying mutual fund, but she’s not sure that’s a better option for her than the couch potato. “I like the couch potato and have done a lot of reading up on it,” says Diane. “The only tweak I’d make is perhaps adding a 5% weighting of a gold ETF. But the big question is how and when to buy the ETFs with as minimal risk as possible.”

The couple’s goal with their money? “We’re trying to beef up our TFSAs over the next five years so we can spend some time abroad,” she explains. “So our goal is really just to maximize returns in our entire portfolio while not taking on too much risk.”

The couple is hoping to make about 4% average annual net returns with a minimum of volatility and risk. And they both know they are coming out ahead simply by topping up their RRSPs. “I know we’re getting big tax refunds so that helps in mitigating my nerves about losing money. But I check the market every day and can’t help but worry about falling prices with everything that’s happening politically in the world. I just want a conservative return while still being able to sleep at night. I know it’s doable with the right strategy.”

The Fix

Investing a large lump sum is always difficult emotionally, and it’s very common for people to sit on cash for months, or even years, because they’re paralyzed with fear, says Dan Bortolotti, CFP, CIM, associate portfolio manager with PWL Capital in Toronto. If Diane is very nervous about investing the couple’s nest egg, there’s nothing wrong with buying in gradually. This has nothing to do with market timing: it’s simply an acknowledgment that we’re all human, explains Bortolotti. If Diane buys in all at once and we have a downturn in the next few months, she may be at risk of selling in a panic and abandoning her investment plan permanently.

The first thing Paul and Diane need to do is decide on an appropriate asset allocation for their TFSA and RRSP. That means finding the right mix of stocks and bonds based on their time horizon, goals and risk tolerance. That should be done with the help of a financial planner, but for now let’s assume they settle on 55% fixed income (bonds and GICs) and 15% each in Canadian, U.S., and international stocks. (Bortolitti doesn’t recommend adding an allocation to gold.) That mix should be enough to provide a 4% expected return over the long term, with relatively low volatility.

If the couple wants to buy in gradually, here’s what Bortoloitti would suggest. First, there’s little point in buying fixed income gradually, because these investments are not likely to move up or down more than a couple of percentage points over a short period. So Diane and Paul can start by investing 55% of their lump sum in bonds and GIC rates. Then they can add a 5% allocation (one-third of their 15% target) to Canadian, U.S., and international equities. Now they will have 15% of the portfolio in stocks, plus 30% in cash.

Three months later, they can invest another 5% of the portfolio in each of the three equity holdings. Now they will have 30% in stocks and just 15% in cash. Finally, three months after that, they can invest the remaining cash in equities and their portfolio will be fully implemented:

One danger here is failing to stick to the schedule. If Diane and Paul plan to buy in every three months, they should put those dates on their calendar and stay away from the financial news for a few days beforehand. It’s all too easy to fall into the trap of convincing yourself you should wait just a little longer. The next thing you know, you’re again paralyzed with indecision.

Finally, I encourage Diane and Paul to remember that their initial $142,000 will not be their only entry point in the market: they’ll be making some big contributions over the next few years as well, so it’s not as though their whole retirement plan depends on how the markets behave during the next six months. That will help put this decision in perspective and give Diane and Paul the confidence to carry out their plan.