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Should you own a lot or a little in Canadian stocks?

It’s not easy being a Canadian investor, is it? Trying to determine how much of your investments to keep in Canadian stocks or elsewhere.  Given recent elections, we’re unlikely to see a pro-business surge anytime soon … to say the least. (It’s not investable info, but did you notice I happened to accurately forecast this?)  Plus, we’ve had to watch other countries’ stock markets beat the pants off our own during the past decade.  U.S. glamour or FAANG stocks (Facebook, Amazon, Apple, Netflix and Google) have been living especially fat and larger than life lately. 

It’s no wonder I’ve been fielding questions about how to best allocate among the global equity markets these days.  How much is too much in Canadian stocks? Should we just dump everything into the U.S. market?  Is diversification dead?

My short answers are:  It depends. No. And, I wouldn’t bet on it. This is an admittedly incomplete response, so let’s consider 4 points and counterpoints to fill in the blanks. 

1)  Canada’s market cap is tiny, and concentrated.  

While we’re rich in land mass, Canadian stocks represents just 3% of the world’s stock market capitalization. Plus, that 3% isn’t very well-diversified, with relatively heavy exposures to banking and natural resources.

Canadian stocks: should you own a lot or a little? | Lowrie Financial

2.  Canadians and everyone else have a home bias.  

Home bias means we prefer familiar objects close to home.  If (like me) you’re rooting for your kid’s hockey team, cheer on. But in the markets, this tempts most investors – and many financial professionals – to pile too heavily into their own countries’ stocks – in this case, Canadian stocks.  

For example, despite recent underperformance, the typical Canadian still allocates 60% of their investments to Canadian stocks.  The Behavioral Investor author Daniel Crosby reports that U.S. investors typically allocate 90% of their holdings to the U.S. market; U.K. investors allocate about 80% of their holdings to the U.K.  No matter where you roam, home bias is right at home.

3.  Markets are unpredictable. 

Before you ship all your investments across the border or overseas, remember:  Markets can turn on you, abruptly and without warning.   While it might seem like a distant memory, it should be noted, from 1999–2009, Canadian stocks (S&P/TSX composite) returned 7.7% per year, whereas U.S. stocks (S&P 500 in Cdn$) seemed cursed in the new millennium, delivering  –2.5% per year … yes that is a negative return for 10 years!

4. Markets are efficient. 

What about any political misgivings you may be feeling? No matter how you may feel, all evidence suggests Canadian markets are still operating efficiently … and here’s how efficient markets work: Our collective hopes and fears are already built into current prices. Even if there’s more bad news to come, as long as it equals or exceeds general expectations, markets can still respond favourably. Since nobody can reliably predict future surprises, let alone how traders will react to them, there’s no sense trying to position your holdings based on a hunch. 

So, what’s your ideal Canadian stock allocation?

Based on all of the above, efficient portfolio theory argues your allocation to Canadian stocks should range between 3%–30% of the equity side of your portfolio. That’s also based on individual preferences on additional details we won’t get into today. 

That said, if 70%–80% of your stock portfolio is currently in Canadian equities, making such a dramatic switch could leave you in a cold sweat. There also are trading costs and tax ramifications to consider.  Practical realities may take precedence over academic theory. 

My advice:  Now that you’ve got some facts in hand, pick a sensible exposure you can stick with, and do what you reasonably can to position your portfolio accordingly. Don’t let recent poor past performance or waves of breaking news weigh too heavily on your mind. As the late, great Vanguard founder John Bogle once quipped: 

“The expectations market is about speculation. The real market is about investing. The stock market, then, is a giant distraction to the business of investing.” 

Let’s get back to business.