A few weeks ago, our biggest concern was Canada’s housing crisis. Now it’s which political leader can best protect the Canadian economy from our unpredictable southern neighbours.
The key buzzword is these conversations is the d-word. No, not “Donald.” Not even “democracy.” The d-word I’m referring to is diversification.
Diversification means not putting all your eggs in one basket. And while Canada’s politicians work on how to diversify our economy away from our southern trading partner, it’s worth asking what we as individuals can do to diversify our own personal financial situation and reduce the likelihood of a financial catastrophe caused by one single point of failure.
Diversify your investments
Canadian patriotism is alive and well: We’ve boycotted U.S. goods and cancelled our U.S. vacations in response to tariff threats. But one area in which patriotism can work against us is in how we invest.
Canadians tend to overwhelmingly invest in the Canadian stock market, a phenomenon known as home country bias. We do this because we like to invest in companies we’re familiar with, but the flip side is that concentrating your investments in your home country makes you vulnerable to issues that affect that country.
The answer is to diversify your investments around the world so that no one geopolitical event can take you down. That’s why we advocate for a globally diversified portfolio that spans the world’s developed economies, a portfolio that consists of equal parts Canadian, American and international stock markets as tracked by the S&P/TSX Composite, S&P 500 and MSCI EAFE (Europe, Australasia and the Far East) indexes, respectively.
The EAFE index, in particular, may ultimately benefit from investor interest trying to avoid the impact of the damaging Canada-U.S. trade war. Not only does the EAFE index cover a wider geographical area, the countries it encompasses are less dependent on the United States than Canada is.
The largest economy in the EAFE index is Japan, and its largest trading partner is China, not the U.S. The EAFE index also includes the European Union, which has a combined economy (in terms of gross domestic product) about equal in size to the U.S. So, European countries are far less vulnerable than we are.
After a string of years in which EAFE has lagged the Canadian and U.S. stock markets, this may be the year that EAFE finally takes the lead. In fact, at the time of this writing, EAFE, as tracked by the iShares exchange-traded fund with the symbol IEFA, has eclipsed the performance of the U.S. index by a wide margin – gaining 7.7 per cent year to date, compared with just 1.8 per cent for the S&P 500.
Diversify your currency
Canadians also tend to hold their assets almost exclusively in Canadian dollars. This is a natural effect of living and working in Canada. However, in case you haven’t noticed, the Canadian dollar has been under assault lately.
In the past year, the value of our dollar has dropped from a high of almost 75 US cents last September to its current value of about 70 US cents, and it’s not hard to guess why.
One easy way to gain exposure to other currencies is to make sure that your ETFs that invest in foreign equities are currency-unhedged. Currency-hedged funds use financial options to counteract, or hedge, against the effect of foreign currency fluctuations.
Let’s use iShares as an example. It has two Canadian ETFs that track the S&P 500 Index: XSP, which is currency-hedged, and XUS, which is currency-unhedged. If the U.S. dollar were to weaken against Canada’s dollar, the currency-hedged fund would do better since you wouldn’t be exposed to the drag of a weakening greenback. But if the opposite happens, and the U.S. dollar strengthens against our dollar, the currency-hedged fund would perform worse than the currency-unhedged fund.
Diversify your income
We don’t know what’s going to happen with this trade war, but what’s becoming increasingly clear is that traditionally safe jobs are no longer safe. Right now, U.S. federal workers’ jobs are under the threat of elimination. Can you think of any job that’s more recession-proof than working for the federal government?
Financial independence and retiring early (FIRE) mean you don’t have to rely on your job for income. Even the most empathetic boss can be replaced, and the best job in the world can disappear through no fault of your own. Aggressively saving and investing your wealth is the best path to safety in an unstable job market.
Other ways to diversify your income include starting a side hustle and becoming a landlord. However, FIRE is the most reliably reproducible method to replace your income and doesn’t require luck or working a second job.
There’s a storm coming, and we don’t know which jobs will be affected. So, the only way to be fully protected is to not need that job at all.
Kristy Shen and Bryce Leung retired in their 30s and are authors of the bestselling book Quit Like a Millionaire.
