How much of your investment portfolio should be in Canadian stocks? Experts weigh in

Home bias among investors in Canada may be on the decline, according to a recent report from Vanguard Canada, but experts say Canadians are still over-investing at home and not getting the full benefit of portfolio diversification.

The report found that Canadians allocate 50 per cent of their equity exposure to domestic holdings, down from 67 per cent in 2012. However, Canadian stocks make up only around three per cent of the global stock market, meaning an excessive home bias remains.

“If you have an over-allocation, you have more potential for volatility in the portfolio,” Ashish Dewan, portfolio consultant at Vanguard Canada and author of the report, said in an interview with Yahoo Finance Canada.

The Canadian stock market is heavily concentrated in financial services, energy, and materials, and the top 10 holdings in Canada make up close to 40 per cent of the market.

At the same time, he says Canadians are going to be underweight in sectors like technology and healthcare, which can offer “high growth potential.” The U.S. tech sector, for instance, has driven a gain of approximately 40 per cent in the S&P 500 since the beginning of 2023.

“It’s not to say Canada is a bad place to invest, a bad place to live, a bad place economically, or anything like that,” Josh Sheluk, portfolio manager and chief investment officer at Verecan Capital Management, said in an interview with Yahoo Finance Canada.

“But it is a relatively small piece of the overall pie when you look at the global markets.”

The solution, they agree, is greater global diversification. But what’s the right mix of domestic and international stocks in a Canadian portfolio?

30 per cent allocation may be optimal, says Vanguard

Based on 10,000 simulations from its proprietary modelling tool, Vanguard found that allocating 30 per cent to Canadian equities and 70 per cent to international equities was optimal for Canadian investors to “minimize the long-term volatility of their portfolio.”

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This holds true for a 100 per cent equity portfolio, as well as the equity component of a balanced 60/40 stock-to-bond portfolio, according to the report.

“Obviously, people like upside volatility — you want higher highs — but it’s those lower lows that you really want to avoid,” Dewan said. “With the diversification benefit, you can basically lower risk in your portfolio without sacrificing too much.”

Sheluk says his firm tends to be in the 20 to 25 per cent range for Canadian equities, though anywhere from five to 30 per cent should be reasonable for most Canadians. He says he wouldn’t have a “strong objection” if someone wanted to get closer to the lower end of the range. But he wouldn’t go much higher, and he certainly wouldn’t avoid Canada altogether.

“Because those exact sectors that are a little bit more concentrated in Canada, namely materials and energy, tend to have some diversifying benefits when you look at a global portfolio,” Sheluk said.

Canadians investing in Canadian companies may also enjoy some tax benefits, Sheluk and Dewan note, particularly through the preferential treatment of dividends.

There are various nuances to consider. For example, how dividends are taxed varies based on the type of account they’re held in and the country of the holding company. But generally, Sheluk says there’s “a lower tax rate on a Canadian dividend versus an equivalent foreign dividend” in taxable accounts.

Time horizon may also play a factor

As with most investment decisions, there isn’t a one-size-fits-all solution to home bias. Due to the tax advantages of investing in Canadian stocks, Dewan suggests investors may want to adjust their home bias depending on their time horizon.

While a younger investor may want to go “a little bit more global,” Dewan says a retired investor who depends on distributions for income could benefit from increasing their Canadian equity allocation to more than 30 per cent.

“Canada has more of a value tilt in its stocks and value stocks generally have more distribution … but you’re also being taxed less on those distributions,” he said.

According to Vanguard’s analysis, the tax liability of a Canadian in the highest tax bracket who receives $100,000 in distributions from Canadian stocks would be $37,813. If they receive the same amount of distributions from global ex-Canada stocks, their tax liability would be $53,492.

Sheluk says there’s also an argument to be made for having more home bias with the bond component of a portfolio. People usually invest in bonds for the “safety” they provide, he says, and the biggest risk Canadians are likely to face is economic difficulty within Canada.

“Canadian government bonds are going to be the best hedge against Canadian economic weakness,” Sheluk said. “But it’s another part of the portfolio that I think overall still benefits from diversification.”

Farhan Devji is a freelance journalist and published author based in Vancouver. You can follow him on Twitter @farhandevji.