Let’s face it; cannabis stocks have been the best source of returns in Canada, in well, probably forever. But, at the same time, these stocks are not for everyone owing to their underlying volatility. Particularly if you’re a retiree and you rely on your pension as a source of income, the draw downs that we have seen this year from sector leaders like Canopy Growth are certainly reasons to be apprehensive.
However, we are still in the early innings of a multiyear bull market in the global cannabis sector, and with the full backing of the federal government behind this industry, cannabis stocks have a place in even RRIF or LIF accounts — provided, of course, that you limit your exposure appropriately, stick to names with staying power, and are comfortable with their volatility.
Position sizing Regardless of where you are on the risk spectrum, the key to successful investing lies in a well-diversified portfolio of stocks and bonds, with no single position taking up more than 5% of your equity holdings. For example, based on the age-old axiom of “100 minus your age to equities” (sometimes this is quoted as “110/120 minus your age”), a 70-year-old individual’s portfolio should only have 30% or less devoted to equities and 5% or less in this 30% devoted to any one name (or 1.5% in absolute terms).
The math behind this can get quite complex, but in plain English, it’s important to know that volatility gets smoothed out due to the uncorrelated assets (assets that do not move in tandem) your portfolio contains.
Staying power To be frank, I would not recommend any retirees place their bets on any one single name but gain exposure to the sector through an ETF such as the popular Horizons Marijuana Life Sciences ETF. Funds like HMMJ, are a one-stop shop to hold all the movers and shakers in the sector, such as Canopy Growth or Aurora Cannabis, while paying out pretty decent yields.
However, if you want to choose individual names, I recommend that you stick to the sector leaders with large cash positions that have inked deals with major international beverage and consumer brands, such as Canopy or a HEXO (note: I did not include Cronos owing to its lofty valuation and poor execution).
Stay true to the course Finally, by limiting your exposure to 1-2% of your total holdings and selecting a broad basket of names or choosing the sector leaders, the last part should take care of itself — that is, being comfortable with volatility.
Look, this sector is still in the early innings, and we will be seeing plenty more mergers, bankruptcies, and news flow (both positive and negative) in the coming years. As an educated investor, you must be able to stomach the wild swings that have characterized the cannabis industry and have a long-term outlook; in other words, only invest what you can lose and don’t pay any attention to the daily ebb and flow of your positions.
By sticking to these three principals of sizing, selection, and comfort with volatility, you might just be pleasantly surprised by your returns in five years.
Fool contributor Victoria Matsepudra has no position in any of the stocks mentioned.
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