Mark Bouris talks about asset allocation, spreading risk and the risk-return curve
In the financial services industry we can talk at length about asset allocation, spreading risk and the risk-return curve.
But when Australians are talking about saving for their retirements, it's the basic idea of the diversified portfolio which is most important.
I was thinking about this recently because I put out a Twitter asking where followers would put $10,000 for a year if I gave them the money.
Two-thirds of the responses would put their $10k into either shares, or property, or cash. But not a single person told me that they'd split the $10k and invest it in different asset classes.
No one said 'I'd put $4000 into shares and $3000 into a property trust and $3000 into a fixed interest account.'
And I had almost 70 people respond to me.
The fund management and financial advisory industries have spent the past 20 years emphasising the benefits of a diversified portfolio and spreading your risk. And at the base of this diversified portfolio is 'asset allocation'.
Allocating your investments by class means devoting portions of your capital to Aussie shares, global shares, cash, property and bonds.
Then you match the ratios of your allocation with what they call your 'life stage': if you're 20, your allocation will be heavier to Aussie and global equities, because the amount of time you're invested will cancel out the volatility cycles and you'll get higher returns.
Likewise, when you're a retiree or a near-retiree, you shift the weighting of your allocation to be heavier in cash and fixed interest, because while they're lower in returns, they're high in stability.
While these dramatic shifts in asset allocation have become par for the course, I've been rethinking it lately.
However, allocating assets by investment class has an extreme look to it. The two main risks that retirement savers face is market risk and inflation risk.
You expose yourself to market risk because you chase higher returns, which means you're invested in volatile equities.
Inflation risk occurs because you're chasing low risk, which means investing in cash which hovers very close to the inflation rate.
Secondly, we are encouraged to skew our retirement investments to either market risk or inflation risk, by the 'default' options at our superannuation fund managers. If you tick default, for most of your accumulation phase you'll be invested 60-70 per cent in equities; and when you identify that you're about to retire, most default funds switch you to a reliance on cash investments.
This is a pendulum and it might not be as successful as we imagine.
How do we stop the pendulum?
The asset class called 'bonds' - half way between the risk/return of equities and cash - is a better long term performer than Aussie equities, with very little volatility.
I believe that the issue of asset allocation will be revisited in this post-GFC market and we'll come to see it as a chance to properly balance a portfolio from the outset rather than change the risk profile to match life stages.
Keep an eye on bonds - they'll be a part of this change.
* Mark Bouris is the Executive Chairman of Yellow Brick Road, a financial services company offering home loans, financial planning, accounting & tax and insurance. Email Mark on email@example.com with any queries you may have.
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