Twenty years ago, a financial term such as ‘asset allocation’ would have been reserved for fund mangers and analysts.
But with the advent of compulsory superannuation in Australia, we have all become investors now. Even members of retail and industry super funds have to at least understand the concept of asset allocation and to make good decisions about how their retirement savings are invested.
Asset allocation is about putting the right amount of your investments to cash, bonds (fixed interest), shares and property. The idea is that when some of the asset classes are doing poorly, at least one of the classes is doing well.
It’s a balancing act.
But how do you make sure you have the right asset allocation for you? The answer isn’t easy, because every person has different needs.
The two main determinants of asset allocation are your risk profile and your life stage.
Let’s start with risk profile.
Risk profile refers to the amount of risk and volatility you accept. Most people know if they are prepared to accept ups and downs in the equities markets to achieve higher returns in the long haul, or if they are prepared to accept low returns of cash and bonds for very little volatility and a high degree of certainty.
Matching asset allocation to your risk profile is important, especially for long term investors who want to be really comfortable with how their investments are performing. The profiles, in order of increasing risk, are: preservation, moderate, balanced, growth and aggressive.
This is how fund management professionals typically match those risk profiles to asset weightings:
Preservation: 40 per cent cash, 60 per cent fixed interest and no allocation to other classes. This is for investors who don’t want any volatility in returns; they want to preserve their capital and have returns slightly in front of inflation.
Moderate: 30 per cent cash, 35 per cent fixed interest, 15 per cent Australian shares, 10 per cent international shares, 10 per cent listed property. The emphasis on cash and fixed interest keeps this portfolio at the non-volatile end of the spectrum but also retains some growth assets to stay further above inflation.
Balanced: 15 per cent cash, 20 per cent fixed interest, 35 per cent Australian shares, 20 per cent international shares, 10 per cent listed property. Balanced is for people with an appetite for growth but conservative instincts. It seeks to anchor the portfolio in inflation-beating investments but gives almost two-thirds of the portfolio for potential growth.
Growth: 10 per cent cash, 15 per cent fixed interest, 40 per cent Australian shares, 25 per cent international shares, 10 per cent listed property. This is for people chasing growth with the chance of volatility. Only a token anchor in conservative investments.
Aggressive: 5 per cent cash, 5 per cent fixed interest, 45 per cent Australian shares, 35 per cent international shares, 10 per cent listed property.
This allocation is for an investor who is willing to let their investments ride with the markets and is prepared to accept the volatility of that decision in order to make the greatest gains (which equities offer).
As you can see, there’s an asset allocation for everyone.
Your job is to find the right one for you. And that will involve the further complicating matter of life stage.
For those unsure about this, the first step could be an adviser.
* 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 mark.neos@ybr.com.au with any queries you may have or check www.ybr.com.au for your nearest branch.