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News Bulletin : ADA News Bulletin August 2011
42 AUGUST 2011 investment insight risk we all face is that our investments will not adequately be able to fund our desired lifestyle once we stop working full-time. Put simply, the greatest risk is living longer than your money. According to the latest statistics, many Australians are already significantly underfunded as they head towards retirement. With so many investors investing in cash and being fearful about their future, it is time that we took a look at our personal balance sheet and matched our assets with our liabilities. Our liabilities (funding our retirement) are long-term but our investment focus seems to be on the very short-term and pushing us towards increased investment in cash and term deposits. Investors need to have investments that provide a real return after taxes and inflation or they risk not being able to afford to retire. Inflation erodes buying power and ultimately limits your future purchasing power. The only way to achieve real growth is to design a portfolio that has the goal of providing returns that exceed inflation. The GFC produced a mountain of debt for many individuals as well as for many nations. We have moved from a nation of spenders to a nation of savers, uncertain about the future. Governments around the world are struggling with high levels of debt and I believe that over the next few years inflation will become a major issue. The US government will continue to print money in order to inflate away their debts which will put upward pressure on inflation. In Australia, our two-speed economy will create upward pressures on wages and our high dollar will hurt our nation’s exporters. However, I am confident that the world is not coming to an end. I refuse to let the short-term focus of the media change my view that the best strategy for investing is to have a well- diversified portfolio that, over time, will deliver real growth that will mitigate the effects of inflation on my wealth. dETERMInInG THE CORRECT ASSET ALLOCATIOn The most important portfolio decision is determining the mix of assets in your portfolio or the asset allocation. The reason I say this is that if shares or property are increasing in value then it is more important to be invested in that asset class than it is to be in the ‘right’ shares or property. Your portfolio will benefit from increasing prices by simply having exposure to that asset class. Asset allocation is the strategy of dividing your investment portfolio among the available asset classes such as shares (Australian and international), fixed interest, (bonds, mortgages corporate debt both Australian and international) property and cash or short term deposits. Essentially, asset allocation is an organised and effective method of diversification. So how does an investor balance the competing factors of risk and return when it comes to constructing their portfolio? As each asset class has different levels of risk, which is related to the potential returns, investors need to consider the following factors: • Risk tolerance: a psychological measure of your willingness to accept higher risk or volatility in exchange for higher potential returns. This is a measure of your financial risk tolerance and is not to be confused with your tolerance for taking other risks like driving fast, skydiving or other risky behaviours; • Investment time horizon: how long the money will be invested – short-term (1-3 years), medium-term (4-9 years) or long-term (10+ years); • Risk capacity: a measure of how much risk you can afford to take. This is often closely linked to the investment time-horizon, because over the long-term, short-term volatility loses its significance. However, investors who need liquidity are constrained as to how much risk they can take and they pay a price for that liquidity in lower returns; • Investment experience: the more experience an investor has, the less likely he/she is to panic when markets decline as they will have seen it all before and resist the urge to sell at low prices. Typically, the asset allocation decision is made with the assistance of a financial adviser but as more and more people are choosing to become more involved in determining their financial future, other options are becoming available that cater to DIY investors. Investors can now access a series of professionally-constructed model or sample portfolios that are researched and designed to cater for various levels of risk tolerance, ranging from conservative to aggressive. Similarly, tools and tests are also available online to help individuals assess their risk tolerance and interpret how that affects the construction of their investment portfolio. Investors can use these professionally-researched model portfolios as benchmarks that help them determine the optimal asset allocation for their personal risk tolerance as well as providing a solid basis for comparing and measuring the performance of their own portfolio. In the past, these model portfolios and associated research were only available through advisory groups but that is no longer the case. The asset allocations of these model portfolios serve as a useful guideline but nothing is set in stone. Investors can modify or finetune the proportions to suit their own individual circumstances. Factors like your future capital needs, your liquidity concerns and your experience with share market investing will help you to determine what mix is right for you. COnCLUSIOn In conclusion, an appropriate asset allocation is fundamental to investment success as well as ensuring that investors are comfortable with and understand the risks they are taking. From time to time we need to step back and conduct a review of our investments to make sure our asset allocation proportions are still in line with both our short and long-term goals. I suspect that for many of you, your allocation to cash and term deposits is significantly higher than it should be at this stage of the business cycle. Perhaps you need to consider the factors discussed above and rebalance your portfolio accordingly. If you have any questions on this topic or would like to know how to access the DIY investor resources discussed in this article, please feel free to contact me. The information contained in this article is believed to be accurate. To the maximum extent permitted by the law, 2020 DIRECTINVEST (AFSL 244 249) disclaims liability for errors in, or omissions from, this article. In no way should this article be construed as providing securities advice or an endorsement or recommendation of any security or product. In preparing this article we have not taken into consideration your investment objectives or your investment needs and make no representation as to the suitability or otherwise of any product, or security, to you. Michael Lannon is the Executive Director of 2020 DIRECTINVEST, an ADA Partner service specialising in the provision of execution only DIY investment services. For more information or any questions please contact Michael Lannon on 1800 352 021 or visit 2020’s website on www.2020DIRECTINVEST.com.au
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