How to bring balance to investment portfolios

The following article appeared in The Australian on July 24, 2017
By · 24 Jul 2017
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24 Jul 2017
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It’s important to have a well-diversified, balanced portfolio of assets that is proportional to your risk appetite


Is your portfolio in sync with your overall investment objectives?

It’s a basic question you should keep asking yourself, because the reality is that a high percentage of self-directed investors have asset allocations that are actually totally out of kilter with the strategies they should be adopting based on their investment time horizons.

A recent analysis by InvestSMART of almost 60,000 Australian investment portfolios, using data gleaned from its online portfolio manager, found some quite startling results.

They showed that a majority of investors have only a single portfolio and are heavily exposed to Australian equities and investment property, irrespective of whether they define themselves as being conservative or aggressive in terms of their risk appetite.

Further, it’s evident that most investors are wedding themselves to a single financial risk profile instead of having multiple risk profiles aligned to their overall investment time horizon and specific investment goals.

In other words, rather than having both conservative and more aggressive portfolios linked to separate short-term and long-term objectives, such as buying a house and building wealth over time, most investors are choosing one strategy to try and fit all their goals. It won’t work.

In reality, most of us have different financial strategies all running at the same time, such as saving for a holiday, paying off our mortgage, buying an investment property, and putting money into superannuation.

Investment should always be about targeted asset allocations. But while the returns from different asset classes move up and down over time, most investors are not rebalancing their investments when they do get out of kilter with their target asset allocations. This leaves them overexposed to certain assets, even though they may need to make only small adjustments every year or two to keep themselves in balance.

Of the portfolios surveyed, about 10,000 investors classify themselves as having a conservative risk profile, and have a zero to five-year investment time horizon. But when analysed their actual mix of assets suggests they are much more aggressive, and they actually have a longer-term growth or high-growth profile.

Indeed, the results show the ­average conservative portfolio is severely out of balance, with an ­aggressive 51 per cent exposure to Australian shares and a 24 per cent exposure to investment property.

Yet a typical conservative exposure, based on median asset ­allocation data derived from ­research firm Morningstar for the same investment time horizon, would warrant a much lower 12 per cent exposure to Australian shares and 6 per cent to property and infrastructure.

Therefore, most investors with a conservative time horizon have a 75 per cent weighting to higher-risk assets such as Australian shares and property, when they should have only 18 per cent of their funds allocated that way.

In addition, on average they have only 5 per cent allocated to fixed interest and 13 per cent to cash, when the recommended ­allocations for a conservative portfolio should be 54 per cent to fixed interest and 17 per cent to cash.

The same sharp divergence is also evident in growth portfolios, where investors are still overweight Australian equities (46 per cent) and property (34 per cent), and severely underweight fixed interest (2 per cent) and international shares (5 per cent). By contrast, according to Morningstar’s ­median asset allocation data, an ideal growth portfolio with a five to seven-year time horizon should have been closer to 28 per cent ­allocation to international shares, a 19 per cent fixed interest holding and 9 per cent in cash. Australian equities should make up 30 per cent, and property 14 per cent.

InvestSMART’s analysis corroborates the findings contained within the recently released 2017 ASX Australian Investor Study, which showed that while 75 per cent of share owners held only Australian stocks, nearly half considered their portfolios to be well diversified. Those who said they were well diversified had an average of only 2.7 products in their portfolios.

Not only are investors highly exposed to Australian shares, but their share portfolios are highly concentrated into just a few shares. On average, many investors have only three to five stocks in their portfolios. So, while some investors consider themselves diversified across asset classes, many are clearly not diversified enough within them.

In addition to the fact that most investor portfolios are chronically out of balance, it is also evident they are staying that way because many investors are continually chasing past years’ returns.

They do this by switching their investment allocations into asset classes, or equities, that have previously performed well in the hope the same assets will continue to outperform. Odds are, they won’t.

All the ingredients in an investment portfolio will go up and down, all the time. The trick is not to chase last year’s returns.

Australian equities have been the No 1 performer over the year. But, over two years, the best performer was property. Over five years, international equities have achieved the highest returns. Yet, over 10 years, it has been fixed ­interest that’s been the best performer.

For self-directed investors, it’s essential to monitor and manage your portfolio on a regular basis.

What’s most important is to have a well-diversified, balanced portfolio of all asset classes that is proportional to your overall risk appetite.

Proper diversification enables individuals to add securities to their portfolio and lower risk, without sacrificing returns. The objective when adding more assets into a portfolio is to introduce ones that are not already held, or that make up a low percentage of the total portfolio. It’s all about plugging the investment gaps.

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Tony Kaye
Tony Kaye
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