Asset allocation: Taking the first step

The first step to understanding whether your existing investment portfolio is appropriate for you is to record everything.

In the famous book The Intelligent Investor, the ‘father of value investing’ Benjamin Graham said something very important: ‘Investing is most intelligent when it is most businesslike’.

The implication is clear. You should run your investments the way you’d run a business. You need to apply due care and skill and, perhaps most importantly, you should have a plan. We advised as much in our special report Building and Managing your Portfolio.

Without a plan – an idea of what you’re trying to achieve – it’s just a hobby. If you’re making it up as you go along, you can bet your investment performance will be below par.

While many of us prefer to focus on picking stocks (guilty, Your Honour) this approach can lead to short-sightedness about the bigger picture. After all, investing isn’t solely about shares – and, if you think it is, you’re likely to end up insufficiently diversified.

Types of asset classes

Asset allocation is the process by which you balance different classes of assets. Over time, you’ll probably need a mix of not just Australian shares, but international shares, fixed interest, property and cash.

Not all asset classes perform well at the same time. If you’re ‘overweight’ to Australian shares you’re taking the risk that our local market will be a poor performer in future. Australian shares have underperformed international shares over the past decade, for example.

The simple idea behind asset allocation is exactly the same as owning a portfolio of individual stocks – diversification. If you diversify using different asset classes, you’ll smooth your returns over time and ensure you take less risk than owning just one or two asset classes.

So how do you know what’s an appropriate asset allocation for you? Financial advisers can help but, as we all know, they’re pretty expensive. And, as someone who used to work in the industry – many moons ago – my experience is that financial advisers are better at the ‘structuring’ than the ‘investment’ side of things.

The first step to deciding an appropriate asset allocation is simply to record everything. You can do this using an Excel spreadsheet if your computer skills are up to scratch. Or you can use an investment platform (or ‘wrap’) to hold assets but they can be expensive – and inflexible.

Portfolio Manager

Alternatively, a simple way to record everything is via a free online tool like InvestSMART’s Portfolio Manager. You can record all details of your listed investments, managed funds, properties and even any debt attached to each.

The benefits of recording everything are many. First, you’ll be able to see exactly how much you have invested in each investment and asset class. This holistic approach means you’ll end up worrying less when an individual stock falls sharply (for example). It’s the total portfolio performance over time that matters, not the performance of any one stock – or fund – over a short period.

Second, if you haven’t already, recording everything will help you think about your investment plan. Your investment plan should ask questions like: ‘What’s my time horizon?’, and ‘How much risk am I willing to take?’. If you’re a conservative investor who will need access to your funds in two years, for example, then you probably shouldn’t be buying ASX-listed small companies.

Portfolio Manager can help with these questions. The tool allows you to set an investment goal and continually runs a portfolio ‘health check’ to help you identify where you may need to rebalance your investments. Portfolio Manager compares your existing asset allocation to what’s optimal for someone in a similar situation.

Of course, only you can decide what your investment goals are – and what asset allocation is appropriate for your situation. But recording everything will mean you’re fully informed – and will help you develop an investment plan to meet your goals.

Remember, treat investing like a business. You wouldn’t run a business without knowing your full financial position, so make sure you record everything. It won’t be long before better information leads to better performance.

Next week: If you’re an investor in ASX-listed stocks, we’ll show you how to allocate capital to each position.

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