How a conservative allocation can give you that little bit extra
This is interesting as we don’t do this in other parts of our asset purchasing lives. Think about your own personal assets; you might own a house, have a cash account or accounts, a portfolio, a car or cars, a boat, personal belongings you value highly, the list can be endless.
As an exercise, right now list what you have, and when you do, look at these assets in total rather than individually – as they are all your assets.
It should also be apparent that there is an array of assets here, all different in their own way and all providing you with life goals and needs.
Investment diversification is exactly the same – you shouldn’t look at your investments as silos but as part of a whole. When you start to think like this, your ability to achieve your financial goals will become a whole lot easier.
Let’s test this further using a few charts of actual Australian investments. Let’s look at investing on a silo basis in just international equities, Australian equities, listed property, fixed income and cash.
As you can see, over the past 5 years each asset has experienced vastly different performances. No doubt, holding just international equities is way too risky for someone who just holds cash, even though it has returned over 92 per cent during this time. Similarly, someone that just held cash has significantly underperformed all others, even with events like COVID which would not work for someone needing higher returns.
The chart also highlights why you should never put all your investment funds into just one asset as the probability of experiencing disappointment is very high. The old saying ‘don’t put all your eggs in one basket’ is the perfect analogy for investing.
So, let’s take those 5 asset classes and invest in them with a conservative diversified allocation; where 64 per cent is allocated to defensive assets like fixed income and cash and 36 per cent is in growth assets like international equities, Australian equities and property.
The light blue shaded area illustrates how blending your investments by diversifying your investment funds not only gives you significantly better returns than just fixed income and cash, but also significantly lower risk fluctuations than a straight risk asset like international and domestic equities.
In short, the diversity acts as a cushion, giving your portfolio valuable protection from serious market falls, and it also means that as riskier assets rise, you are able to take advantage of the outperformance they give compared to defensive assets.
Taking that point a little further, let’s compare investing in Australian sovereign bonds to the same diversified conservative portfolio.
Bonds are very conservative in nature; they give you a fixed income stream, are backed by government so are near enough to being risk-free and are very stable in its pricing. However, unlike cash, bonds have capital gains and losses which is why they are riskier as you can technically lose some of your capital investment (cash only has income, your capital investment will be returned to you unchanged). However, it also means bonds can give you capital growth which is why they outperform cash.
So, if you had invested in bonds over the last 5 years, your total return (capital gain and income) would have been 17.5 per cent as you can see in the chart below.
If you invested in a conservative diversified portfolio which holds the same bonds that gave you 17.5 per cent but also allocated your investment funds to cash, equities and property over the same period, your total return would have been 33 per cent – a 15.5 per cent difference which could be the difference between reaching your financial goals and not.
This is why a conservative portfolio gives you that little bit more you might need to reach your investment goals in the timeframe you want.