Most investor portfolios chronically out of kilter

Getting the right investment balance is key.

Summary: We've analysed the investment portfolios of almost 60,000 Australians and found that a high percentage of investors are completely out of balance in terms of their selected investment objectives.
Key take-out: A sensible investment strategy should involve regular portfolio health checks using a portfolio manager. When a portfolio moves out of balance, instead of buying more of the same asset classes it makes sense to plug your investment gaps with other assets to achieve better diversification.

A high percentage of self-directed investors have asset allocations that are totally out of kilter with the strategies they should be adopting based on their investment time horizons.

Most are also wedding themselves to a single risk profile, which may have been shaped by a recent experience, when they should have a risk appetite based on time horizon, being more conservative for short-term investment goals and more aggressive for long-term goals.

And, as different asset classes move up and down over time, most investors are not rebalancing their asset allocations when they do get out of kilter with their target asset allocation, even though they may only need to make small adjustments every year or two.

Analysis of more than 56,000 investment portfolios using InvestSMART's free portfolio manager shows a majority of investors have single portfolios and are heavily exposed to Australian equities and investment property, irrespective of whether they classify themselves as having a conservative or high-growth risk appetite.

Of these portfolios, around 10,000 classify themselves as having a conservative focus, with a zero to five-year time horizon. But their actual mix of assets suggests they are actually more aggressive with 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 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.

In other words, most investors with a conservative time horizon have a 75 per cent weighting to Australian shares and property, when they should have only 18 per cent.

Furthermore, on average they only have 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 a 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 only held Australian stocks, nearly half considered their portfolios to be well diversified. Those who said they were well diversified only had an average of 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 only have 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.

Investors chasing past returns

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 portfolios will go up and down, all the time. The trick is not to chase last year’s returns.

Australian equities have been the number one 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.

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

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 gaps.