Archive for June, 2009
Protected Equity Products: Can you have your cake and eat it?
Loss protection and tax advantages …
Protected Equity Products (PEPs) are heavily marketed at this time of year.
They are promoted as an opportunity to benefit from share market growth, without the risk of losing capital. They involve borrowing up to 100% of the purchase price of a basket of shares for a minimum period (generally 3 – 5 years). You keep the dividends and any gains and are protected against investment loss.
The loan interest is also usually prepaid to bring forward a tax deduction and reduce a current year “tax problem”. What a deal – no downside and tax benefits!
However, even with this basic explanation, the alarm bells should ring for smart investors. PEPs play to at least one psychological bias (i.e. “loss aversion”) that investors should be wary of and contradict at least one of our wealth management decision making principles (i.e. “It’s about ends, not means”).
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Should you hold international shares in your investment portfolio?
Invest in international shares for reduced risk …
Many individual investors, particularly do-it-yourselfers, do not hold international shares in their investment portfolios. Why would you, they ask – returns have been poor for almost a decade now.
But the argument for allocating part of your share portfolio to international shares is not based on returns. Returns cannot be reliably predicted – past performance does not provide a guide to future performance.
As part of your portfolio, international shares offer the prospect to reduce risk without affecting expected return i.e. increasing your risk adjusted rate of return. This is partly the “don’t put all your eggs in one basket” idea. But also because global share markets do not go up and down in tandem with the Australian market, international shares can reduce the variability of your share portfolio’s returns.
The risk reduction effect, or diversification benefit, is sometimes called “the only free lunch in finance”. But if this argument for holding international shares is accepted, how much should be allocated to them?
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