How should I rebalance my growth portfolio?

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The key decision is your defensive versus growth allocation

It is a key element of our approach to investment risk management that you should select a target asset allocation that is consistent with your attitude to risk (i.e. a level of investment risk that will enable you to “sleep well”, regardless of what investment markets are doing). The target is to be met at or before your desired retirement date and/or by the time you wish to be financially independent (i.e. have sufficient investment wealth to support your desired lifestyle, without the need to work).

The target asset allocation is primarily focused on your mix of defensive assets (i.e. cash, fixed interest) and growth assets (i.e. primarily, Australian and international shares, and property). If the current defensive/growth allocation varies from target, we work with clients to develop and implement a strategy to transition over time from where they are now to that target.

We also agree with clients how they allocate the growth component of their investment portfolio between the primary growth asset classes i.e. Australian shares, international shares and property. While this allocation decision is both part art and part science, most investors (both in Australia and around the world) tend to have a strong “home company bias” i.e. Australian investors tend to heavily overweight Australian shares and property, despite our markets only being a small percentage of global share and property markets.

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Will share returns remain low?

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Share and cash investment returns are unexciting

It feels like the Australian share market has been going up and down in about the same spot for the past six or seven years. Many are becoming disillusioned with shares as an investment class and are looking to “juice returns” with the various hybrid structures and private equity “opportunities” on offer to take advantage of the discontent.

Cash, in the form of term deposits, has also lost its lustre, with yields at record lows. It’s not surprising that in this environment the perennial favourite, direct investment into residential property, has become even more popular. The house price rises experienced over the past three or four years, particularly in Sydney and Melbourne, make the share market appear a pretty dull alternative.

This article examines some of the historical facts that underpin current feelings. While we don’t know what will happen in the future, the past suggests that current investment returns are not inconsistent with what investment theory would expect and may not be a good guide to future investment returns.

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Investment Yield versus Return for Risk

Investment Yield versus Return for Risk
What to do when cash rates fall?

With interest rates on cash in Australia falling to record lows, in absolute terms, there seems to be a scramble by investors to chase higher returns for their capital. Cash, which often ends up as the investment of choice by default, seems no longer a palatable option, with cash rates at a level that is now causing significant pain for many investors.

With cash rates so low there are numerous alternatives that offer a higher income return, or yield, than cash. For example, Australian Bank shares offer investors a grossed up dividend yield of close to 7.0% per annum – that’s a significant uplift on the Reserve Bank ‘s 2.25% per annum cash rate. This appears as an appealing alternative to investors who can no longer stomach the opportunity cost of holding cash.

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Your emotions complicate investment decision making

Your emotions complicate investment decision making
Lifestyle asset decisions have a heavy emotional content

It’s not always clear what’s a lifestyle asset versus an investment asset. Recent discussions with a client regarding a proposed holiday house purchase raised some interesting issues not only in relation to this matter but regarding investment assets, more generally.

In this case, the client expected that the holiday house would be available for rent for most of the year, with the family using it only for a couple of weeks during peak holiday periods. Based on previous net rental income figures, the return on the property would exceed the current cost of borrowing.

The client’s reasonable view was that because of the anticipated net income, the property should be regarded as an investment asset rather than a lifestyle asset. Further, given the likely reliability of that income, he questioned whether it could be considered as an alternative to holding low yielding, high credit quality, defensive assets.

We were not comfortable with the “defensive asset” alternative idea, given that prices of holiday homes fluctuate considerably and, in poor markets, there is often little liquidity. However, a typical response to this view is that there is generally no intention to ever sell a holiday home. Often, it’s regarded as an asset for the family to enjoy and, potentially, to be passed on to the children.

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How much investment risk can you bear?

How much investment risk can you bear?
Your allocation to growth assets is a key measure of investment risk

In our previous article in our series on the Personal Financial Dashboard – a graphic format that succinctly captures the journey to, arrival at and maintenance of financial independence – we discussed the need to be tax aware when investing. Financial independence is harder to achieve if there is an unnecessarily large tax leakage.

But tax shouldn’t be the overriding factor when making investment decisions. Rather, the primary focus should be on risk and related return. The Personal Financial Dashboard includes two charts which look at key aspects of investment risk management i.e.:

  1.  the Growth  Asset Allocation Ratio (Chart 5); and
  2. the Diversification Ratio (Chart 6).

In this article we focus on the Growth Asset Allocation Ratio (“GAAR”). The Diversification Ratio is discussed in our next article.

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The Pros and Cons of Lifetime Annuities

The Pros and Cons of Lifetime AnnuitiesLifetime Annuities and the quest for certainty

Lifetime annuities offer you the opportunity to outsource a large slice of the uncertainty associated with managing your retirement capital. You get to exchange your capital for an annuity that will offer you a guaranteed income stream for life. And, for an additional cost, this income stream can be indexed with inflation.

The growing demand for greater certainty since the Global Financial Crisis has brought lifetime annuities back to the forefront as a retirement solution. In this article, we ask whether they are a suitable alternative to the self managed solution that most retirees select by default?

The Uncertainties of Managing Retirement Capital

There are a number of risks to consider when managing retirement capital, including:

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Managing investment uncertainty

Managing investment uncertaintyMost investors should hold a combination of defensive and growth assets

In our last article, we explained why we don’t think that the past five years of poor share market investment performance provides sufficient evidence that the investment world has changed i.e. we don’t yet believe there has been a paradigm shift.

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Is a 100% defensive portfolio low risk?

Is a 100% defensive portfolio low risk?
The real risk is running out of money

In turbulent and generally downbeat financial markets, like we have experienced since the end of 2007, there is natural tendency to become more cautious. To spend less, save more, pay-off debt and, particularly for those close to or in retirement, hold more investment wealth in defensive assets i.e. cash and fixed interest.

We may get a sense of comfort from knowing that the value of our investments cannot fall further and believe we have adopted a sensible, low risk investment strategy. And this is certainly true, if you think that investment risk is measured solely by the volatility of investment returns, pre inflation and tax.

But if the risk you are more concerned about is that you won’t be able to live the lifestyle you want or that your money might run out before you do, then high levels of defensiveness may be very risky.

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Understanding asset allocation

Understanding asset allocationAsset allocation: a measure of your investment risk

Our objective is to help clients become financially well organised and make smart financial choices so they have the best chance of enjoying the financial future they want. A key to achieving this objective is agreeing an appropriate investment risk exposure with each client and carefully managing that exposure over time. For us, this risk exposure is most appropriately measured by the client’s asset allocation.

This is the first in a series of four articles that explain our approach to asset allocation. Most people think they have a pretty good idea of what asset allocation is all about. Our experience suggests they don’t. While we start off pretty basically, we hope that by the final article you will agree that by viewing asset allocation in the lifelong context we advocate some conventional financial planning views are challenged and some smarter ways of thinking about personal finance issues emerge.
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Wealth Management: a risky business

Share and property investments are risky …Wealth Management: a risky business

Most people understand that the returns of growth investments (i.e. shares and property) fluctuate considerably. If they didn’t prior to the Global Financial Crisis, they most certainly have a better grasp of that now.

But most don’t really have a good understanding of the potential range of variation of returns, without anything particularly unusual happening. And nor do they appreciate how dramatically the pattern of returns can affect long term wealth outcomes.

We use the Australian share market experience of the 25 years to December 2009 to shed some light.
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