Diversification v Concentration: A tortoise and hare story

160315.Diversification v Concentration

Concentrate your investments to make and lose a lot of money

The following recent Twitter exchange was the catalyst for this article:
 

 
The initial tweet above is a quote from Jim Rogers, a well known US investment commentator, who believes he can reliably pick investment winners and time investment markets, despite robust academic research suggesting such skills are both incredibly rare and difficult to identify. However, his view that if you want to make a lot of money you should avoid diversification (i.e. spreading your investments as broadly as you cost effectively can) is undoubtedly correct.

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Confessions of a frustrated financial planner

Confessions of a frustrated financial planner
Responding to what I consider “dumb” money decisions

The recent Christmas/New Year period again provided time to meet less regularly seen family, friends and acquaintances and catch-up on what they have been doing. Inevitably, given what I do, the subject of personal finance often arose in some shape or form.

And it’s not usually raised by me. Invariably, the initiator is looking for my endorsement of whatever financial action/decision they have already taken or are committed to taking. They really aren’t particularly interested in hearing the almost inevitable reservations I may have.

Sheltering behind my ongoing obligation to “know the client”, I avoid getting involved in what experience has told me is likely to be a frustrating and fruitless conversation by simply saying I don’t have enough information to provide a worthwhile opinion.

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The only free lunch(es) in finance

The only free lunch(es) in finance
The investment equivalent of par golf

One of our four key investment philosophies is that “Diversification is key”. Effective diversification requires you to invest in broad based asset portfolios of every asset class where risk is rewarded over the long term in a strong and reliable manner.

Diversification provides the opportunity to reduce investment risk, without reducing expected return. As such, it is often described as “the only free lunch in finance”. But when combined with the practice of rebalancing your investment portfolio on a regular basis to target asset allocations, in order to preserve a desired risk exposure, a “free” return benefit may also arise (i.e. “the rebalancing effect”).

The discipline of regularly reducing exposure to asset classes when they become overweight, due to relative outperformance, and increasing exposure to relatively underperforming asset classes imposes a desirable “buy low, sell high” bias to an investment portfolio. Provided asset class values move differently, but generally have extended periods of relative outperformance and underperformance, rebalancing will not only serve to maintain a desired risk exposure but also enhance investment return.

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Don’t put all your investment eggs in one basket

Dont put all your investment eggs in one basket

Concentrated investments add to risk but have no expected extra return

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 – examined the rationale for setting a target maximum growth asset allocation. And, as a corollary, a minimum defensive asset allocation.

This article looks more closely at an aspect of how both growth and defensive assets should be held in order to increase the chances of both becoming and remaining financially independent. It is the focus of Chart 6 of the Personal Financial Dashboard, the Diversification Ratio.

When you are relying entirely on your investment wealth to finance your desired lifestyle for an indefinite period, it’s generally not the time to take more investment risk than you need. While you may wish and require your wealth to grow, effective wealth management should largely be about ensuring that in the quest for higher returns unnecessary risk is avoided.

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Portfolio Diversification versus Portfolio Insurance

Portfolio Diversification versus Portfolio InsuranceHow can I protect against a loss of investment capital?

Since the GFC there’s been a lot of talk about ways to protect investment portfolios from the types of falls experienced in late 2008. There are two ways to overcome this risk: portfolio diversification or portfolio insurance (or hedging). We’ve compared the two in this article.

Portfolio diversification involves the practice of combining investments with low correlation to reduce the overall volatility of the portfolio. This invariably means holding some “losers” amongst your “winners”; a practice that often doesn’t sit well with a “winner’s” mindset.

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Global Equity Investing

Global Equity Investing
The concept of a single strategic equity asset class

Globalisation has meant that world equity markets are now much easier to access. This is leading to the next stage in investment development – global equity investment mandates that offer access to world equity markets via a single investment exposure.

This differs from the current approach that involves holding a combination of equity investments that include a home country exposure, international developed market exposure (often held at a country or regional level) and international developing market exposure.
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Baby boomers’ housing experience may not repeat

Baby boomers’ housing experience may not repeat

Baby boomers still borrowing to buy property

Over the six years to 2009-10 [1], baby boomers (those born between 1945 and 1964) continued to pour money into both owner occupied housing and other property. And they were happy to take on additional debt to do so.

The table below shows the change between 2003-04 and 2009-10 in the percentage of households, by age of reference person, where the homeowner has a mortgage.

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You can be better off paying capital gains tax!

You can be better off paying capital gains tax!

Surely, it’s better to defer paying tax

It is not unusual for clients to have sizeable exposures to individual shares that they have held for long periods of time. We generally would encourage them to sell these holdings and invest the proceeds into highly diversified investments to reduce the risk of their portfolios, without a loss of expected return.

However, we often experience considerable resistance to this advice if sale of the shares would result in the crystallisation of significant capital gains and the obligation to pay capital gains tax. Clients reasonably ask “What’s the point of taking an unnecessary action that brings forward the payment of tax?”

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The Allure of Gold

The Allure of Gold

Gold as a safe haven

The allure of Gold, as a viable long term investment option, has shot to new heights in the past five years. While this is perhaps understandable given its status as a safe haven, should it be a fundamental component of an investment portfolio?

There is a lot of misunderstanding about gold, its role in the financial system and use within an investment portfolio. We aim to address some of these misunderstandings.

A Brief History of Gold

Gold first became a transferable form of money around 560 B.C. when gold coins (stamped with a seal) were used by merchants to simplify trade. The coins were valued according to their inherent gold content. In 1066, Great Britain developed the British pound (symbolising a pound of sterling silver) and other units of currency based on their inherent metal value. During this period, gold (and silver) represented the main means of exchange (i.e. money).

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How does your “Personal Financial Scorecard” look?

How does your “Personal Financial Scorecard” look?

A picture paints a thousand words…

Our recent article, “What is “The Value of Financial Planning”?”, introduced a number of key metrics that we monitor to assess clients’ progress toward meeting their financial objectives. Together with some additional important measures, a “Personal Financial Scorecard” can be created for each client.

This Scorecard succinctly captures financial progress and highlights strengths and weaknesses in a client’s current situation. It’s easy to see whether a client is on track to achieve their desired financial future and what steps they need to take to enhance their financial position.

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