Understanding asset allocation
Asset 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 …
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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Should cash distributions drive investment decisions?
Money to live …
It is not at all uncommon for those in retirement and near retirement to be concerned about the amount of cash distributions their investment portfolio is paying. Often, their objective is to be able to live off this cash and, thereby, keep their initial capital intact.
Typically, such investors understand they need to be concerned about the long term safety of their portfolio. But, at the same time they require some scope for capital growth to avoid the possibility that they will run out of money.
Therefore, they tend to go towards a balanced/growth type portfolio, allocating 40-50% to what they consider “defensive” assets and 50-60% to “growth” assets. Provided their asset allocation has been determined appropriately (see “The Asset Allocation Decision”), this sounds eminently sensible.
However, their focus on cash heavily influences the types of “defensive” and “growth” assets they choose. These choices may, in fact, totally undermine their asset allocation decision.
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Is there value in trying to time your entry & exit from the market?
This article aims to address the pros and cons of the investment strategy known as ‘market timing’.
Market timing is the strategy of making buy or sell decisions of financial assets by attempting to predict future market price movements. The prediction may be based on an outlook of market or economic conditions and the strategy is based on the outlook for the market as a whole, rather than for a particular financial asset.
The aim of the market timing strategy is essentially to switch between growth assets and defensive assets in order to generate a better risk adjusted return than that from holding a strategic combination of both asset types. When the future looks bleak, the market timer reduces their exposure to growth assets and increases their exposure to defensive assets. When the future begins to look rosier, they will begin to increase their exposure to growth assets at the expense of defensive assets.
