Step 4: Allocating Your Assets
The fourth step in our process, asset allocation, involves choosing between cash, fixed interest, property and sharemarket investments, not only in New Zealand but also internationally. Rodger will explain key principles for a disciplined approach to allocating your assets and show you how the Money Matters responsible investment approach applies these to help you avoid the traps of market emotion and market timing.
Taking a disciplined approach to investment is as essential to the performance of your portfolio as a well maintained engine is to the performance of your car. It helps you ride out adverse fluctuations in the market and ensure maximum mileage for your money. The Money Matters' approach is based on creating a well-diversified portfolio on which the assets are allocated in a way that reflects your goals and risk profile.
A long-term or strategic asset allocation (percentage weighting) for each of the asset classes (cash, fixed interest, property and shares), and within each asset class (e.g. large companies vs. small companies) provides guidance for investing, and ranges for holding each of these assets provide further discipline. By holding the strategic allocation, you could expect to achieve the long-term returns of the different asset classes. However, further value can be added by making tactical or shorter-term decisions to overweight (buy) and underweight (sell) compared with the long-term target, but within the disciplined ranges.
These tactical asset allocation changes seek to take advantage of times when market sentiment, dominated by fear and greed, changes the prices that people are willing to pay for assets. When assets become overpriced, your portfolio can benefit from under weighting (selling). Conversely, when assets become underpriced, your portfolio can benefit from overweighting (buying).
By adjusting your portfolio in a disciplined manner, you avoid having to pick the precise timing of the highs and lows whenever the market moves outside a fair price range. Furthermore, if the tactical asset allocation decisions prove, in hindsight, not to have been made at the best time, the impact is not substantial.
The disciplined approach involves extensive research and relative value assessment. Knowing the investment themes that affect these markets, and examining their historical performance and cycles, can provide a fair guide to when they represent reasonable value.
With a diversified portfolio, the golden rule is that all markets must be considered together. If you are going to increase your allocation for shares, the money has to come out of your allocation to another asset class. A fundamental challenge in portfolio management, therefore, is to apply the value concept simultaneously to shares, property, cash and bonds.
History shows that over time investors have a greater chance of generally meeting their objectives if they select an appropriate mix of investments, have a realistic time horizon and are patient. This means that they need to be prepared to accept ‘bumps’ in the return on their portfolio, which will occur from time to time.
Investors who opt for a high-growth strategy will experience a rougher road with high volatility in the short term. Longer term, however, it is expected that if their investment is maintained for the appropriate period in a well diversified portfolio with quality assets, managed by leading investment specialists, the investor will be rewarded with higher returns for tolerating this additional risk.