Finding a good balance

In the same way finding a balanced lifestyle is conducive to good health, finding balance in an investment portfolio gives investors the healthiest chance of achieving their long-term goals.

Having a diversified mix of assets is essential because it mitigates market volatility and reduces portfolio risk. This is because the best performing asset one year can be the worst-performing the next.

Take for example cash – in FY22, a year marked by economic uncertainty and geopolitical conflicts, cash topped the list as generating the best returns at 0.1 per cent. The last time cash was king however was more than 10 years ago during the Great Financial Crisis.

Conversely, the worst performing asset in FY22 was Australian listed property returning -12.3 per cent. A year before, it was amongst the best performing asset classes with 33.2 per cent.

What’s clear from these returns is that markets are impossible to predict; past performance does not guarantee future performance. So, one of the best thing investors can do to lessen this ambiguity is to simply diversify.

Finding a good balance

A dive into diversification

What does it mean to be diversified? A good place to start is to understand what it is not: that the more investments you own, the better diversified you are.

Investing in several shares from similar industries may reduce single-company risk, but it may not sufficiently protect you from sector downturns, nor does it let you capitalise on potentially stronger performance elsewhere.

Different asset classes have different risk/return characteristics, and as evidenced in the cash-property example earlier, generate different rates of return in any given year. Generally, shares and bonds move in different directions. During periods of equity market downturns for example, high-quality investment-grade bonds tend to act as a buffer to volatility and can cushion any dramatic falls in portfolio value.

Similarly, investing only locally or in one region carries limitations also. Politics, industries, and consumer sentiment vary widely by country, generating different rates of economic growth. Not investing internationally may cause investors to miss opportunities to temper domestic market swings, given global economies do not grow nor contract in sync.

A balanced allocation

Broadly speaking, there’s three risk/return profiles investors can choose to build a portfolio upon: conservative, balanced, or growth. Which allocation is best depends on an investor’s goals, time frame and age.

A conservative portfolio generally allocates the majority of money to less risky assets such as bonds, whereas a growth portfolio will preferences equities. Generally, the longer your investment horizon, the more risk you can take as short-term volatility tends to smooth out in the long-run; day-to-day market fluctuations therefore have little impact over the long-run.

An example of a balanced portfolio could consist of 50 per cent growth assets such as Australian Shares, International Shares and emerging markets, and 50 per cent income assets such as Australian fixed interest, International fixed income and cash.

The right way to rebalance

The combination of assets investors choose to include in their portfolio – known as their asset allocation – is one of the key determinants of investment returns and explains the majority of portfolio variability over time. Market timing and stock selection on the other hand have little impact on long-term performance.

Which is why sticking to the right asset allocation through periodic portfolio rebalancing, as life goals evolve and markets fluctuate, is important.

Say you’ve selected a balanced approach and for simplicity sake, are targeting a 50/50 split between shares and bonds, which no reinvestment of dividends or capital gains, no additional contributions nor factoring in investment costs and taxes.

You originally invest $1000 in a shares fund which buys you 20 units. You invest another $1000 in a bond fund, which similarly buys you 20 units.

Fast forward a few months and assume shares have performed strongly while bonds have been flat.

Which means the asset allocation is getting out of balance, away from your desired 50/50 split. From a returns perspective, this might seem positive but the market risk within the portfolio has edged higher than desirable for a balanced investor. This means you are now overweight in shares and taking on more risk than you may have first anticipated.

Rebalancing the portfolio backs to the 50/50 allocation is the logical remedy but many investors struggle to do it because it can seem counterintuitive to sell a well-performing asset to buy more of the under-performing asset. But keep in mind rebalancing is about managing risk and not maximising returns.

There’s no way of predicting if shares will continue to outperform or if they’ll tumble tomorrow – if they do, you might be losing more than you are comfortable with.

The benefits of ready-made portfolios

An alternative to building your own portfolio is to invest in Diversified funds or ETFs – akin to a ready-made investment portfolio aimed at providing long-term returns that match an investor’s desired level of risk.

Not only, as the name suggests, do Diversified funds and ETFs have in-built diversification across multiple asset classes and markets, they also reduce the transaction costs associated with investing in different assets as you simply invest in just one.

As these funds and ETFs are professionally managed, investors also benefit from the investment expertise and automatic periodic rebalancing.

Contact us today on 03 9553 0271 if you would like to talk about your portfolio.

An iteration of this article was first published in the ASX’s October newsletter.

Source: Vanguard

Reproduced with permission of Vanguard Investments Australia Ltd

Vanguard Investments Australia Ltd (ABN 72 072 881 086 / AFS Licence 227263) is the product issuer. We have not taken yours and your clients’ circumstances into account when preparing this material so it may not be applicable to the particular situation you are considering. You should consider your circumstances and our Product Disclosure Statement (PDS) or Prospectus before making any investment decision. You can access our PDS or Prospectus online or by calling us. This material was prepared in good faith and we accept no liability for any errors or omissions. Past performance is not an indication of future performance.

© 2022 Vanguard Investments Australia Ltd. All rights reserved.

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Interprac Financial Planning Pty Ltd 

Darryl Jopling

Senior Adviser

I have worked in the financial services industry since 1982 and as a Financial Adviser since 1999.

I have worked for large Financial Planning businesses, Membership based organisations and looked after the financial planning needs of clients within an Accounting Practice before starting my own business.

I am married, have 4 older children and a grandson and I am keen golfer with mixed results like many .

I have been through many of the strategies I talk with clients about myself and with my family.

I have been through the journey of seeing my parents move into Aged care and negotiated the difficulties and pitfalls of understanding the system for them and this gives me an excellent insight into what is required to assist families at this difficult time.

In a previous roll I used to run retirement seminars looking at Centrelink and Retirement Incomes and how to make these work for you. I have helped many of my clients with Aged Care advice when their parents needed to move into Nursing Homes. For many clients I assist them with superannuation, building wealth and protecting their loved ones with insurance.

I am supported by his, Licensee, Interprac Financial Planning’s in-house resources and ongoing technical, systems and training.

I am committed to understanding your needs and identifying strategies and products to help you achieve your goals.

My guiding principle as an Adviser is to design plans which help to provide my clients with clarity of purpose and the opportunity to build a solid financial foundation.
I will take the time to listen, explain things clearly and keep you informed throughout the advice process.

My experience is complemented by professional qualifications including:

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At Choice Financial Advice we work with you along the way on life’s journey.

Whether you are getting married, starting a family, embarking on the trip of a lifetime, planning to enjoy your years after work or assisting elderly parents with Aged Care and Nursing Home placements, we can help.