When we talk about asset allocation, or where you are going to invest your funds and how much, what we really mean is matching your investments with your risk appetite. First deciphering your risk appetite, AKA how much volatility you’re willing to accept on the value of your investments, is the first step to any asset allocation process. My advice considering the last 30 years working as an investment professional, would be to first work out how much of a drawdown you are prepared to accept, over what time frame and what it is that you are trying to achieve in terms of results. From here, connecting those key values with an appropriate asset allocation is the next step.
Generally speaking, having direct ownership of shares is something you’d see for people in the mid-high range on the risk appetite spectrum. By owning direct shares, I’d argue that you have to be prepared to accept the stock the potentially volatile specific risk that comes with doing so, along with accepting the broad market risk. Events occurring such as corona virus or the GFC can cause markets to wipe off 30-40% in value over a short period of time to which investors have to be prepared to ride out. Like anything, with risk comes reward – in the stock market, there is significant capital gains potential if you mentally handle the vicious swings.
Buying and selling real-estate has been one of the few methods the majority of Aussies can hang their hat on as their money maker. The property market typically could suit anywhere from low to medium on the risk spectrum as it really depends on what you’re doing. If you’re buying real-estate from an investment perspective, this could be commercial or residential, single story, multi-dwelling, off the plan, new or old build plus a myriad of other combinations. Each are fraught with their own levels of risk, albeit it’s important to note that most people who buy property utilise a mortgage and are therefore geared into that investment. Gearing comes with its own set of risks for obvious reasons; however, the popularity of the property market remains given the asset continues to perform well and price action remains relatively robust.
As the age-old philosophy would argue, holding cash at the bank is typically your conservative ‘safe haven’ investment. This, in today’s climate, is simply not true. If you take a look at current returns on cash at the bank right now at 0.05%, once you factor in the current inflation rate of 3.8% and assume a 30% corporate tax rate, your real return on this money is actually -4.05%. Don’t get me wrong, we all need to hold some cash during periods of indecisiveness or to pay your bills, however, cash is not an investment!
When they say, ‘one size fits all’, this really isn’t true in the world of investing. As we’ve talked of a multitude of asset classes above, there is no right nor wrong answer here – once again, it boils down to your risk appetite as to what you may choose to hold. The everchanging nature of financial markets and easy access to information has meant that investors can chop and change, pick and mix these asset classes as they please. Like knowing what coffee to order at the local shop, you have to know what your taste is – investing is much the same. For anyone unsure on what their taste is, reach out to Australian Investment Education to learn more and join me at one of my seminars here – http://bit.ly/aie-mjb
Frequently Asked Questions
1. What is asset allocation in investing?
Asset allocation is the process of dividing your investment portfolio across different asset classes such as shares, property, cash, and bonds. It is designed to balance risk and return based on your financial goals and risk tolerance.
2. Why is asset allocation important for investors?
Asset allocation is important because it helps manage risk and smooth out investment returns over time. By diversifying across asset classes, investors can reduce the impact of market volatility on their overall portfolio.
3. How do I determine my risk appetite for investing?
Your risk appetite is based on how much market volatility and potential loss you are willing to accept. It is usually determined by your financial goals, investment time frame, income stability, and emotional tolerance for drawdowns.
4. What is a good asset allocation for beginners?
A beginner-friendly asset allocation typically includes a mix of shares, cash, and possibly property exposure. The exact mix depends on risk tolerance, but many beginners start with a more balanced or conservative allocation before increasing exposure to higher-risk assets.
5. Is property a good investment compared to shares?
Property can be a stable long-term investment, but it often requires higher capital, leverage through mortgages, and lower liquidity. Shares, on the other hand, offer higher liquidity but come with more short-term volatility. Both have different risk profiles.
6. Is holding cash a good investment strategy?
Cash is considered a low-risk asset, but it may lose purchasing power over time due to inflation. While cash is important for liquidity and emergencies, it is generally not a strong long-term growth investment.
7. How does diversification reduce investment risk?
Diversification reduces risk by spreading investments across different asset classes and sectors. This helps protect a portfolio from large losses if one asset or market performs poorly.