The Asset Allocation Matrix: Investing Based on your Risk Tolerance

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

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