For the best financial advice, get personal
Get help to set your investment return target and have a happy retirement.
General financial advice dominates the decision-making processes of most investors. It encourages them to compete in an investment return race, attempting to pick the latest table-topping super fund, managed fund or hot stock. Unfortunately, excessive trading, switching and ultimately risk-taking is the result, and investment returns suffer the collateral damage.
Personal financial advice is not so freely available; it takes time, deep analysis and comes with a relatively high price tag. It also comes with stringent licensing regulations that ensure the financial services industry keeps most advice strictly general.
However, getting personal is what really counts for investors. An estimated four-fifths of Australians may not explicitly seek personal financial advice, but this is how investors need to start thinking if they are to build smarter portfolios.
How much is enough?
Superannuation, which is never far from the headlines, is a classic example.
The median super balance is currently just $100,000 for men aged 60 to 64 and $28,000 for women (although the average is higher thanks to a small number of investors with significantly larger balances), according to a December 2015 analysis by the Association of Superannuation Funds of Australia (ASFA). It represents a significant shortfall on the estimated $500,000-plus that the average couple needs to live comfortably in retirement.
Yet this means little for individuals. Savvy investors should instead start assessing their own position: how much do they have and how much do they need at retirement?
ASFA and other organisations publish regular retirement standards that can provide some guidance around personal expectations.
With a start and end point fixed, investors can focus on the variables required to get there: get the savings rate and investment returns correct, and expenditure in retirement can be supported.
This calculation is complex and a good financial planner, supported by a powerful analytic platform, can help immensely. Nonetheless, retirement calculators have their usefulness, even if many have significant limitations, such as predicting returns as a smooth line and failing to take into account variables such as the rising Superannuation Guarantee (SG) or legislative changes to the age pension.
The end result should be a personal annual investment return target, or range, which will underpin portfolio construction.
I suspect many investors will be surprised: they do not need to chase double-digit returns or hot stock tips to achieve their own long-term target. This personal goal is, ultimately, all that counts.
Laying the groundwork asset by asset
Translating this target investment return into a practical portfolio remains an enormous task, but one that needs to be attempted.
Take a hypothetical 45-year-old investor who estimates she needs to achieve annualised returns of 5 to 7 per cent over the next two decades. The portfolio will be shaped by this goal and should drive those investment returns while adequately managing risk.
Investment professionals are notoriously poor at predicting the future and, while history is no guide to future returns, it at least provides a starting point.
The strongest-performing asset classes over 20 years to December 2014 were residential investment property (9.8 per cent) and Australian shares (9.5 per cent), according to ASX’s 2015 Long-Term Investing Report.
Unhedged global listed property (8.9 per cent), hedged global fixed income and hedged global shares (both 8.6 per cent) also performed well. (Editor’s note: unhedged investment are not protected against currency movements.)
However, these returns give no indication of risk in the form of volatility and capital losses. That 20-year period includes an Australian sharemarket gain of 30.3 per cent in 2007 and a loss of 22.1 per cent in 2009, according to Vanguard.
The impact of volatility can even be seen across long-term returns. Change the start and end date by 12 months and unhedged global listed property posted 6.2 per cent a year over the 20 years ended December 2013 – well under the 8.9 per cent over the 20 years to December 2014.
Diversification is key
Finally, investors must incorporate an assessment of current market conditions. Many economies are still carrying significant debt in the wake of the GFC. The fiscal stimulus efforts of governments has arguably inflated many asset prices and created an Australian residential housing bubble.
How these factors will affect future asset class returns is hard to predict, heightening the need for diversification.
Diversification remains a key portfolio strategy to protect against risk but unfortunately is one that many investors continue to ignore. When one asset class may go down, another should go up, smoothing out returns.
We know from the Bell Direct client base that the average self-directed portfolio has less than eight investments. Of these, close to six are in the ASX 200 and the remaining two are ETFs. Compare this to advised portfolios, where there are closer to 12 investments in a portfolio, closer to three ETFs and a higher concentration in the ASX 200.
Neither of these groups represent an adequate amount of diversification, in our view.
What combination of assets are most likely to deliver the 5 to 7 per cent a year that our hypothetical investor needs over the next two decades with the least amount of risk?
A well-rounded portfolio is likely to have exposure to a range of quality assets such as shares, property, fixed income and cash – and more.
However, investors must also keep sight of the underlying drivers of risk behind each asset class, rather than simply adding multiple asset classes to their portfolio. Asset classes that share the same risk drivers (whether it be economic growth, valuation, inflation or liquidity) are likely to produce more highly correlated returns over time.
Choose the right vehicles
Our investor has now decided on their target return and an appropriately diversified portfolio of assets. They now face a dizzying array of potential vehicles to choose from.
Direct stocks are a favourite of many self-managed super funds; they provide potentially high returns but also represent a concentrated risk. Many investors know their direct share investments well but even blue-chip companies encounter operational issues that can hamper returns and dividends.
A more diversified exposure can be obtained through exchange-traded funds (ETFs), which are growing in popularity. They track a wide variety of indices offering broad exposure to Australian and global shares, as well as other asset classes such as fixed interest, property and cash.
ETFs remove the dangers (and benefits) of individual stock picking. Listed investment companies (LICs) offer an alternative: diversification and active management. However, they can trade at a significant discount to net tangible assets and regularly do. Many newer LICs also charge significant fees compared to ETFs.
A newer option for investors looking for outperformance can be found through the ASX mFund service, which allows investors to buy and sell managed funds in the same way they trade shares.
They also offer the lure of outperformance and expert management, but with higher investment fees and no guarantees. Selecting a good fund manager relies on an assessment of their reputation and process, which are difficult to gauge.
Nonetheless, asset allocation remains the key driver of risk and return rather than active management.
Whatever path an investor chooses, they must be comfortable that their asset allocation is always in alignment with their personal investment goals, which encompass both risk and return.
ASX online courses cover shares, interest-rate securities, warrants and instalments, exchange-traded funds, options and futures. The shares course has 11 modules, each taking 10 to 15 minutes to complete. Topics covered include: What is share; How to invest; Risk and benefits of shares; what to consider in an investment; and How to buy and sell shares. Simple summaries and quizzes in each module make learning fast, easy and enjoyable.