Investing for protection
As your assets grow, decisions about whether to buy, sell or hold become more significant. The amounts are larger which makes decisions difficult. Minimising taxes becomes more important and ultimately there is the question of how to preserve wealth for the next generation. If you are at the stage where a modest portfolio has become much more than that, now might be the time to think about strategies for preserving wealth. Some of what follows is common sense, some requires a different approach to investment and some the use of new products.
How relevant are defensive strategies?
This is a fair question given that the All Ordinaries Index has consistently risen over time with equites one of the best performing asset classes. If you would like to learn more read the Towers Perrin Study of 10-Year Investments 1993-2003. Chopping and changing between shares, property and fixed interest markets can be costly and a balanced portfolio is probably the best bet, however this doesn’t mean taking defensive action can be ignored.
Avoiding, or at least minimising the effects of any downturn in the share market, means selling out of the most vulnerable securities (cyclicals- building materials, media) when conditions deteriorate and buying defensive stocks (food, utilities) in their place. If you own shares via a managed fund or managed super, these decisions are made by the fund manager. Changing the composition of those funds is not your decision.
On the other hand, if you manage your own super or portfolio the first step to preserving value is to recognise that different stocks do well at different points in the economic cycle. Reducing exposure to those sectors / stocks that are likely to under-perform is the first step, buying into stocks that attract those funds is the next logical step. For investors that traditionally buy and hold this may mean a couple of extra trades a year, albeit very important ones.
Diversify both domestically and abroad
The time to practice disciplined investing with a diversified portfolio is before diversification becomes a necessity. By the time an average investor "reacts" or your brokering firm issues a sell recommendation, it’s often too late. A truly diversified portfolio should include different securities - shares, interest rate securities and derivatives, both domestic and overseas. The chances of a downturn in different parts of the world and to the same extent are lot less likely than investing exclusively in one’s home market. Just ask a Japanese investor about the performance of their market over the last decade and the risks become apparent. Diversification of assets may not prevent losses. 2001-2 were particularly bad years for equities markets globally, however in general, a well-diversified portfolio combined with an investment horizon of three to five years can weather most storms.
Don't put all of your investments in one stock or one sector. Build a portfolio of companies you know, trust, and perhaps even use. People will argue that investing in what you know will leave the average investor too heavily retail-oriented, but knowing a company or using its goods and services can be a profitable way to build and maintain a portfolio. Investment clubs often use this approach with great results and joining an investment club is a fun way to regularly build and maintain portfolio – there is probably one in your neighbourhood. Consider adding Listed Managed Investments to the mix. LMIs can provide you with exposure to sectors such as private equity, wine, mining and property trusts through investments in LICs and ETFs. LMIs allow you to diversify into sectors outside your area of expertise in a low cost and simple manner. Adding Interest Rate Securities further protects your portfolio against market volatility and uncertainty.
Add to your investments on a regular basis and monitor
Investing in one hit is fraught with danger. If you’re unlucky you end up buying stocks and securities when the market is high only to suffer the consequences for years to come. If you have $50k - $100k to invest, dollar-cost-averaging is used to smooth out the peaks and troughs. As with any portfolio of shares, property etc, investing at regular intervals is not a substitute for monitoring and buying and selling as appropriate. Companies fortunes wax and wane, business conditions change and your commitment and those of your immediate family, if they can be encouraged, is important at every stage of the cycle - not just in bull markets. In this way the fruits of many years of disciplined investing are preserved.
© All rights reserved 2005. This material is educational and it is not intended to constitute financial advice.
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