How to give yourself a financial health check

Photo of Tony Kaye, Eureka Report By Tony Kaye, Eureka Report

min read

Former ‘right’ strategies may not be working as well now.

A high percentage of Australian self-managed investors are dicing with danger, simply because they are putting their portfolios on cruise control rather than actively managing them.

Without a proper investment strategy and by using traditional do-it-yourself approaches, many investors are overweight in some asset classes and underweight in others. They are missing out on opportunities to minimise risk and achieve higher investment returns over time.

Below are the consequences of poor portfolio management and some of the steps and strategies to take more control and improve your overall investment portfolio and wealth creation.

Lack of diversification

Probably the biggest single danger for investors with a set-and-forget portfolio mentality is the risk of overexposure to a specific asset class.

Alarmingly, a high percentage of Australians managing their own wealth would not pass a financial health test.

Research just completed by InvestSMART, covering almost 25,000 investment portfolios and around $15 billion in assets, shows the majority of Australian investors are heavily exposed to domestic equities and residential property, but are underweight in international equities and fixed interest.

This trend is most evident at the lower end of the investment spectrum, covering investment holdings of up to $50,000, where investors on average have around 55 per cent of their capital tied to direct shareholdings in Australian companies. A further 37 per cent is held in managed funds and the remainder mostly tied to cash in the form of term deposits.

Those with larger portfolios, ranging from $250,000 to $10 million, have close to 40 per cent of their assets tied to domestic stocks and about 35 per cent in direct property.

A 2000 study by Yale School of Management’s Emeritus Professor Roger Ibbotson, Does Asset Allocation Policy Explain 40, 90, or 100 Percent of Performance?, concluded that “asset allocation explained virtually 100 per cent of the level of fund returns”.

Ibboston examined the 10-year return of 94 US balanced mutual funds compared with the corresponding indexed returns and, after adjusting for the cost of running index funds, found that their actual returns failed to beat index returns.

Having a high exposure to a particular asset class is fine, as long as it matches your investment goals and time horizon.

Keeping pace with changing conditions

Investment markets are ever-changing and, at any particular time, certain assets will achieve strong returns while others will languish. What may have been a “right” strategy before, could be wrong now.

For example, not all that long ago a global boom in commodity prices fed by strong demand meant Australia’s resources sector was the place to be for capital growth. Similarly, investors seeking high yields flocked to the banking sector, in the process pushing up bank stocks to record levels.

Yet volatile global economic and financial conditions have seen both those sectors, and many stocks within them, lose substantial ground.

By contrast, because of other circumstances and events, demand for technology and healthcare stocks has brought about some spectacular returns. In Australia, returns also have been particularly good from Australian Real Estate Investment Trusts (AREITs), linked to the strong real returns being generated from the residential and commercial property sectors.

But even investors who make the correct choice when they buy into the growth sectors of the day need to be attuned to changing market conditions and their portfolio structure, and be ready to take decisive action to reduce, or exit, their exposures to underperforming assets.

Setting investment goals

Fundamentally, every individual’s investment goal is different, but a lot of the decision-making process is governed by time and risk profile.

A shorter time horizon generally warrants a more conservative approach; a lower exposure to Australian equities and a higher allocation to fixed interest. A longer time of 10 years or more will warrant higher exposures to both Australian and international shares.

Taking a financial health test

Just as you should get a physical health check from time to time, the best way to get a financial reality check is to test your investment holdings and allocations.

Entering all your assets (and liabilities) including shares, super, managed funds, property and cash will present a clear picture of your overall financial health and net worth.

Doing so will quickly reveal whether you are too heavily weighted to certain shares or sectors, or asset classes, and underweight in others, based on the type of investor you are and your investment time horizon.

The illustration below is an example of InvestSMART’s portfolio health check based on an individual’s investments compared against an ideal asset allocation based on their investment goal (in this case, the individual has chosen a high-growth strategy over 10 years-plus).

Financial health check

Getting the correct asset allocation is very important for ensuring you get the best return for the risks you are taking.

Improving your portfolio

For investors with a lower-than-recommended Allocation Exposure Score, the most prudent course of action is to rebalance your asset allocation to improve diversification, reduce risk and improve returns.

A good way of doing this is to simulate changes to your current investments and/or add new investments to see how they could affect your overall portfolio’s diversification.

But before leaping into any investments, it is vital to undertake comprehensive research. This is an area where many investors fall short and often either overpay or fail to take into account the underlying dynamics of either the broader market, a sector and, when buying shares, those factors impacting a specific company.

Reactive and active go hand in hand

Various tax benefits in Australia provide reasons to hold direct shares and other investments. However, diversification across asset classes is important in minimising risk and potentially improving returns.

The key to successful portfolio management is having, and sticking to, defined investment objectives. Emotion should never come into play but when circumstances dictate, active investors should be ready and prepared to respond.

That could mean selling out of a company that has become overvalued and using the proceeds to reinvest into another stock or asset where there is better return potential. Conversely, it could mean selling a stock that has fallen, to minimise losses.

It is all about being in control, using the vast array of information available to build and maintain a well-balanced portfolio of assets, and to maximise investment returns over the longer term.

The right tools for the job

To manage a portfolio well, having access to the right tools is critical. Fortunately, in terms of equities, fixed interest and even property investments, the level of online information available to investors these days is extensive and readily accessible.

On listed companies, for example, you can readily access stock recommendations, a company’s expected price range, and all written analysis. Creating company alerts allows individuals to monitor ASX announcements on specific companies, and build watch lists containing companies of potential investment interest.

In essence, investors have all the information they need at their fingertips and can access it from anywhere at any time.

About the author

Tony Kaye is the editor at Eureka Report, owned by InvestSMART Group. This article contains general investment advice only (under AFSL 282288). To unlock stock research and buy recommendations, take out a 15-day free membership. Find out whether your investment portfolio needs attention. Take a free portfolio health check with InvestSMART’s Portfolio Manager.
Follow: @InvestSMART_AU

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