Investment Research Group
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Here are some pointers:
Decide you need a proper portfolio. When you are young with your working life stretching before you, you can take risks with your money.
There is time to sit through the inevitable volatility of riskier assets, such as shares, while benefiting from high capital returns.
But later in life the need to preserve capital, which can generate income during retirement, becomes a bigger priority.
The principle of spreading risk has long been known. But it was only in the 1950s that investors really began to understand the principles of risk and return, following some startling conclusions in a university paper by Harry Markowitz, which later earned him a Nobel prize.
Markowitz found that two very risky investments could be added to a portfolio and the outcome could be to lower the risk of the entire portfolio, while increasing returns. This apparent contradiction occurs when two investments move in opposite direction under the same conditions.
This is the reason for putting gold, resources, industrials, bonds and property in the same portfolio, because they don't react the same to all conditions. Shares, for example, hate sharply rising inflation, but gold loves it. Gold in itself could be called a risky investment but when combined with other shares it can lower the portfolio risk.
Decide what assets to put in your portfolio. The mix of assets between the five main asset classes; cash, fixed interest, property, commodities and shares, should get the most attention in your portfolio. Based on studies, many now conclude that over 90% of your returns can come from how assets are allocated to a portfolio, with less than 10% attributed to any combination of market timing, security selection and luck.
If you are the type of person who likes to "go it alone", the one time you are going to have to swallow your pride and get advice is at this asset allocation stage. You need quality research, good personal profiling and someone with experience to put it all together, and be prepared to pay a fee for that initial advice.
Be realistic about returns. Research from the world's biggest and most sophisticated investment markets, in the US, provides a benchmark. Since 1926, the returns (after inflation) has averaged at: Shares 8% per year, Bonds 3% per year and Cash just 0.8%. These are pre-tax returns, indicating that on average real cash returns are negative, and so cannot be an option in a long-term portfolio. Portfolios, it should be understood, are not a strategy for getting rich quick. However, they are the most effective and reliable way of compounding wealth to create a meaningful nest egg in retirement.
Any long term return above the market averages must inevitably involve taking a higher risk. And there are many in the investment industry prepared to take that higher risk on your behalf, for the promise of a better return.
There is nothing wrong with taking higher risks if you are young, have a personality that fits risk taking and the risk is mitigated within the framework of your portfolio.
So you can have some high growth punts among your shares to try and increase returns, but they should not dominate your portfolio.
In the next column I will add the rest of the steps needed to get you to retirement.
