Investment Allocations – Part One

A woman that I know, is confused – and frightened – by her lack of knowledge regarding her investment portfolio.

Firstly, let me say that she is a single lady, getting up there in age, is employed but not making huge money, recently sold her family home, is now renting, but seeks a new house to buy. I do not know the value of her investment portfolio, but I do know it is large enough to require some serious investment decisions.

Currently her funds sit in a savings account (or something similar) with a very low interest rate.

“I need more income for everyday purposes, but I can’t afford to lose value”. Nothing unusual about that at all. Income is critical to survive, while value cannot be replaced through earnings when one is of age. Dilemma.

The decision she has to make is whether Portfolio Income is more important than Portfolio Value.

Preamble re Returns :

The percentage returns below are examples, and used solely to illustrate the arithmetic differences between annual income return and annual value return. They may not be actually achievable in the market at acceptable levels of risk. Always discuss with your financial advisor.

So, for argument’s sake let’s say she has $100,000 in her fund. If she targets Income return at 5%, then she would have annual income of $5,000 with no diminution in the $100,000 hopefully. She could do this through a Bond portfolio or Preference Shares portfolio. The risk should be palatable, although must be fully understood.

On the other hand, if she targets a fund value of $110,000 by the end of the year, and uses an Ordinary Shares portfolio, she would be targeting a 10% increase in Value, with little, if any dividend Income. Not completely impossible, but again the risk awareness is paramount.

Thus her dilemma, in these examples, is $5,000 income for the year, with no value increase …. or $10,000 value increase for the year, with little, if any, income.

Can she survive…?

Well, before she gets into the investment decision-making process she must create her annual budget. What expenditures does she project ..?

This is a little bit trickier than it first seems. It is the ability to have enough cash inflows each year, to cover all cash outflows. This is the financial survival test.

As we get older, we typically have “gathered” all the big things we need for the rest of our life. House, car, appliances, etc. So, if we feel that those capital items are in place – and (importantly), will last for the rest of our lives – then we don’t have to factor in replacement costs down the line.

If that issue is adequately covered, then we can more easily calculate our everyday expenses – food, utilities, transport, etc….. and, more importantly, decide if our expenditure levels are fairly stabilized for a reasonable period of time. That would be a tremendous benefit in the investment-making decision process.

Once the budget has been prepared, including a “wiggle factor”, then we’re ready to start the investment process.

No investment decisions can, or should, be made until the expense budget process has been thoroughly completed.

In Part 2, we will provide some thoughts on how to structure your investment portfolio.


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