Investment Allocations – Part Two

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In Part One, we established the difference between income goals and value goals. But before we looked at the investment allocations, we declared :-

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

In this Part Two, here are some thoughts on how to structure the investment portfolio.

The two anchor issues about portfolio structuring as we get older, are :-

  1. Risk appetite
  2. Income versus Value as mentioned above.

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.

Broadly speaking, the greater the risk factor, the greater the overall return on investment (“ROI”). Typically, a retirement fund should be geared more towards income provision than value appreciation. But, if you have other sources of income in retirement e.g. a part-time job, then it is possible that you’re appetite for risk is higher than the norm.

The old pie chart approach is still the best way to view the structure. For example, the typical chart for retirees is probably something like this :-  graph

Commentary on the chart :-

  1. This is      a medium-risk structure.
  2. Cash” will not produce much, if      any, income, but is useful for special needs. Risk Profile is “Lower Risk” Investment Category.
  3. Bonds” and “Preference Shares” have been grouped together, largely because      they are referred to as “fixed income” securities i.e. the income produced      is established at the issuance of the security, and apart from unexpected      problems with the issuer, will pay a fixed amount annually. Risk Profile is “Moderate Risk”      Investment Category.
  4. Ordinary Shares”, will (hopefully)      increase in value, but are always subject to price fluctuations, so      beware. Some ordinary shares are “pure value” i.e. they do not pay much,      if any, dividend, and are only held for value increase. Other ordinary      shares pay higher dividends, but 3-4% per annum would be classified as a “good      dividend payer”. Risk Profile is      “Higher Risk” Investment Category.
  5. Mutual Funds” are included because      they are managed by professional advisors instead of managing your shares      yourself. There are all types of mutual funds available, ranging from cash      to ordinary shares, so the underlying      securities are no different from the above three Investment Categories. It      is the management that      differentiates, and mutual funds are very popular because most people      don’t want to buy and sell securities themselves. Some mutual funds pay an      annual income, while some are structured to only fluctuate through their      price (up or down) i.e. are value-based investments. Risk Profile depends on the type of underlying securities in      the Fund.

Is this for me  … ?

Well. Of course, the answer is “yes, it could be”.

The decision factors, as mentioned above are Portfolio Income versus Portfolio Value, driven hugely by Risk Appetite..

So, if you feel you want more income, then you would increase the Bonds/Preference Shares percentage and/or seek higher dividend-paying Ordinary Shares.

If you want higher Value you would increase the percentage of Value-based Mutual Funds and/or seek value-driven Ordinary Shares.

This analysis does not take into account your personal tax situation, so please be careful of the impact of passive income (from investments) and value increase, for capital gains tax, and so forth. A professional advisor would be well worth thinking about.

So, to sum up :-

  1. Prepare a stabilized Budget for the next several years as best you can.
  2. Determine whether you want/need Portfolio Income or Portfolio Value.
  3. Adjust the Asset Mix (i.e. the above chart) percentages to accommodate your decisions and risk appetite (discuss with your financial advisor and review at least annually).
  4. Check your investments regularly (PLEASE).

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