Why allocation is important
ASSET ALLOCATION EFFECTS YOUR WEALTH-BUILDING
Keeping up with and outperforming inflation should be your priority when investing.
With thousands of shares, bonds and unit trust funds to choose from, picking the right investments can be confusing. But if you don’t do it correctly, you can find yourself eroding your wealth and retirement nest egg.
Beating inflation
Inflation impacts you in the build-up stages and, more particularly, in retirement. You need to start saving early, but also be sure you’re accumulating retirement wealth at a rate greater than inflation. If your investment returns (after costs and tax) don’t outperform inflation, you can save yourself poor. Make keeping up with and outperforming inflation (known as the real return of an investment) your investment priority.
Asset allocation
Some financial experts believe determining your asset allocation is the most important decision you’ll make regarding your investments – even more important than the individual investments you buy.
Investments are usually divided into five asset classes: cash, bonds, equities, property and exotics (e.g. collectibles like art). The characteristics of the first four asset classes make them suitable for different investment objectives:
Cash (including money markets and fixed deposits) is considered a short-term investment with low risk. But, these investments offer very low or negative real returns. While your account balance might be increasing, you’re losing money in real terms.
Bonds (long-term debt instruments) are considered medium- to long-term investments, carrying a relatively high degree of risk. A safer form of bonds may be something like RSA retail bonds.
Property (residential and listed property funds) is considered a long-term investment with its own unique risk. Investors face several options with property funds and it’s important to understand their differences i.e. property unit trusts and real estate investment trusts.
Equities (shares in companies) are generally considered long-term investments with a degree of high risk over shorter periods. Equity-based investments are the most volatile asset class: investment values rise and fall according to prevailing market conditions. Historical analysis, however, shows returns on equity investments have been superior over the long term.
Asset allocation’s important because it has a major impact on whether you’ll meet your financial goals. Without enough risk in your portfolio, your investments may not earn a large enough return to meet your goals. Include too much risk, and the money for your goal may not be there when you need it. A portfolio heavily weighted in equity, for instance, would be inappropriate for a short-term goal, (eg a holiday), while investing only in cash over a long time will leave you poor at retirement.
Let’s consider two portfolios: a money-market fund and a multi-asset high equity portfolio. Money markets might outperform equity over short periods, but equity will be the superior performer over longer terms (seven years plus).
An upfront R1 million investment in a money-market portfolio (100% cash exposure; 1% estimated total expected return) leaves you with about R1.16 million in 15 years. In contrast, a multiasset portfolio (75% equity, 10% property, 10% bonds, 5% cash, with 5.95% total expected return) will be worth an estimated R2.38 million.
If your investment returns (after costs and tax) don’t outperform inflation, you can save yourself poor.
This article was first published on Ascor’s blog