Nothing affects your long-term returns more than structuring your portfolio with the right mix of assets.1
So what steps should you take?
The first step is to determine how your money will be invested across different asset classes like shares, property or bonds. Asset values and markets move up and down constantly, so you also need to think about the amount of risk you're prepared to take on and what your overall investment objectives are.
How your portfolio should be structured therefore comes down to a combination of these three things:
- Risk profile – are you comfortable with taking risk or do you prefer to play it safe?
- Your investment timeframe – when do you need the money for other purposes (like buying a car or a house, or taking a holiday)?
- Rebalancing – reviewing your investment allocation to make sure it’s still doing what you want, and adjusting as needed.
Structure your portfolio in line with how you feel about risk
Many people think they need to choose between risky investment options, such as shares and more stable investments like cash or bonds, when constructing their portfolio.
But the truth is, when making decisions about the different types of assets to include in your portfolio, you should first consider the amount of risk you are willing to take.
When you’re thinking about risk, consider it in terms of volatility – the severity of the highs and lows you’re likely to experience. If you don’t think you’ve got the stomach to endure major gains but also significant losses, then consider including more diversification in your portfolio. When done properly, this can help to build some shock absorbers that can take the heat.
Diversify your portfolio
When building your investment portfolio, it’s important to think about choosing asset classes which are not correlated with each other.
This means you want your portfolio to have assets which move in different directions and at different times. It’s these differences that provide stability in your portfolio.2
If one of your asset classes performs poorly and your assets are not correlated, then your other asset classes may be performing well - helping to offset the losses of the poor performers.
For example, shares and property are what is referred to as ‘growth’ assets but their market values tend to move differently. When these assets are combined, the overall volatility is typically reduced. You could also include some ‘defensive’ assets in your portfolio such as bonds and cash to even out the volatility further.
Downside of diversification
While diversifying your portfolio can help to reduce risk and volatility across a group of investments, it can also limit your returns. This is because your portfolio is more likely to mimic the market average. Not only that, it can be time-consuming given you’ll have more investments to manage.
Your portfolio investment timeframe
When considering your timeframe, it’s really about maximising the chance that your money will be there when you need it.
Generally, if you’re investing money that you don’t need for a long time, then you might consider investing in riskier options such as stocks. If however, you’re looking to take your money out in 6 months, you may be better off choosing safe asset classes like cash.3
Let’s break this down in more detail.
If you’re approaching retirement for example, you’ll be wanting to start accessing money from your portfolio in a few years. However, most of your investments won’t be needed until after you’ve retired which could be years away. Taking a highly conservative approach with your investments, may not deliver the best outcomes as your investment time horizon is likely long enough to withstand the volatility of higher risk assets.4
Reviewing your portfolio
Markets never stay the same so you should regularly review your investment portfolio to check whether changes may be required.
To validate that it continues to provide the level of return you’re after and at the level of risk you’re comfortable with, it’s important to regularly review your asset allocation and change it accordingly – this is known as rebalancing. Avoid doing this too often though - around once a year is typically ideal.
1. Professional Planner: https://www.professionalplanner.com.au/2016/02/the-right-mix-of-asset-classes-drives-optimum-portfolio-performance/
2. ASIC’s Money Smart: https://www.moneysmart.gov.au/investing/invest-smarter/risk-and-return/diversification
3. ASIC’s Money Smart: https://www.moneysmart.gov.au/investing/invest-smarter/goals-and-risk-tolerance
4. Investopedia: https://www.investopedia.com/articles/investing/110813/using-time-horizons-investing.asp
The article was prepared by Bryan Ashenden, Head of Financial Literacy and Advocacy at BT Financial Advice and is current as at 26 February 2019.
BT Financial Advice advisers are representatives of Westpac Banking Corporation ABN 33 007 457 141 AFSL & Australian Credit Licence 233714 (Westpac). BT Financial Advice is a Division of Westpac.
This information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to these factors before acting on it. This information provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. This information may contain material provided by third parties derived from sources believed to be accurate at its issue date. While such material is published with necessary permission, no company in the Westpac Group accepts any responsibility for the accuracy or completeness of, or endorses any such material. Except where contrary to law, we intend by this notice to exclude liability for this material. Any tax considerations outlined in this publication are general statements, based on an interpretation of the current tax law, and do not constitute tax advice. The tax implications of super investments can impact individual situations differently and you should seek specific tax advice from a registered tax agent or registered tax (financial) adviser.