When it comes to investing, most of your clients will understand that putting all of their investment eggs into a single basket of assets is risky business. That is why a diversified approach is essential in achieving an optimal balance of risk vs. exposure to wealth creation opportunities.
Advising your clients to get the balance right through risk-managed diversification makes sense, and is what asset allocation aims to achieve. Balanced funds accomplish this by investing in a wide spread of equities, property, bonds and cash with the primary aim of achieving capital growth.
The best mix of asset allocation will depend on your client's risk profile, coupled with their investment objectives and time horizon.
HOW ASSET ALLOCATION (BALANCED FUNDS) WORKS
Asset allocation funds use an optimal mix of the various asset classes, which often correlate differently, to reduce the amount of risk exposure to any one asset class, especially equities.
The fund manager is usually supported by a team of specialists in each of the various asset classes who analyse and track the individual securities in their area. He is then able to focus attention on the critically important asset allocation decision.
Numerous research studies conclude that choosing how much exposure to the various asset classes a fund has can contribute as much as 91% of an investor's return.
Asset allocation, done properly, is not guess-work. Fund managers make use of quantitative research, evaluate risk tolerance and take into account economic trends. Stability and consistency are twin imperatives.
TYPES OF ASSET ALLOCATION OR BALANCED FUNDS
There are three broad types:
- The most well known are the prudential funds which are designed to meet the specific requirements for investing in retirement funds. These funds are often colloquially called balanced funds and come in a range of risk profiles, to meet any of your clients' needs. Generally, the higher the level of potential exposure to the equity sector, the more risky the fund can be - but also consequently, the more likely to provide inflation-beating returns over time.
- Flexible funds on the other hand, allow the fund manager to have wide discretion in terms of the level of exposure to any one class - with no limits set by any outside regulation. These funds are ideal for clients who are comfortable leaving all decisions to an expert fund manager, and happy also to potentially take on more risk than balanced funds at times.
- There is varied and broad category of allocation funds called Targeted Absolute and Real Return funds. These portfolios tend to display below average short term volatility and are mandated to manage towards a predetermined, explicit benchmark or target, usually inflation.
WHAT IS A GOOD ASSET ALLOCATION FOR A REGULAR INVESTOR?
Choosing the best mix of assets can be done according to your client's risk appetite. Suggested allocations according to risk profile are as follows:
Conservative:
Cash 40-60%
Bonds 20-30%
Property 0-20%
Equities 5-20%
Moderately conservative:
Cash 20-40%
Bonds 20-30%
Property 0-20%
Equities 30-40%
Moderate:
Cash 15-25%
Bonds 20-30%
Property 0-20%
Equities 45-55%
Moderately aggressive:
Cash 5-15%
Bonds 10-20%
Property 0-20%
Equity 60-75%
Aggressive:
Cash 0-10%
Bonds 0-10%
Property 0-20%
Equity 75-95%
We believe equities form an essential component of any portfolio, and the risk can be mitigated by having a balance of asset classes.
IS THERE A GOOD TIME TO GET INTO THE MARKET AND STAY THERE?
It is important to advise your client not to try to time the market. Time in the market is the best advantage an investor has, so investing for the long haul makes sense. Over the past 60 years, one would never have lost any money in the local equity market had one stayed invested for any rolling four year period.
To minimise risk, invest in a diversified portfolio, and go slow and steady. Advise clients to invest smaller sums more regularly, rather than less frequent lump sums. This allows one to take advantage of 'cost averaging' which means one's fixed investment amount each month will buy more units during periods of weak markets, and when market prices rise again, these units should enhance the return of your client's portfolio.