Roll into six financial planners' or stockbrokers' offices and you will probably get six different views of how your retirement savings portfolio should be allocated between bonds, property and shares - and this is before you get down to which actual products to buy.
Even putting aside the standard biases
induced by fashion, commission and tax, to name a few, there is a wide variety of views as to what constitutes a balanced portfolio for mum and dad who sold the farm.
Checking out what the professionals do might be useful but whether one should copy them or do the opposite is open to debate: For the past 10 years or so, fund managers have embraced the "buy overseas shares, sell NZ" mantra espoused by various consultants, irrespective of the relative pricing of each.
Buying expensive US stocks with the sale proceeds of cheap local shares has not been a great trade, it must be said. As at June 2005, the average pension fund had more than $2 in overseas sharemarkets for every $1 invested locally. In the past five years, the NZ stockmarket has returned 15.8 per cent pa versus -10.5 per cent pa for global equities.
Don't smirk though, if you are in a super scheme you're paying for that advice. For what it's worth, the average NZ pension fund, according to investment consultants Aon's June 2005 update, has 40 per cent of their clients' savings in bonds/cash, 16 per cent in NZ shares and 37 per cent in overseas shares with the balance of 7 per cent in property and alternative assets.
But even the expert opinion is divided - at one end of the spectrum the conservative folk at BNZ Fund Management in June had 54 per cent of their client portfolios in bonds while at the other end the giant NZ Superfund is betting on more good times with 64 per cent in shares, most of which were offshore. So which way should mum and dad jump - equities or bonds, hope or despair?
Often the best way to approach the problem of asset allocation is to work backwards from the income you need. If you are 60 and have $50,000 to invest, you will most likely be interested in maximising income so hedge funds and international shares are probably out. But if you aren't constrained by income requirements, you can be a bit more creative.
Earlier this year, the Financial Times business editor suggested a simple yet sensible alternative method driven by prospective returns rather than present practice.
What he suggested was that instead of looking over the fence at what everyone else is doing and copying their mistakes, why not embrace the popular strategy of absolute return investing like the hedge funds do except using the conventional asset classes and without the fee structure of the hedge funds.
In other words, invest your money according to the prospective return of each asset class - more money in assets offering higher returns and less in those that look overpriced. Sounds a bit like common sense, what's more it's easy to do.
For simplicity, might we limit ourselves to the four major asset classes: bonds, property, NZ shares and overseas shares. We know the return on bonds, it will be about equal to the medium-term Government bond yield - 2009 bonds are yielding 5.9 per cent.
Economics tells us that the future return on property and shares is equal to the dividend yield plus the growth rate of dividends. Each stockmarket's dividend yield is pretty easy to find as it is the average dividend yield of all the stocks on the market.
Telecom yields about 9 per cent or so, Contact 6.5 per cent or so and the average dividend of the NZ stockmarket is about 7 per cent. The local property sector's yield is around 7.5 per cent.
US research showed that the average growth in profits per share of the US stockmarket over about 100 years was roughly equal to inflation plus 1 per cent.
If inflation is 2.5 per cent then adding 1 per cent to that plus a dividend of 7 per cent gives a total prospective return for NZ shares of 10.5 per cent.
Do the same thing for international shares with a dividend of 2.5 per cent and you get a prospective return of 6 per cent. We can perhaps be a bit more conservative with property and assume that rents grow at the same rate as inflation.
As you can see in the table below, bonds, property and shares total 32.5 per cent so we should structure our portfolios in the ratio of 6 per cent, 10 per cent, 10.5 per cent and 6 per cent. In other words 18.5 per cent in bonds, 31 per cent in property, 32 per cent in NZ shares and 18.5 per cent in international shares.
The resulting split is very different to that of the average pension fund - less in bonds, much less in international shares and a lot more in property and NZ shares. On balance, the portfolio will be quite a bit riskier than that of the average pension fund.
Note that this strategy has no regard to either the risk profile of the individual or their income needs which a cynical reader might observe is no different from normal practice.
So does the DIY absolute return strategy work? In the three years ended June 2005, the average pension fund returned, according to Aon, 9.7 per cent pa before fees and tax with the best manager returning 12 per cent and the worst 7.4 per cent. The absolute return strategy would, on the same basis, have delivered a total return of about 12.3 per cent pa.
The DIY strategy would be a lot cheaper to implement if one used direct bond investments and index funds so after fees could be further ahead.
Prospective returns:
(Portfolio / Percentage)
Bonds 6%
Property 10%
NZ shares 10.5%
Int shares 6%
Total 32.5%
Roll into six financial planners' or stockbrokers' offices and you will probably get six different views of how your retirement savings portfolio should be allocated between bonds, property and shares - and this is before you get down to which actual products to buy.
Even putting aside the standard biases
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